My point is that there’s too much reliance on past performance. I get your point about a few bad apples.
Even an index fund line Nifty 50 or N Next 50 provides approx 10-13% returns over a 10 year period. Isn’t that safer?
Its not all invest and forget kind of passive option. There is active management involved and its definitely not recommended for a novice unlike an index fund.
Nifty50 actually gives close to 15% over a decade in total returns. We see only returns excl. dividends and reinvestment of the same. If you were to buy an index MF direct with the growth option it should touch 15% cagr over a decade.
Yes! they actually heavily advocate index ETFs/funds. The idea of the coffee can is to beat the index’s 15% over a decade by selecting companies from all market caps and weeding out poor performers from the index. A simple example would be the index owns companies like SBI, a company that perhaps an active investor would leave out. So that is the idea… Youve got a base of 15% cagr now by picking out the stronger companies fundamentally coupled with a few fundamentally strong smaller companies, with zero churn, no cutting positions and a concentrated PF you should be able to generate close to the 20% cagr over a decade. That is the basic premise… They do have a large cap CCP as well that has outdone the index and done very well over decade long periods. The guidelines for market cap of course keep changing. Also you cannot build a CCP without coffee can like franchises (hard to find haha!) in that case it does not work. The filters simply help you out in identifying the potential CC companies. You should read both books, it should answer all your questions 
Thanks for clarifying @1.5cr. Your point about SBI and government owned companies in the index is well noted. What would be a good screener filter link you would recommend to get started.
Do you recommend the following or is there an improved one?
?
Also any thoughts on
You can use a combination or variant of the filter as you please. For example ITC and Nestle wont make the filter. Nestle due to the maggie issue and ITC due to stagnating top-line in the last two FYs. However I believe those two cos are great coffee can franchises. It is not just PSUs. It is also companies in cyclical sectors. Like an L&T is not going to generate alpha over a decade on average. It may generate returns in an upcycle however. Then you have sectors like steel as well.
You can also tweak it to 5 and 7 years since that will also throw up quality companies like a Dr Lal or an astral poly. You can tweak the market cap too.
I would however start with an index MF and a quality all cap/mid/small MF. This should be around 60% of the PF. That should ensure atleast a 15%cagr over a decade and should make sure that you do not underperform the index. The remaining 40% can be used for the coffee can portfolio and you can even throw in a few 3-4 year stories to generate higher alpha. I think it is important to think on a portfolio level. We should aim to generate index plus 1-2% cagr over the next decade. That would be a great achievement if achieved and good goal to start off with…
Great insights, @1.5cr. Really appreciate your inputs. My thoughts on portfolio construction are on similar lines.
Would prefer to add an ELSS and an NPS product to make the portfolio tax efficient and gain the 2 lakh tax exemption per annum in addition.
This is as per my understanding -
The Idea:
The original idea of Coffee Can Investing came from early 90’s, when Index investing wasn’t a common norm (though indices were there yet the idea of index investing got popularized in late 2000’s). This method of investing attracts people who prefer passive style of investing; those who don’t have time or willingness to research business.
Buy/Sell decision ?
So, if go by pure Coffee Can idea, it says identify businesses which have performed reasonably well consistently over last couple of years, reflecting a compounding nature and then keep adding them over years; not letting brokers/stock analyst buy / sell call affect your decision to invest in such businesses. Since, greatest of businesses will still have rough quarters; triggering a sell call from brokers/stock analyst.
an Index vs coffee can
An index investing would be simpler, low cost, low maintenance idea. Though when you buy an index you buy good performers as well bad performers (for eg. Nifty50 carries few cyclical businesses and you can’t expect them to provide you long term compounding effect). Secondly, in India, Indices are yet to mature due to limited pool of quality businesses. Whereas coffee can idea allows you to pick and choose which businesses attracts you – irrespective of their market cap.
Which works better / why aren’t they popular ?
Instead of going into what works and what doesn’t; both approaches will yield you above average returns but the true potential of these can only be seen when applied over long term (let’s say 8-10 years or longer). Which limits the use of these approaches for long term goals only. You can’t expect a great compounding to fructify in a year or two. You can’t really compare a year or two performance and reject one or the other.
