good and clean companis

8/12/2019 Good and Clean Companis

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Ambit CapitalPvt. Ltd.

Summary: No PE re-rating for India; enter Good & Clean 7.0

P/E matters more than EPS over shorter timeframes

Whilst over long time periods (say, over a decade or more), Sensex returns mirror earnings

growth, over shorter timeframes (like on YoY basis), P/E is a bigger driver of index returnsthan earnings growth.

What has driven the Sensexs P/E?

Short-term rates, the slope of the yield curve, US bond yields and Gross Fixed CapitalFormation (GFCF) growth seem to affect the Sensexs P/E. GDP growth and earningsgrowth on the other hand do not seem to materially impact P/E.

Whilst most of these factors seem to be at inflection points currently, they have not as yetstaged a meaningful turnaround (barring US bond yields).

What has driven the Sensexs EPS?

Monetary easing, rising US bond yields, higher GFCF growth and higher GDP growthseem to affect the Sensexs EPS favourably. On the other hand, high levels of inflationseem to impact it negatively.

Given that our Economy team expects a muted recovery in FY15 with persistent inflationand hawkish monetary policy, we expect our current bottom-up Sensex EPS estimate of1,530 to be downgraded.

Pg 2


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Summary (contd)

Our prognosis for the Sensex in the year ahead

We see no major P/E rerating for the Sensex but earnings growth should lift the index to

24,000 (16% upside from current levels) by March 2015.

Portfolio strategy

We retain our quality at a reasonable price (QARP) approach to portfolio construction asthe reversion in the following polarisations would continue: (1) defensives to cyclicals, (2)large caps to small-caps and mid-caps, and (3) growth stocks to value stocks.

This QARP approach was incorporated in the Good & Clean portfolio 6.1 portfolio that welaunched on 23 September 2013. This portfolio has generated an alpha of 280bps sinceinception. On a cumulative basis, our Good & Clean portfolios have outperformed theBSE500 by 17 percentage points since inception 11 quarters ago.

We now update our 23 September 2013 Good & Clean portfolio to incorporate the latestvaluations and FY13 consolidated accounts (which drive the latest iteration of our

greatness model). This new portfolio - G&C 7.0 is shown on page 31 of this note.

Pg 3


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Contents

P/E matters more than EPSover shorter timeframes page 5

What drives P/E? page 9What drives EPS? page 14

One-year prognosis for Sensex page 19

Portfolio strategy page 22

Pg 4


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Sensex returns are mean reverting

Globally, equities are known to mean revert. Thus, prolonged periods of superior equityreturns are followed by periods of mediocre returns and vice versa.

The exhibit below emphasises this dynamic in the context of Sensex returns - a rolling

five-year return plot for the Sensex suggests that Sensex returns mean revert over longperiods.

Since over the past six months we have just started rising from the zero line, there seemsto be a reasonably high likelihood that the recent period of sub-par returns could befollowed by a period of superior returns. But what drives Sensex returns?

Pg 5

Rolling five-year Sensex return CAGR

Source: Bloom berg, Amb it Capital research


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Whilst Sensex returns mirror EPS growth over longerperiods

Pg 6

but on a YoY basis there is no correlation between Sensexreturns and EPS growth

Over long periods Sensex returns mirror EPS growth

Sou rce: Ace Equ ity, Ambi t Capi tal re search ; N ote: Both Sensex and Sensex EPS

values have been rebased to 100 at the beginn ing of 19 91

Over any time frame Sensex returns has two parts to it: change in P/E and EPS growth

i.e., P = P/E + EPS (approximately, without considering the interaction term)

Since 1991 both Sensex returns and EPS CAGR have been nearly same at roughly 14% but an R-square of close to zero suggests there is no correlation between the two on a

YoY basis.

Sour ce: Ace Equi ty, Ambi t Capital research


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P/E is a more important driver over shorter timeframes

The annual change in P/E has a much tighterrelation with YoY Sensex returns suggesting P/Eis a bigger driver of Sensex returns over shortertimeframes (see chart on the right).

Whilst P/E is a bigger factor in driving Sensexreturns, it is also the more volatile factor (seetable on the right).

That said, over time P/E seems to have becomeless volatile for the Sensex (see chart and tablebelow).

Dividing the last 20 three years into two equalphases suggests that the volatility in P/E hascome down by over half in the second phasevis--vis the first phase.

