High performance with consistency: Most of us know
quality when we see it. There is a certain finesse in
performance, consistency and reliability about quality.
These characteristics of high quality are common to
products as they are to companies. The challenge is to
objectify such subjective assessment, especially in the
context of companies. The common principle is that high
ROE, high free cash flow, low beta and low financial
gearing represent quality. We argue that apart from high
performance (say high ROE or growth), the volatility (i.e.,
consistency) of metrics such as ROE and growth is also
critical in measuring quality.
Quantifying quality: We try to short-list India’s best-
quality companies of the past decade from among the
top 200 by market cap with a minimum listing history of
three years. We rank companies in descending order of
ROE, EPS, sales and dividend growth, and net margins;
and in ascending order of the coefficient of variation of
these metrics. We also rank stocks in ascending order of
trailing 10-year returns and in descending order of beta,
debt-equity, and trading volumes.
Our argument: high quality has high performance in the
form of high ROE, net margins, sales, EPS and dividend
growth. Simultaneously, the variability of these
fundamental factors needs to be low. High quality is also
about high returns albeit with low beta, stable investor
bases (thus low share turnover) and low financial risk. We
assigned company scores based on their ranks for each
of these 14 metrics (see Exhibits 1-2 for the results).
If I could wave my magic wand: Ideally, we need to
know the companies that will be on such a list 10 years
hence. Unfortunately, it is beyond our ability to forecast
which companies will deliver the best performance with
the highest consistency in the coming decade. Still, even
though one of the most common disclaimers in our
industry is that historical performance is not a guide to
future performance, the achievers of the past decade
could continue to deliver results in the coming 10 years.
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quality when we see it. There is a certain finesse in
performance, consistency and reliability about quality.
These characteristics of high quality are common to
products as they are to companies. The challenge is to
objectify such subjective assessment, especially in the
context of companies. The common principle is that high
ROE, high free cash flow, low beta and low financial
gearing represent quality. We argue that apart from high
performance (say high ROE or growth), the volatility (i.e.,
consistency) of metrics such as ROE and growth is also
critical in measuring quality.
Quantifying quality: We try to short-list India’s best-
quality companies of the past decade from among the
top 200 by market cap with a minimum listing history of
three years. We rank companies in descending order of
ROE, EPS, sales and dividend growth, and net margins;
and in ascending order of the coefficient of variation of
these metrics. We also rank stocks in ascending order of
trailing 10-year returns and in descending order of beta,
debt-equity, and trading volumes.
Our argument: high quality has high performance in the
form of high ROE, net margins, sales, EPS and dividend
growth. Simultaneously, the variability of these
fundamental factors needs to be low. High quality is also
about high returns albeit with low beta, stable investor
bases (thus low share turnover) and low financial risk. We
assigned company scores based on their ranks for each
of these 14 metrics (see Exhibits 1-2 for the results).
If I could wave my magic wand: Ideally, we need to
know the companies that will be on such a list 10 years
hence. Unfortunately, it is beyond our ability to forecast
which companies will deliver the best performance with
the highest consistency in the coming decade. Still, even
though one of the most common disclaimers in our
industry is that historical performance is not a guide to
future performance, the achievers of the past decade
could continue to deliver results in the coming 10 years.
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