How to Evaluate Stocks of Fastest Growing Companies in India?

[Updated: 09-Nov-2019] How to evaluate fastest growing companies? This article can shed some light about how to do it. [List of fastest growing companies]

We all want to buy a prospective ‘growth stock’, but we often end-up buying a wrong one. How to eliminate this miss? Read more about stocks with highest last 10Y returns.

What I want to explain here is the concept of “fast growth”. Why to know the concept? Because the way we search for fast growing companies is not a safe approach. Why I say so?

Because, to unearth a fast growing stock, we must look deeper. A superficial search will not highlight a truly fast growing company. Then, how to go about it?

The Concept – Look Deeper

Fastest Growing Companies - Iceberg

Suppose I ask you this question, “which are the potentially fastest growing companies in India in 2019”? How you will answer this question? Our first instinctive reaction will be to look at the historical prices.

For people who know more about stocks will see growth rates of sales, net profit, EPS, dividends, net worth, asset etc and make a guess. Read more about high EPS stocks & its growth rates.

The question is that, is this the right way?

The approach is not wrong, but a value investor would like to see deeper. Signs like sales growth, profit growth etc is only the tips of the iceberg.

What lies beneath is what’s making these metrics grow.

Fastest Growing Companies - PAT,EPS Growth rates

How a business grows?

PAT, EPS, Dividend, Net Worth of a company cannot grow on its own. It must be grown. In order for the company to grow, it must take actions. What are those actions?

  • Reinvestment of Retained Profit: What are retained profits? Net Profit minus Dividend. It is that portion of net profit, which has not been paid to shareholders as dividends. Cumulative of all passing years retained profits are shown in companies balance sheet as “reserves”. Companies use its reserves fund growth. Read more about how companies use retained profits.
  • Making Company More Efficient: Businesses utilise resources to generate profits. Companies which are efficient, generates more profits per unit resource utilised. Such efficient companies has a better chance to grow faster in future. Read more about profit margin of companies.

So lets sum up, how a company grows?

Company Growth = Growth due to (Reinvestment + Efficiency improvement)

Formula-1

1. How fast a company can grow?

Estimating future growth is like acting god. Why? Because future prediction is impossible.

No body can claim to know what will happen tomorrow. Neither Warren Buffett, nor you not anyone. But what can be done is this:

Estimate future growth based on business fundamentals of a company.

What does it mean? Estimating future growth based on business fundamentals is more maths than fortunetelling. I am sure, you will agree that mathematics is more reliable.

But maths will forecast high future growth only if the “business fundamentals” are good.

Which fundamentals will ensure fast growth? Like growth is a factor of reinvestment & efficiency, speed of growth also has an interrelation. It has follow two interrelations:

  1. How much is reinvested: Out of the total profit that the company, a portion of its is paid to shareholders as dividends. The balance is retained by the company for reinvestment. The retained profit is called reserves. Out of these reserves, a portion is reinvested back into the company in form of CAPEX plans. The objective of CAPEX plans is to make the company grow.
  2. How well it is reinvested: Even if the company is reinvesting its reserves, more important is to get the final results. What is the final result? Enhancement of profit, and profitability of the company. If both these parameters are increasing, it is a sign that the reinvestment is being done well by the company.

Generally a fast growing company reinvests most of its profit back into the business. The result is that, its profit and profitability grows faster with time.

Which are the stock metrics which can tell us, how much is reinvested and how well it is reinvested? Please read further…

1. How much is reinvested:

Fastest Growing Companies - REINVESTMENT

In order to understand how much is getting reinvested, one can use the below two metrics.

  • Retention Ratio [(PAT-Dividend) / PAT ]: The higher is the retention ratio, means the company is giving out less as dividends, and retaining more profit for reinvestment. For such companies, the “reserves” in balance sheet grows faster.
  • Reinvestment Ratio [(Net Capex+Change in WC) / {EBIT x (1-t)}]: How much is reinvested out of reserves is more important. How to know it? This can be known by calculating the reinvestment ratio.

Higher reserves also makes additional funds available for the company. How?