Pg 7

Over shorter timeframes P/E seems to be a bigger driver ofSensex returns

but volatility in P/E is much larger than in EPS growth

Volatility in P/E has come down in the second phase vs first

Source: Ace Equi ty, Ambit Capi tal Research; N ote: * An nua l percentage

chan ge in Sensex P/E and Sensex EPS over Dec 19 91 to Dec 201 3

Measure Standard deviation of annual percentage change*

P/E 0.34

EPS 0.19

Phase Period Max P/E Min P/E

(Max-Min)/average

for the period

Phase 1 Jan-91 to Nov-02 57.4 9.8 2.1

Phase 2 Nov-02 to Dec-13 28.6 10.4 1.0

Volatility in the Sensex P/E has come down over time

Source: Ace Equi ty, Ambi t Capital research

Source: Ace Equi ty, Ambi t Capital researchSour ce: Ace Equi ty, Ambi t Capital research


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Contents

P/E matters more than EPS over shorter timeframes page 5

Whatdrives P/E? page 9What drives EPS? page 14



Pg 8


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Drivers of P/E: The theory

Pg 9

A simple valuation tool like the Gordon growth model (GGM) measures intrinsic value as thepresent value of expected dividends discounted at the required return on equity. The formulacan be readily modified to give a formula for P/E:

Po/Eo=[(Do/Eo*(1+g))/(ke-g)];where, ke = cost of equity = Rf + ERP

P/E should thus be posi ti vel y l in ked to g row th and negati vel y li nked to i nte rest r ates and theequi ty r isk premium (ERP). In the subsequent slides in this section we use actual historicaldata to gain insights into the practical drivers of Sensex P/E and consequently what theyimply for the Sensex P/E going forward

Interest rates:We use one-year government bond yields as a proxy for interest rates. (Foryears prior to 2001, due to lack of data on one-year government bond yields, we use SBIsone-year deposit rate.)

Growth:Whilst g in the formula shown above is the growth rates in dividends, we use boththe real GDP growth rate and the trailing earnings growth rate as proxies for expectationson g; further, to measure the expectation of economic growth, we use the slope of the yieldcurve as a proxy as well.

ERP:The ERP may be affected by several non-quantifiable factors like political stability. Wehowever explore US bond yields as one factor here, as we surmise that rising US bond yieldsshould indicate an improving global economy and increased risk appetite, leading to inflowsinto EMs like India. This should result in easier equity availability, thereby reducing their ERP.


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Source: Bloomber g, Ace Equi ty, Ambi t Capital Research; N ote: 1 -year

G-Sec yield h as been u sed to rep resent in terest rates starting 2 001

and SBI 1-year d eposit rate has been used prior to 20 01

What has driven Sensex P/E historically?

Pg 10

Rising US bond yields usually lead to a P/E reratingMonetary easing seems to be a prerequisite for P/E rerating

Source: Bloomber g, Ace Equi ty, Ambit Capi tal Research; N ote:

Yield differential between 10-year b onds and 1-year b onds; the

red arrow denotes current level of the explanatory variable

A steepening yield curve is positive for a P/E rerating too No strong link between P/E and trailing 12-mth earnings growth

Source: Bloomberg, Ace Equi ty, Ambit Cap ital Research; N ote: US yields

used here have been detrended f or the structural d ecline of the last two

decades- please see slide 34 for the ra w series

Sou rce: Ace Equ ity, Amb it Capi tal Research


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Sou rce: CEIC, Ace Equ ity, Ambi t Capi tal Research; N ote: GFCF

growth ba sed on 1999-2 000 prices till March 2006; the red

arrow denotes current level of the explana tory variable

What has driven Sensex P/E historically? (cont.)

Pg 11

P/E shows little link with real GDP growth

P/E does not seem linked with trailing 3-year avg GDP growth The link, however, is much stronger with YoY GFCF growth

Source: Bloomberg, Ace Equi ty, Ambi t Capital Research; N ote: 3 -year

average GDP growth is average GDP growth o ver trailing 1 2 qua rters

No strong link between P/E and previous 3-year EPS CAGR

Sou rce: Ace Equ ity, Amb it Capi tal Research

Source: Bloomberg, Ace Equi ty, Ambi t Capital Research; N ote: We

have plotted YoY grow th in real GDP on a qua rterly basis since 98. In

the periods prior to that, we h ave used the same annua l GDP growth

for all fo ur qua rters of that fiscal d ue to data limitations.


