Possible to get 20% CAGR from Indian stock markets?

First let us complete the question. The target is to achieve five year CAGR of 20%. We are not saying that each year one can generate 20% + returns. That is unlikely in stock market. The nature of stock market returns is lumpy. One year you could get -10% and another year 50%. The question is whether at the end of 5 years the fund will increase to 2.5 times the initial value which essentially means a 20% CAGR for 5 years. Is there a reasonable chance that this could happen? Our answer is yes, there is a reasonable chance that this could happen if the fund is invested for a period of 5 years. Here we present an operational strategy for the same.

Margin of Safety

These are three critical words in investing. An investor must demand a discount from intrinsic value of the shares before buying it. This is always important. At a time when a number of stocks are overpriced and for some companies’ expectations are sky high its importance cannot be overemphasized. There are almost 2800 companies which are daily traded in BSE and NSE. Though it is a challenging task one can find shares of companies which are available with margin of safety.

Growth, Cash Flow and Integrity

We are looking at companies which can sustain 15% + earnings growth without infusion of capital or equivalent EPS growth with infusion of capital. That essentially means we are looking for companies with high return on equity.

The quality of earnings is also important. Whether earnings are free cash flow or are required just to sustain current business is very important. Clearly as investor we are looking at the former category where company can deploy cash for further profitable expansion or return the same to investors if it has no use of the same.

Managerial integrity is another vital aspect for investors. We think honest management is needed if minority investors are to share profits. There have many cases in India where profits have not been used for benefits for investors but rather have been wasted in over ambitious projects. If managers of the company use cash flow for pursuing projects that cater to their ego rather than investors return those companies are best avoided. It is especially important for Indian companies because the top management typically consists of promoters who have too much control over the company. The top management promoter does not have oversight especially in terms of allocation or return of capital.

Portfolio

Our portfolio consists of 14–15 stocks. We do a bottom up investing. So, we are strictly looking for companies which can make profit for investors while being sector agnostic. The weighted historical PE ratio is around 16 for portfolio. These companies have a reasonable growth prospects which should exceed 15%. If the earnings growth expectation is fulfilled returns expectation will also be fulfilled.

Here sectors of our portfolio companies are revealed

Renewable Energy

Luxury Goods Retailer

Bank

Financial Institution

Feed Company

Luxury Goods Retailer

KPO

Chemicals

IT Company

Pharma

Auto Ancillary

Pharma

Processed Food

Real Estate