As reserves goes up, the company’s equity base becomes richer. This brings down the companies Debt/Equity ratio. Hence it becomes eligible for more loans. Which loans?

  • Long term debt: This will further increase the employed capital of the company. Companies can also use this extra fund to further boost its expansion and modernisation plans.
  • Short term debt: This will also increase company’s current assets. Companies can use this fund for its business operations (working capital etc).

A company which has high retention ratio gets double benefits. One one hand it has more funds available for CAPEX. On other hand it can also borrow more from banks (loan) and further boost its liquidity.

2. How well profits are reinvested:

Fastest Growing Companies - EFFICIENT

The objective of reinvestment should not only be to increase profit, but also to enhance efficiency. If the efficiency is growing with profit, it is a sign that reinvested work is being done well.

How to know if the efficiency is increasing or not? By looking at ROE and ROC history.

  • ROE (PAT / Book Value).
  • ROC [ EBIT x (1-t) / (Equity+Debt-Cash).

[Read more on how to calculate ROE – Example.]

3. “First” Formula for speed of growth

A combination of retention / reinvestment ratio with ROE/ROC respectively will give this answer. Combination of the two formula will tell us about the speed of growth of a company.

Formula for growth in company due to reinvestment =

= Retention Ratio x ROE

Formula-2.1

= Reinvestment Ratio x ROC

Formula-2.2

What the above formulas signify? To grow, a company reinvests its profits back into the business. This reinvested money ensured future growth. How fast will be the growth?

There are are two ways to look at it. (a) A general observation – through retention ratio and ROE. (b) More specific observation – through reinvestment ratio and ROC.

  • Retention Ratio * ROE: talks about how much a company adds to its equity to generate extra profits.
  • Reinvestment Ratio * ROC: talks about how much a company adds to its assets to generate extra profits.

One can use either of the above formula to estimate growth rate of company due to reinvestment. 

Abbreviations used:

  • PAT = Profit After Tax.
  • CAPEX = Capital Expenditure.
  • WC = Working Capital.
  • EBIT = Profit Before Interest & Tax.
  • t = Effective Tax Rate.
  • ROE = Return on Equity.
  • ROC = Return on Capital.

4. “Second” Formula for Speed of Growth

Suppose there is a company whose total asset is say Rs.100 Crore. This company generates PAT of Rs.10 Crore. What is its ROC? 10% (PAT/Asset).

[Total Capital (Equity + Debt) = Total Asset.]

Now, this company has target to improve its ROC from 10% to 12%. But it does not intend to grow though “reinvestment” route. What it can do to improve ROC? By cutting down on its cost. This way companies PAT will go up.

But this growth in PAT has happened without adding anything to its asset base (zero capital expenditure). 

Here we can say that the company has been able to increase profit by improving its efficiency. Ideally, this is the best way to ensure growth. But such growth has two major limitations:

Beyond that, growth can only happen from reinvestment (by asset enhancement). What is the formula that can be used to quantify growth due to efficiency improvement?

Growth in company due to efficiency improvement =

 = (ROE2 – ROE1) / ROE1

Formula_3.1

= (ROC2 – ROC1) / ROC1

Formula_3.2

So this brings us to our final conclusion. Total growth of a company can happen in two ways (both included).

  • By reinvestment of its profit back into the business. 
  • By efficiency improvement. 

This way the total growth formula comes out to be like this:

Total Growth = Formula_2.1 + Formula_2.2 or

Total Growth = Formula_3.1 + Formula_3.2

Conclusion

Let’s conclude the topic of “companies growth”. Using ROC Formula, growth rate of a company is represented as:

Total Growth = Reinvestment Ratio * ROC + (ROC2 – ROC1) / ROC1

  • Case-1: Company is not reinvesting: If the company is not reinvesting its capital, CAPEX + Change in working capital is zero.Mens, its reinvestment ratio is zero. In this case, growth is totally dependent on efficiency improvement. Growth = (ROC2 – ROC1) / ROC1
  • Case-2 : Company is only reinvesting: If the company is only reinvesting, its growth due to efficiency improvement will be zero. In this case growth is totally dependent on reinvestment. Growth = Reinvestment Ratio * ROC

What we can conclude from this article?