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In conclusion

Pg 12

What affects P/E?Short-term rates, the slope of the yield curve, US bond yields and GFCFgrowth seem to affect Sensex P/E. GDP growth and trailing earnings

growth on the other hand do not seem to materially impact P/E.

What do these variables suggest for PE going forwardWhilst most of these indicators (i.e. the yield curve slope, GFCF growth)are at inflection points currently, they have not staged a materialturnaround yet (barring US yields).

Given that our Economy team expects a muted recovery in FY15 withpersistent inflation and hawkish monetary policy, we do not see arerating for Sensex P/E in the year ahead (more on this on slide 19).

Factor Theoretical relationship Historical relationship

Monetary easing Positive Positive

Steepening yield curve Positive Positive

Rising US bond yield Positive Positive

GDP growth Positive None

Earnings growth Positive NoneGFCF growth Positive Positive


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Contents


What drives P/E? page 9

Whatdrives EPS? page 14



Pg 13


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Drivers of EPS: The theory

Pg 14

Corporate earnings are linked to corporate revenues which in turn should be linked to theoverall level of economic growth.

The part of economic growth most directly impacting corporates is capital formation.

Easy access to both debt and equity capital should in turn provide a fillip to capitalformation.

Whilst the cost of debt capital is directly linked to interest rates, equity capital availabilitycan be linked to US bond yields. As we have often highlighted in the past (cl ick here for theG&C 6.0 note da ted June 1 3, 20 13) , rising US bond yields are indicative of an improvingglobal economy and increasing investor risk appetite, leading to increased capital flowsinto EMs like India (Appendix 1 on page 34 reinforces this view).

Inflation, on the other hand, may eat into corporate profit margins and negatively impactEPS.

EPS growth should thus be positi vely li nked to GDP and GFCF g rowt h and ri sin g US bondyiel ds and negat ivel y li nked to in terest ra tes and inf la tion.In the subsequent slides in thissection we use actual historical data to gain insights into the practical drivers of Sensex EPS

and consequently what they imply going ahead.
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Source: Bloomberg, Ace Equi ty, Ambi t Capital Research; N ote:

We have used WPI infla tion Jun-05 onwards and du e to data

lim itation s we ha d to use CPI prior to tha t

What has driven Sensex EPS historically?

Pg 15

Periods of monetary easing lead to higher EPS growth

Source: Bloomberg , Ace Equi ty, Amb it Capi tal Research; N ote: 1 -year

G-Sec yield h as been used to represent interest rates starting 2 001 and

SBI 1-year deposit rate ha s been u sed prio r to 200 1

EPS growthseems to follow US yields with a lag

Low inflation rates indicate an improving economy butbeyond a point higher inflation leads to lower EPS growth

Source: Bloo mberg , Ace Equi ty, Ambit Cap ital Research; N ote: US

yields used here have been detrended f or the structural d ecline of

the last two decades- please see slide 34 for the ra w series


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Source: Bloomber g, Ace Equi ty, Ambi t Capital Research; N ote:

We have used WPI infla tion Jun-05 onwards and du e to data

limi tations we had to use CPI prio r to that

Source: Bloomberg , Ace Equi ty, Amb it Capi tal Research; N ote:

GFCF growth ba sed on 199 9-00 prices till March 2006 ; the

red arrow d enotes current level of the explana tory variable

What has driven Sensex EPS historically? (cont.)

Pg 16

The link between EPS growth and GFCF (capex) growth iseven tighter

Over longer timeframes Sensex EPS growth shows linkageto nominal GDP growth as well

Over longer timeframes there is a link between Sensex EPSgrowth and real GDP growth

Source: Bloomber g, Ace Equi ty, Ambi t Capital Research; N ote: We

have plo tted YoY growth in real GDP on a quarterly basis since 98. In

the periods prior to that, we have used the same annua l GDP growth

for all fo ur qu arters of that fiscal du e to data limitations.

I l i


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In conclusion

Pg 17

What affects EPS?

Monetary easing, rising US bond yields, higher GFCF growth and higher GDP growthseem to affect Sensex EPS favourably. On the other hand, high levels of inflation seem toimpact it negatively.

What do these variables suggest going forward?

Our Economy team estimates only a moderate recovery in GDP growth for FY15 whilstthe monetary policy is likely to remain hawkish as high inflation persists. Against theseheadwinds, rising US bond yields (and hence a likely global recovery) seem to be thekey supportive factor for the Sensexs EPS. (For our FY15 macro view, please cl ickhere.)

