Can Growth destroy Value?

Is it a complicated question? Yes, it is. A very complicated question, and the answer is going to be complicated. It is perhaps a 5 minute read, but a 30 minute understanding kind of a reply, so read carefully!

The average RoE in India should be in the range of 15% – the rate at which you would have grown your capital had you invested in 1982 and held on to the sensex till today. So if a company earns less than that, you might as well ignore that company.

Take Gillette – it has a net margin of 21% and a RoE of 33%. Is there any doubt that it is a screaming value buy? But hey the PE is 92?. What do you do? do you buy? Well what if it grows at 20% p.a? is it a good buy? what if the growth is 30%p.a. does it become a good buy? Is it a value buy or do you buy because of its growth? So does it mean you want to buy Growth at any price? btw if you buy at Rs. 6500 are you expecting it to become Rs. 13000 in 2023? anything else will you be better off in a 10.5% debenture with 4 years maturity? and listed ….

What about Shanthi Gears? Its margin has fallen from 33% to 22% over the last 4 years. It has a RoE of 9%, RoA of 7.93% . Is it a growth share, a value share or a great share to go short on? It is a dull boring engineering company with not much excitement in the market.

Well in Gillette you could lost due to PE contraction, and in Shanthi Gears you could lose because it is earning less than 15% – the basic below which you are not keen on investing.

I am not suggesting any action, just kicking your a..e and wake you up.

For Growth to be good, the growth should be worthwhile. If the RoE is less than 15, the company is actually better off paying higher dividends or is it? Some more ingredients are required for growth –

Profitability and Reinvestment. These  ingredients are many a times missing in value stocks. Investors are told regularly that growth is sexy, and growth is far more important (look at all start ups). Management is under pressure – to tackle poor profitability (Shanthi) OR a lack of suitable investment options will push them into growth which is actually destroying shareholder value. Shareholder might be better off asking SG to pay huge dividends and invest that money in Gillette. Oops just a comment, not suggesting this action.

For growth to happen Investment is required. If RoA is 8% and Roce is 11% what will you tell the board? As a CEO you have Rs. X crores to invest. I am sitting on the board (which I don’t). So I tell him…he could do the following:

• Acquire a new business
• Invest in the existing business
• Pay dividend
• Buy back shares
• Wait for opportunities – and keep in Liquid funds

What do you think should be the parameters that the Ceo should use? How do you think actual allocation happens?

Well as a VI you should SELL OFF BAD management – those who allocate capital on hunch…will be wiped out I guess.

Obviously a rigorous exercise should be carried out and only if the RoA, and RoE are attractive the money should be invested. If your shareholders can get a better return investing in the Index! or a bank fixed deposit. Or if you are going to give less than 15% cagr.

When a company earns less than 15% cagr is it a good value buy?

If yes, when will you sell the share?

Oops Investing is not easy..