Companies which reinvest its money, and also has higher ROE / ROC is more likely to grow faster in future.

Example of future growth estimation…

How to estimate future growth rate of a company? We can use the below two steps:

  • Step #1. Pull out the numbers: Which numbers to be obtained from the companies financial reports? We need to pull-out specific data from companies “profit and loss a/c” and from the “balance sheet”. The numbers that I am talking about are these:
Fastest Growing Companies - DataPullfromReports
  • Step #2. Calculate: Sample calculation is shown in below image. [P.Note: In row “ab” & “ac” which is Efficiency Growth (ROE/ROC), will be zero if the preceding years ROE/ROC is more than 0.20. Why? Because, I have assumed that a company which already has a high ROE/ROC, cannot grown more on basis of efficiency improvement. Such companies must reinvest for future growth. Total growth of such companies will be a factor of reinvestment.
Fastest Growing Companies - GrowthCalcu3

In the above example, we have two total growth numbers: (a) Total Growth (ROE based), and (b) Total Growth (ROC based).

Which one to be referred? Frankly speaking, there are no preferences. The selection is totally based on the researcher’s judgement. I generally prefer ROC based total growth calculation. Why? Because it is based “net capital expenditure and change in working capital”.

What shall be the grown rate for the above example stock? For me a safe assumption for future growth rate will be 7.5%. Why? The rationale behind this decision is shown below:

Fastest Growing Companies - TotalGrowthROC2

List of Fast Growing Companies

(Updated: 09-Nov-2019)

  • SG (5Y): Sales/Revenue Growth in 5Y (p.a.).
  • EPSG (5Y): EPS Growth in 5Y (p.a.).
  • EPSG (5Y): EPS Growth in 5Y (p.a.).
  • NWG (5Y): Net Worth Growth in 5Y (p.a.).
SLNameSizeSG (5Y)EPSG (5Y)NEG (5Y)
1L&T Tech.Mid106.28166.5547.52
2Sadhana NitroSmall52.82157.35139.45
3HEG Small35.06107.8831.47
4SVP Global Ventures Small80.83173.2673.76
5Valiant organics LtdSmall70.1371.752.89
6Graphite India Small31.3692.0724.91
7Refex Industries Small79.8293.0598.94
8Future Retail Mid53.853.36202.62
9KP Energy Small75.7788.4981.57
10Varun Beverages Mid19.2749.3352.86

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36 Comments

  1. Hi Manish. Thank you for your help by writing these post.

    My query is not just for companies listed here, but in general when it comes to fast growing and penny stocks.

    Should these stocks be held long term or only for a while (months time). If your answer is “it is based on my desired target amount” how long should I ideally wait and is 15% return of invested amount a good target.

    • Holding time should be based on ones investment philosophy. I prefer holding my stocks till my goal is achieved. Setting up of goal may vary from person to person. This is where stock analysis helps. It gives an idea of the potential return from a stock.

      • Thank you for your prompt response.

        I’ve another question for you.
        As per your stock analysis sheet desired stock is mentioned as overvalued and correct value is highlighted in orange.

        I’d like your input on this scenario
        Say Company A’s LTP is 100 and correct price is 80 as per your workbook
        If market always have an upward trend, one fine day it may reach 150 and even after a year it may hit low of 110, but does not come down to 80
        What should be done on such scenario

        Also, your workbook’s correct price is point in time. But everything has an expiration period. So for how long does correct price mentioned in the workbook holds true

        I understand if market hits high it should come down as well. But what if stock never comes down to correct price mentioned in workbook.
        If this is case, how often should I use your workbook to analyze stocks.

        As I’m a man with lot of questions, do you’ve a mail ID to which I can direct my questions instead of posting comments.

      • Overvalued stocks cannot stay overvalued forever. Generally speaking, price cycle will make stocks to gyrate between undervaluation and overvaluation.

        Re-analysis of stocks, at least once a year, is a good practice.
        [p.Note: The worksheet has been programmed to analyze stock based on quarterly data as well.]

        Thanks for your query.