Our bottom-up estimate for FY15 EPS stands at 1,530 currently. Given the headwindshighlighted in the preceding point, we expect this estimate to be cut going forward(overestimation of EPS by the consensus has become a trend over the last few years -please see page 19 for details).

We expect a number closer to 1,400, implying 10% YoY growth vs the last ten-yearaverage of 14% (Dec03 - Dec13) and last five-year average of 8% (Dec08 - Dec13).

Factor Theoretical relationship Historical relationship

real GDP growth Positive Positivenom. GDP growth Positive Positive

GFCF growth Positive Positive

Monetary easing Positive Positive

Rising US bond yields Positive Positive, but weak
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Contents



What drives EPS? page 14

One-year prognosis for the Sensex page 19


Pg 18

D t t P/E ti f th S


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P/E rerating in the 2002-2008 bull phase came at thefag end despite consistently high earnings growth

Do not expect a P/E rerating for the Sensex

Pg 19

Analyst scepticism in the bull phase vs hope in thebear phase

We do not see a major rerating for the Sensex P/E (vs its last ten-yearaverage of 17x on a trailing basis).

Amongst the drivers of P/E noted earlier (short-term rates, yieldcurve, GFCF growth and US bond yields) whilst most are atinflection points currently, they have not staged a materialturnaround yet (barring US yields). Moreover, our Economy teamexpects that GDP growth should only modestly increase to 5.1-5.6%in FY15 with monetary policy remaining hawkish (rea d th e note here).

The popular notion seems to be that a P/E rerating comes at theinflection point and hence towards the beginning of a period ofimprovement. In the 2002-2008 bull phase, however, the P/Ererating happened towards the fag end of that run. This low P/E

perhaps reflected scepticism which is usually an importantingredient of bull markets. This scepticism also manifested itself inanalysts underestimation of one-year forward EPS growth in thatphase (i.e. CY06-07, full year consensus estimates are not availableprior to 2006). On the other hand, consensus has overestimatedEPS growth over the bear phase of the last few years.

A favourable political outcome (which the latest CSDS survey ispointing to click h ere fo r ou r 2 7 Ja n 20 14 no te on this su rvey ) is

the most likely wild card that can bring about a revival in animalspirits leading to a P/E rerating. But weighing this against the hostof factors highlighted earlier makes us wary of betting on a reratingon balance. We continue to see FY15 as an in-between year(between a challenging and a more promising phase) for India. Source: Bloom berg, Ambit Capita l Research; N ote: The exhib it

abo ve plots the percentage diff erence between actual EPS for the

year vs its estimate 12 mon ths ahea d based on CY end num bers.

Source: Bloomberg , Ace Equi ty, Ambit Cap ital Research

EPS growth to drive Sensex to 24 000
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EPS growth to drive Sensex to 24,000

Pg 20

EPS estimate

Our Sensex EPS estimate for FY14 stands at 1,270 (implying 7% YoY growth). Furthermore, ourbottom-up estimate for FY15 currently stands at 1,530.

We believe there is a downgrade risk to these numbers (as has been the case for the last few years- please see the exhibit on previous slide) especially with monetary policy remaining tight. Webelieve the FY15 Sensex outturn is likely to be close to 1,400 (implying 10% YoY growth). Thiscompares with the last ten-year EPS CAGR of over 14%(Dec03 - Dec13)and the last five-year EPSCAGR of over 8%(Dec08 - Dec13).

Sensex target

Applying a ten-year average of 17.0x trailing P/E leads us to a March 2015 Sensex target of

24,000.

C t t


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Contents



What drives EPS? page 14

One-year prognosis for the Sensex page 19


Pg 21

Three types of extreme market polarisations are normalising


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Three types of extreme market polarisations are normalising

Pg 22

Valuation premium of defensives to cyclicals is reverting from multi-yearhighs

Value has been out of favour for the last three years; value now seems tobe staging a comeback

Smallcaps and mid-caps reverting from excessivevaluation discounts to large caps

Source: Bloomberg, Ambit Capi tal Research

The economy seems to beginning its normalisation


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The economy seems to beginning its normalisation

Pg 23

Indias growth normalisation process to begin in FY15

Inflation is likely to remain elevated in India in FY15 thereby motivating continued repo rate increases until 1HFY15

FY15 is likely to be an in-between year for Indianmacros

GDP growth normalisation should begin as thecountry reverses the declining growth trend albeit

marginally

Inflation likely to remain elevated, motivating rateincreases in the first half before the eventual reliefin the second half.