Where these two approaches stand when compared to Actively managed Funds ?
Over a longer period, main factor would the fund management fee paid (plus its compounding benefits in portfolio) for actively managed funds. Above average returns may come or may not; but fee paid is certain. As long as funds manages to beat the indexes by significant margin; fee paid wouldn’t affect choices.
Based on what we see in more mature economies, as the indices as well economy mature, generating real alpha over index would not be an easy ask. wait… that’s well in future; why to bother now … right ? … as the indices mature (what I mean is SENSEX30 will not be good comparison when typical large MF holds 50-65 stocks), we will soon have similar trends in India.
Ambit CCP :
Identifying great business with compounding effect - wait … isn’t that a million dollar question ?What Ambit attempted is to provide a math formula to simplify it so that even a novice person can understand and adopt the method.
From your explanation, which I assume is pure CC approach, there should not be any selling, exiting irrespective of rising or falling stock. The core assumption here is winners will compound steadily and take care of losers. Over time their weight will increase and losers weight will decrease. Any new comer selected by CC screener gets added but no stock is exited.
Is my understanding correct?
well, yes. So at every addition (lets say at yearly interval), you apply a filter - is it still a great business providing long term compounding effect ? That way loosers weight in overall portfolio will decrease overtime.
Large cap MFs by in large have underperformed the index over the last 7 years as of 2017 as data is provided for the same. The new SEBI rules further squeeze them. Net of fees large cap equity MFs have and perhaps will continue to underperform the index. If you venture beyond into the mid and small cap universe then yes fund managers can find alpha. This is actually advocated by them in the book.
The classic coffee can screen does not just look for business who have performed in the last couple of years, but over the last decade consistently. Hardly 15-20 cos pop up if you run the screener properly. ( The screener query is the closest to the CC screen. Some extra companies manage to squeeze through as screener query is always cagr sales growth. Whereas CC screen states 10% each and every year.)
That is not the case. They actually tell you to invest in equities via tracker funds(index) and look for good small/mid/all cap funds. The CC filter is merely a starting point post which you look into selected companies and take a call as to how they will continue to perform & grow. The idea is very few companies even make the filter. And those that do will inevitably be of superior quality. They do not advocate you buying all the companies that the screen throws up. Or for that matter any new cos that the screen throws up each year.
As per the concept only if you have additional funds you deploy in the following year’s CCP. Else you stay put with your CCP. It is the concept and philosophy that is interesting. Not the nitty gritty’s. We can take alot from the philosophy. The good thing is we are able to get good returns by buying well known franchises.
In this article Mr. Mukherjea makes a great point. As Mr. Nikunj asks him about how the heavy hitters in the USA (GE Kodak 3Metc:) when bought at high valuations in the 1960s gave investors no returns over a long period of time.
To this he responded by saying “that is why I write Books in India”.
The Indian markets are too different and we are in a way influenced by the greats from other parts of the world.
He brings up a great point about how companies like Asian Paints etc: generate substantially higher returns than their cost of capital. And they tend to do this for very very long periods of time. He says great companies in the US like walmart and JP morgan chase generate return on capital very close to their cost capital due to the nature of their economy.
This is perhaps why companies like Asian paints trade at such fancy valuations. You have a company that generates a far higher return on its capital than its cost of capital, a company that can do this for a very very long time, a company that maintain its competitive advantage for perhaps more than a decade and a company that deploys atleast 50% of its capital and generates that high return (assuming 50% is paid out to shareholders).
Would love to hear the views of our senior VPers not on Asian paints but on how this high ROCE generated by such cos can generate shareholder more than satisfactory returns over a decade long period.
my 2 cents,
A High ROCE is defended by not taking huge risks (in terms equity dilution, high debt and so on), which in a way keeps the profit growth in a limited range. This low risk approach help the businesses navigate the difficult times with ease without compromising on PAT (as these is no EPS dilution or interest outgo).
On one hand, this low risk approach will restrict the mega earnings growth. So such business will not be a market darling.
Yet, Even slightly low PAT growth (often stable) enables businesses to generate substantial shareholder returns over a long period of time.