    • Hi mani,
      I have problems the way sip calculated.I going to through some examples. consider one time investment of 1.2 lak which period of one years.consider returns are 12 percent p.a.Then principal 120000+ return 14400.
      Case 1 :now consider rd which has fixed interest rate of 12 percent p.a .Then principal 120000+ return 7800 which is near or above 6 percent.
      Case 2 : In sip of mf unit value change unlike r.d.Without knowing units per price of each month of investment. How can we calculate real return from moneycontrol or your sip calculator.
      I like to have feedback from u.

      • In SIP, average return (for the period) shall be considered (assumed) for calculation of the potential corpus. Thanks for asking.

    • The stock analysis worksheet tries to estimate the future growth rate with lot more data. Yes, it includes the above method as well. Thanks for asking.

  2. Dear Mr. Mani
    Your pursuit for financial independence has forced you to passionately research into the arena of share trade which is really an intellectual booster for people who would like to know more and more and become financially independent like you! I appreciate the effort. The best thing is the daily research along with the change in perception as time passes. Yes, there is not one single formula for success in this field. Thanks for helping us to save our time from doing individual research. Please continue your contribution in this field. It would be great if not many emails are not sent to the emails given while posting the comments. Maybe weekly or fortnightly newsletter will do.

    • Thanks for posting your feedback.

      Regarding emails, you must have subscribed to the comments feed. Probably this is why receive updates as it happens. I will suggest you to unsubscribe from it. For updates you can subscribe at twitter and facebook.

  3. sir, I a list of best managed companies and companies which are listed based on their market share in their respective segments. esp. growing market share. can you help>

  4. Your English needs a lot of improvement. I had to read everything carefully just to ensure I didn’t miss an important point 🙂

    Logic is flawed. It is NOT important for a company to REINVEST its profits. That’s only an ideal scenario. For e.g., if HUL or ITC doesn’t need money to REINVEST, it will distribute the yearly surplus as Dividends. The shareholders can use the same DIVIDENDS to BUY more shares of HUL/ ITC (& consider them as ‘FREE’). So, net net, the problem that a company faces (inability to REINVEST) is NOT necessarily a problem for the SHAREHOLDERS.

    Stock market is an ever changing dynamic system. No single logic works here all the time. Check Castrol. Its ROCE & ROE would be more than 150% (one of the highest amongst listed companies). It has destroyed value in last 5 yrs.

    • I will not comment on your understanding. You are the best judge for yourself.

      Though for me, a company which is not “reinvesting” its profits, instead paying all its profits as dividends will not sustain for a long time.

      Castrol has high ROE and RoCE. It is a very good indicator for the company. Even the last 10 years sales and PAT has been growing at a reasonable pace. Together (ROE, ROCE, Sales growth, PAT growth) should have created value for the investors. But it did not. Why? The reasons could be hidden in the way the company has decided to issue shares in the last years. Nos of shares outstanding for the company has increased from 12.36 crore to 98.91 crore. This is a growth rate of 23% CAGR. Such massive liquidation of companies shares is almost a crime. Shareholders will lose for sure. Why company is doing this? B.O.D will tell better. So the point is, ROE, ROCE etc need not be blamed for this default.

      By the way, I am grateful to you for posting your comment. Though it could have been more polite :). Thanks.

  5. The step by step approach is excellent. A complete outstanding methodology to get deeper insight of terminology and better understanding. Thanks to the efforts

    • The criteria is based on ROE, Operating Profit Margin, and ROC. Moreover, we are looking at a probable future growth….

  6. More practical and awvesome information that is definitely helps us to understand basic things

    • Generally the numbers published by companies in their annual reports are “audited” by external agency. Though there are chances of bungling, but in most cases, good companies don’t do it.

  7. Really good one especially for beginners.More practical and encouraging.Simpply I would say tough task made easy.Hope to get awesome solutions in future too.
    Thank you very much .

  8. Awesome article. I’m most definitely interest in this one. I am in reality happy with article quality and direction. This post is spot on in informative how some ideology applies to any script location. You are simply great and simply the just a single in the event that we discuss your specialty. Thanks a lot for preservation huge stuff. I am extremely a good deal grateful used intended for this place. Thanks a lot for protection massive things.

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