(c lick herefor the detailed note by our Economist)

No te: Indicative trajectory for pol icy rates reflecting ou r tightening

expectation.

What stocks shou ld work in such an environment of downbeat

but turning macro?

We look b ack at history for cues! Source: Bloomber g, Amb it Capital Research

Look back - Performance of cyclicals vs defensives
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Look back - Performance of cyclicals vs defensives

The 1990s were characterised by a rising valuation premium of defensives over cyclicals - thispremium eventually peaked around 2000.

Cyclicals were then rerated relative to defensives and this continued till the early 2008 Sensex peak.

What has ensued since is a period of defensives outperforming cyclicals again.

Periods of relative rerating of defensives were periods of bear markets for the Sensex (as seen in theplot of inflation-adjusted Sensex below) whilst the phase of cyclical outperformance was a period ofstrong Sensex returns.

The interesting point to note, however, is that cyclicals had started outperforming defensivesfrom around mid-2000, about two years ahead of the beginning of the Sensex rerating itself. Withindications of this ratio having peaked again, could a Sensex upmove be around the corner?

Pg 24

Cyclicals to defensives in these periods

Source: Capital ine, Am bit Capi tal Research; N ote: In the exhi bit a bove we d efine cyclicals as Nif ty stocks from Banks & Financia l Services,

Construction , Cap ital G ood s, Automobiles and Realty sectors. Defensives are defi ned a s Nif ty stocks from Pharma and Con sumer Staples sectors.

Look back - Performance of small/mid caps vs large caps


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Look back Performance of small/mid caps vs large caps

Small-caps relative to large caps: Three distinct

phases

Valuation derating for small-caps relative tolargecaps from 1994 to 1999-2000.

This was followed by an upward rerating until 2005-06, followed by the current phase of derating.

Interesting to note that small-caps turned up (down)ahead of the Sensex re(de)-rating itself.

Pg 25

Small-caps to large-caps in these periods

Mid-caps to large-caps in these periods

Mid-caps relative to large-caps: Three distinct

phases

Valuation derating for mid-caps relative to large-capsfrom 1994 to 1999-2000.

This was followed by rerating upwards until 2005-06,

followed by the current phase of derating since then.

Again interesting to see that mid-caps turned up(down) ahead of the Sensex re(de)-rating itself.

Sour ce: Capitalin e, Ambit Capital Research; N ote: Large-caps are the top 10 0

stocks based on ma rket cap each year w hilst smal l-caps are stocks with market

cap ranks between 301 and 5 00

Source: Capi talin e, Ambit Capital Research; N ote: Large-caps are the top 10 0

stocks based on mar ket cap each year w hilst mid-caps are the n ext 200 stocks

(i.e. mcap ran ks between 10 1 to 300 )

Look back - Performance of RoCE quintiles


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Look back Performance of RoCE quintiles

Pg 26

Whilst high RoCE stocks have done well recently as they had done in the 1990s,

they were the worst performers in the 2000-2008 period.Note: Q5 almost never delivers regardless of decade

Source: Bloomberg, Capitalin e, Ambit Capital Research; Note: In the exhibits above w e look at the m edian performan ce of the top 200

compa nies on mcap each year ex-BFSI (an d for BSE200 firm s since 200 2; th is index was launched i n 200 2); perf orm ance assessment i s on a

forw ard- loo king 1-year b asis using trailing RoCEs.

Look back - Performance of beta quintiles


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Look back Performance of beta quintiles

Pg 27

this wasnt always the case as the 2000-08 period tells a different storyNote: Q1 almost never delivers regardless of decade

Whilst low beta stocks have done well recently as they had done in the 1990s,

Source: Bloomberg, Capitaline, Ambit Capi tal Research; Note: In the exhibits above we look at the average performance of top -200 companies

on m cap each year (and for BSE200 firms since 2002; this index wa s launched in 2002 ); performan ce assessment is on a fo rward-lo oking 1 -

year basis using adj usted beta as on 31stMar each year.

Look back - Performance of valuation quintiles


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q

Pg 28

Valuations have not mattered in recent times with the most-expensive stocks performing the best

and expensive stocks had done well in the 1990s as well

In the 2000-2008 period, however, valuations did matter, withthe cheapest stocks delivering the best returns

Source: Bloomberg, Capitalin e, Ambit Capital Research; Note: In the exhibits above w e look at the m edian performan ce of top-200

compa nies on mcap each year (and for BSE200 firms since 200 2; this index was launched in 2 002 ); perf orma nce assessment is on a

forward -looking 1-year basis using trailing P/ Bs.