Hi Sir,
ROCE in itself is return on entire capital employed. For eg: capital employed is 100 and return on that capital is 10 (110 incl capital employed). In that case ROCE is 10%. So the structure of the capital does not make a difference in this metric.
You might be thinking of ROE. Return on Equity can be driven up through leverage. Take the same assumption assume no intrest on the leverage for simplification purposes. Capital employed is 100 ROCE is 10% (so like mentioned earlier 10 and with capital 110).Assume also the entire capital is in the form of equity from the promoter/company itself. So ROE is also 10%.
However if one were to leverage in this structure, 20 (equity) + 80 (debt) = 100. ROCE of 10% means 110 (10%). But, ROE is not 10%, instead ROE is 50%. 10/20*100 (10=roce, 20=equity put in for that return). So ROCE will still be 10% but ROE goes up multifold. Take a lending franchise, take HDFC Bank itself, they are looked at in terms of ROE. Since they cant lend at 25% their ROCE will always be low.
There are very good companies are listed that have a high ROCE and a high ROE implying good use of equity (many industries require leverage as a norm pretty much, for eg: RE) and a return on capital that is far higher then cost of capital.
Senior members please correct me if im wrong!
http://marcellus.in/wp-content/uploads/2019/02/Marcellus_CCP_Newsletter_Feb_2019-1.pdf
In this newsletter, Mr. Mukherjea explains exactly why this concept works in India and may not hold true in the western markets.
It was a good read so I thought I would share it. I would love the views of the VP members on the same!
Hi, one of the reasons why the difference between ROCE and Cost of Capital remains high in India can be this-
Some of the cost esp Capex is incurred in the past. Since accounting is done on historical cost method, time value of money is ignored. While the revenue is accounted based on current prices, some of the cost would be considered based on last 3-4-5 or more years ago prices.
Therefore the real gap between ROCE and CoC becomes overstated in an economy where inflation is high.
Very good list. Your and mine thinking pattern is similar. In software please do consider product based companies also
I beg to differ on yours comments on TCS it is the company which has transformed itself. Please bear in mind that there are other European and American Giants also for deals in addition to Indian player s.
Hi all,
I would like to add two more ideas that I think have the characteristics of a coffee can franchise for the upcoming 7-10 years. They dont satisfy all the metrics but I think they have a decent outlook and can do quite well going forward.
The stock seems cheap with a high yield and throws out a good amount of cash. It trades at 16x earnings and 14x cash flow ops and 18x free cash.
I think two-wheeler volumes will grow in the long run. I think Hero can capitalise on this and grow volumes in high single digits in the long run. There are short term headwinds but that is perhaps why we are getting this price.
Products are good and they have a household name in the splendour. They seem to be taking active steps on the EV front as well. They have a big stake in Ather energy. I think the short term headwinds should pass and growth should pick up slowly.
A 10% cagr growth in earnings over the next 5 years is a fair expectation coupled with the 3.5% yield today, should give a stable 15% cagr with low downside in the long run.
If the company continues to do well then one can hold for a longer period of time. Mgmt. Seems to be focussing on the scooter segment and premium bike segment now. I think looking 5 years ahead Ather’s scooters could end up being a big optionality for the firm.
The ROCE is very high and thus satisfies the coffee can filter, however the sales filter is obviously not satisifed. But this is fine as it is seems to be a kind of a pseudo cyclical/cyclical but no a traditional cyclical kind of a business. I think the ability of the company to increase its FCF at a decent rate is a major plus point in the long run.
A combination of deleveraging, margin expansion (due to focus on premiumisation & franchise led expansion of other brands) & nominal sales growth will drive earnings to grow much faster.
The above triggers will in turn improve the ROCE and ROEs of the business.
USL & the alcohol industry will be a direct beneficiary of increase in discretionary spending once it takes off.
Per Capita Alcohol Consumption in India is ~5.7 litres as of 2016. Compared to the USA at about 9.7 litres and China at around 7 litres. I expect India to reach that 7 litre mark over the next 5-7 years so around a 2-3% cagr on that aspect. (this is 2016 data I could not find latest data)
I expect a slow shift towards premium alcohol and spirits as per capita income hits and goes beyond that 2k range. I think USL will be a direct beneficiary of this.