What works best in the current context? QARP!


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Source: Bloom berg; Cap italin e, Ambit Capi tal Research; N ote: In the exhibits

above we look at the median perform ance of the top-200 companies on mcap

each year ex-BFSI (an d for BSE200 firms since 2 002 ; this index w as lau nched

in 2 002); performan ce assessment is on a forward -looking 1-year basis using

traili ng magi c scores.

Pg 29

it has worked over the entire 16-year period since 1997

Not only has magic formula delivered in the 2000-08 periodSummarising this section so far

In a normal market scenario, cyclicals and small/mid-caps outperform defensives and large-caps, with thisinflection preceding the inflection in Sensex returns.

Neither the markets love with quality nor its blind eyeto valuations (as seen over the last few years) continuesin a bull phase. More impo rtantly, low quality n ever delivers, i rrespect ive of the market phase!

The current phase is characterised by an economy whichwhilst it continues to be challenging, is looking tonormalise; at the same time, it is also characterised by a

polarised stock market which has only just started torevert.

Implications for portfolio strategy

As we move toward a normal market scenario,combining valuations with quality should work best.

Joel Greenblatts magic formula (magic formula

combines earnings yield with return on assets tostrike a balance between the two) is a demonstration ofQARP.

Not only did it work in the normal 2000-2008 period,it has delivered over the last 16-year period as well.

G&C 7.0


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Ambit CapitalPvt. Ltd. Pg 30

Portfolio construction methodology

Our own version of QARP involves identifying stocks that fulfil the following criteria

Do well on our greatness and accounting frameworks[cl ick herefor our 26

Nov 2013 note explaining our greatness framework and cl ick herefor our 22 Nov2013 note explaining our accounting framework]

Are cheap on at least one of P/E, P/E and EV/EBITDA vs their own five-yearhistory

Whilst we weed out the most illiquid names, even from the resulting set of stocks, we assign2x weightage to more liquid names (above US$2mn ADV) and 1x to illiquid names.

This quality at a reasonable price (QARP) approach to portfolio construction in todays

environment results essentially in a play on cyclicality, value and small/midcaps whilstnot losing sight of quality.

Even after clocking 280 bps of outperformance for G&C 6.1 vs the BSE500 (since September23, 2013), we stay the course on this approach in our new portfolio, G&C 7.0.

G&C 7.0 portfolio vs the popular benchmark Nifty 50

Median mcap 6M ADV Median Median Median

(US$ mn) (US$ mn) FY15 P/E (x) FY15 P/B (x) FY13 RoE (%)Nifty 8,220 18.0 12.1 1.9 17.2 1.00

G&C 7.0 1,790 2.9 8.8 1.4 18.2 0.96

Portfolio Beta

G&C 7.0- The composition
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We update the previousportfolio for the latestiteration of our greatnessframework (the qualityaspect) and for the latest

valuations (the reasonableprice aspect).

Only four changes to the listof 30 stocks from G&C 6.1:

Exits:Bank of Baroda (weturned sellers on bottom-up on November 1, 2013),

Voltas (fall in greatnessscore), Jagran Prakashan(better replacementavailable on greatnessmodel) and SupremeIndustries (valuations).

Entrants: Federal Bank,Shree Cement, DB Corp

and Bharat Electronics.

Source: Bloomberg, Amb it Capital Research

Bajaj Auto BJAUT IN Auto 4.3 9,064 12.8 (0.7) 23% 58% 18% 14.2 4.8

Tata Motors TTMT IN Auto 4.3 18,213 45.3 0.6 89% 50% 10% 7.5 1.8

Exide EXID IN Auto Anc 4.3 1,432 3.1 (2.3) 4% 21% 14% 13.4 2.2

MRF MRF IN Auto Anc 4.3 1,330 4.4 0.4 32% 22% 8% 7.7 1.4

ICICI Bank ICICIBC IN BFSI 4.3 20,134 71.0 NA 28% 13% NA 8.6 1.5

Federal Bank FB IN BFSI 4.3 1,157 3.8 NA 25% 13% NA 7.4 0.9

IDFC IDFC IN BFSI 4.3 2,475 20.0 NA 20% 14% NA 7.0 0.9

ING Vysya Bank VYSB IN BFSI 2.1 1,733 1.2 NA 40% 13% NA 11.7 1.4

LIC Housing Fin. LICHF IN BFSI 2.1 1,728 12.5 NA 15% 20% NA 6.8 1.2

Larsen & Toubro LT IN Engg & Const 4.3 15,452 41.8 1.6 6% 16% 14% 16.9 2.3

Engineers India ENGR IN Engg & Const 2.1 853 0.6 (1.1) 12% 35% 22% 9.1 1.9

Coal India COAL IN Metals/ Mining 4.3 26,436 14.7 (1.3) 22% 38% 19% 9.1 2 .8

NMDC NMDC IN Metals/ Mining 4.3 9 ,293 6.6 (0.8) 23% 32% 74% 8.9 1.7

Oil India OINL IN Oil & Gas 4.3 4,670 2.7 (0.6) 11% 20% 35% 6.7 1.2

Petronet LNG PLNG IN Oil & Gas 4.3 1,362 2.1 0.4 42% 29% 7% 9.2 1.5Cummins India KKC IN Cap Goods 4.3 2,043 2.2 (0.4) 15% 31% 17% 18.3 4.3

Power Grid PWGR IN Utilities 4.3 8,286 16.6 2.5 27% 15% 70% 8.2 1.3

Torrent Power TPW IN Utilities 2.1 843 1.5 1.1 -24% 18% 20% 9.8 0.8

Grasim GRASIM IN Cement 4.3 3,843 3.4 0 .1 -6% 15% 17% 8.6 1.0

Shree Cement SRCM IN Cement 2.1 2,501 1.3 (0.3) 11% 20% 13% 15.2 2.8

HCL Technologies HCLT IN IT 4.3 15,942 24.5 (0.0) 47% 29% 16% 14.4 4.1

Cadila Healthcare CDH IN Pharma 2.1 2,819 1.5 0.8 8% 30% 17% 18.9 4.1

Torrent Pharma TRP IN Pharma 2.1 1,492 1.2 0.0 27% 31% 16% 15.4 4.2

Bharti Airtel BHARTI IN Telecom 4.3 20,318 26.8 1.3 -38% 9% 14% 19.8 1.9

Oberoi Realty OBER IN Realty 2.1 1,093 0.6 (0.3) 3% 15% 55% 9.1 1.3

Sobha Developers SOBHA IN Realty 2.1 468 0.8 0.6 18% 10% 27% 8.2 1.1

McLeod Russel MCLR IN Agro 2.1 484 1.4 0.1 6% 17% 23% 7.9 1.2

Bharat Electronics BHE IN Industrials 2.1 1,298 0.5 (0.8) 5% 16% 10% 9.1 1.0

Sadbhav Engg. SADE IN Infrastructure 2.1 217 0.2 3.7 -45% 9% 11% 13.3 1.1

DB Corp DBCL IN Media 2.1 945 0.3 (0.0) 6% 27% 23% 17.1 4.3

Company Name Bloomberg SectorWeight

(%)

Mcap

(US$ mn)

6-mnth

ADV

(US$ mn)

Latest

Debt

Equity

FY15

P/E

FY15

P/B

3-yr

earnings

CAGR (%)

3-yr

avg RoE

(%)

3-yr

avg PBITM

(%)

G&C 7.0 - Implied sector weights


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As highlighted earlier, for theconstruction of G&C 7.0, we look forstocks that do well on the greatness

framework, are cheap on at least one ofP/E, P/E and EV/EBITDA vs the stocksown five year history and are relativelyliquid.

Even within this set of stocks, we assign2x weightage to more liquid names(above US$2mn ADV) and 1x to illiquidnames.

The sector weights, as displayed in theexhibit on the left hand side, are anoutcome of the above process. We do notsubscribe to using a market-capweighted index as a reference point forportfolio construction.