It seems like the numbers are finally improving since Diageo’s takeover right?
The business, its brands, the mgmt. & the industry gives some long term visibility and is recession proof. So as long as they show high single digit growth to low double digit growth in revenue and maintain a high ROCE for a long period of time we could have a great compounder over the next decade.
At current levels it satisfies the ROCE filter of 15%. This could be much higher as things start to improve (which they already have)
They are slightly expensive on valuations but you cannot take the PE too seriously on this scrip since earnings do seem depressed as there are multiple triggers that will improve the earnings and the fundamentals of the business.
Do post your thoughts! and do add some compounder kind of ideas of your own:)
http://marcellus.in/wp-content/uploads/2019/02/Marcellus_Newsletter_April_2019-compressed.pdf
Tracks Asian Paints over the last decade and throws up some very valid points regarding coffee can/consistent compounder kinds of companies and how we miss out on benefitting from them let alone ever owning them.
Edelweiss as a coffee can idea…
broadly speaking they have 3 verticals.
Credit- This consists of things like SME finance, Agri Finance, Mortgages, Other forms of structured credit, ARC of course and other products that the company has in terms of credit (like ESOP loans recently etc:). Basically to my mind its a diversified credit vertical.
Wealth - This consists of their Wealth mgmt., Advisory, AMC and Broking business.
Insurance- This is their insurance JV with Tokio Life. This vertical is currently in loss making mode (this is however only a book entry due to the nature of the business in its investment phase. This will turn profitable in the near future so we can adjust the numbers accordingly since losses are notional in nature)
Let us just look at the business from a bird’s eye view.
We have one vertical (credit) that needs equity to grow. Hence, if it grows at a pace higher than the ROE of its vertical it will need to dilute/need equity infusions to continue to grow faster than its ROE.
We then have one vertical that, by nature of its operations needs virtually no equity to grow. That is their wealth mgmt. vertical. (this is evident through the nature of AMCs etc: They typically dont need much capital to grow and operate). Therefore this vertical can grow with pretty much no equity. The ROE will naturally be very high.
And of course the insurance business that will have a float that can be deployed as Edelweiss sees fit.
So in essence we have a credit business that has access to not only capital externally but also has access to capital from the other vertical of the company that do not need much equity to grow (akin to HDFC Bank’s mega fee income that boosts is ROE number). This will enable the company to grow for a long time without diluting which is a big plus in a credit business.
The themes that these three verticals play on have a long runway ahead in terms of growth. Credit, savings & protection have a long way to go in our country.
In a financial services firm more often than not the bet is on the jockey and I think Rashesh Shah is among the best in the country. I’m sure many members here have read about his journey and seen its result in Edelweiss!
In my view we have a company where most of its capital is going to be redeployed and that can generate a high combined ROE (17-20%) in a growing industry without diluting equity for a long period of time with a great guy at the helm.
Valuations for Edelweiss don’t seem expensive at the moment. The way they have navigated through this rough period shows the resilience and the quality of the business and its mgmt. The Real estate book is a concern but let us not forget their ARC business that has successfully taken over RE projects. They have a full fledged Real Estate advisory business that includes sales as well. So even in the case of major defaults in the Real Estate book the company can salvage a decent amount of value is my view.
Moreover, over the years they have managed to become a non-cyclical business as a whole. Growing from a pure play brokerage house to now a leading diversified Financial services business.
The fact that they have been able to tide over this rough patch by taking various measures and have a great management track record, let alone a great track record of growth makes me believe that they could be a worthy coffee can candidate for the next decade.
Please share your views and if any member has a detailed thesis please do share it with us!
P.S Mr. Mukherjea has recently added Bajaj Finance to his portfolio in his new avatar.
P.P.S Fun Fact: Edelweiss is a flower that grows on harsh Alpine Terrain. The flower is known to be very resilient against the harshest of climates, and therefore difficult circumstances, is used as a medicinal remedy, and symbol of courage, dedication, love and bravery, since one has to climb into high altitudes to harvest one of them.