SectorG&C 7.0

weight (%)

Delta between

G&C 7.0 and BSE200

Agro 2.1 2.1

Auto 8.5 1.5

Auto Anc 8.5 7.3

BFSI 17.0 (6.8)

Capital Goods 4.3 2.9

Cement 6.4 4.1

Chemicals - (0.2)

Conglomerate - (0.8)

Consumer Durable - (0.2)

Engg & Const 6.4 3.3

Fertilizers - (0.6)

FMCG - (12.8)

Industrials 2.1 1.9Infrastructure 2.1 1.6

IT 4.3 (11.4)

Logistics - (0.2)

Media 2.1 1.2

Metals/ Mining 8.5 3.7

Miscellaneous - (0.3)

Oil & Gas 8.5 (1.7)

Pharma 4.3 (2.8)

Realty 4.3 3.8

Retail - (0.7)

Shipping - (0.2)

Telecom 4.3 2.1

Utilities 6.4 3.1

Source: Bloomberg , Ambi t Capital Research

Audit of G&C 6.1


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G&C series- cumulative performance

Note: Performance fo r Coal India includes special

dividend

Source: Ambi t Capi tal Research

Ticker Stock Stock

weight (%)20-Sep-13 28-Jan-14 Performance

BJAUT IN Bajaj Auto 4.3 1,992 1,938 -3%

TTMT IN Tata Motors 4.3 338 355 5%

EXID IN Exide 4.3 126 101 -20%

MRF IN MRF 4.3 12,991 18,882 45%

BOB IN Bank of Baroda 4.3 550 565 3%ICICIBC IN ICICI Bank 4.3 987 1,013 3%

IDFC IN IDFC 4.3 99 93 -6%

VYSB IN ING Vysya Bank 2.1 501 537 7%

LICHF IN LIC Housing Fin. 2.1 208 200 -4%

LT IN Larsen & Toubro 4.3 846 983 16%

ENGR IN Engineers India 2.1 171 153 -11%

VOLT IN Voltas 2.1 75 100 34%

COAL IN Coal India 4.3 302 279 -7%

NMDC IN NMDC 4.3 124 142 15%

OINL IN Oil India 4.3 467 458 -2%

PLNG IN Petronet LNG 4.3 125 105 -16%KKC IN Cummins India 4.3 409 436 7%

PWGR IN Power Grid 4.3 102 97 -5%

TPW IN Torrent Power 2.1 72 100 38%

GRASIM IN Grasim 4.3 2,821 2,589 -8%

HCLT IN HCL Technologies 4.3 1,062 1,400 32%

CDH IN Cadila Healthcare 2.1 685 812 19%

TRP IN Torrent Pharma 2.1 445 546 23%

BHARTI IN Bharti Airtel 4.3 344 305 -11%

OBER IN Oberoi Realty 2.1 171 192 12%

SOBHA IN Sobha Developers 2.1 282 286 1%

MCLR IN McLeod Russel 2.1 259 257 -1%

SI IN Supreme Inds. 2.1 326 423 30%

SADE IN Sadbhav Engg. 2.1 60 86 43%

JAGP IN Jagran Prakashan 2.1 83 89 7%

6.2

7,281 7,528 3.4

2.8

16.8Cumulative Alpha (%, since Mar 11)

G&C 6.1 alpha (%, since Sep 13)

G&C 6.1 weighted returns (%)

BSE500 index (%)

Price (INR)

Appendix 1- Rising US bond yields positive for EM equities


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Uptick in US bond yields have been positive for Indian equities historically

Average quarterly returns during periods of high yields (shaded grey in the previous chart)

Period 1 (from 5.4% to 7.9%) start date: 31/10/1993 end date: 08/01/1995 0% 5% 8%




Period 5 (from 1.6% to 2.8%) start date: 08/07/2012 till date 5% 0% 3%

4% 8% 9%

2% 2% 3%Overall avg for the period (Sep-92 till date)

Period (and US 10 yr bond

yield change)Particulars

S&P 500

returns

MSCI EM

returns

Sensex

returns

Avg for these 5 subperiods (i.e. periods of rising yields)

Appendix 2 - Median stock performance vs Sensex returns


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Bear markets for the Sensex are even more brutal for the broader markets, with average and median stockperformances significantly inferior to Sensex returns.

Overall, across timeframes, the median firms stock performance is significantly inferior to both the averagestocks performance or the indexs performance pointing to the centrality of appropriate stock selection!

Pg 35

Over the full period, median returns significantly lowerthan the average as well as the Sensex

In the 02-07 bull phase, average stocks did better thanthe Sensex but the median remained marginally lower

Median and average stock returns much worse than theSensex in bear phases - as in the 92-02 period

as well as since the 07-08 peak

Source: Bloomberg, Capitaline, Ambit Capital Research; Note: In the exhibits above we look at the average and m edian p erformance of the top-200

compa nies on mcap each year (and for BSE200 firms since 2002 ; this ind ex was lau nched in 2 002 ); freq uency of perform ance assessment is qua rterly.

Disclaimer


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