Beat Inflation With Coffee Can Portfolio
What are Coffee Can Portfolio and investing methods? How accurate it performs and has the probability of 93-95% to beat the inflation with great returns. Book Notes.
In this article, I will explain in detail about :
The Coffee Can Investing Portfolio (CCP)
How to build CCP Portfolio
If you have read the previous article, focused on how to beat the inflation, then you are looking for how to make such a portfolio for the long term, that can give high returns over time.
The Coffee Can Investing concept.
Coffee Can Investing - The concept in today’s world is simply “buy and forget”.
Investment for the longer term will give high returns and eventually beat inflation over time. The long term also ensures that we give these good companies complete economic cycles to show it’s performance – removing the impact of the recession, temporary negative sentiments that result in a drop in share prices.
Look at the chart of Asian Paints Ltd, in 1999-2001 it was around 11 INR. and it grew so much that today it’s the price is at 3,311 INR per share, returns of 27,770.30% all time.
So the overall concept is if you hold it for a minimum of 5+ years or more than 10+ years, you’ll also get the result of compounding returns but only if you invest in companies like Asian Paints Ltd, so in this article, I will explain about how to find next Asian Paints Ltd, type shares for your coffee can portfolio.
In Berkshire Hathaway’s 2007 letter to shareholders, Warren Buffett explains that the kind of companies he likes to invest in are ‘companies that have :
a) A business we understand
b) Favorable long-term economics
c) Able and trustworthy management
d) A sensible price tag.
A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Business history is filled with “Roman Candles”, companies whose moats proved illusory and were soon crossed. Our criterion of “enduring” causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all. Long-term competitive advantage in a stable industry is what we seek in a business.
On the subject of For how long should an investor hold the shares they buy, Warren Buffett, in 1988’s Berkshire Hathaway’s letters to shareholders stated, ‘When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.’
The power of compounding: Holding a stock for ten or more allows the power of compounding to play out its magic.
Over the longer term, the portfolio comes to be dominated by the winning stocks whilst losing stocks keep declining to eventually become inconsequential. Thus, the positive contribution of the winners disproportionately outweighs the negative contribution of losers to eventually help the portfolio compound handsomely.
Coffee Can Portfolio(CCP) offers more than 95 percent profitability of generating a positive return as long as investors hold the portfolio for at least three years. If held for at least five years, there is more than a 95 percent probability of generating a return greater than 10 percent.
How to build a Coffee Can Portfolio?
Parameters to look for, to build a coffee can portfolio.
ROCE
Sales Growth
Earnings Growth.
Why Return on Capital Employed (ROCE)?
A company deploys capital in assets, which in turn generate cash flow and profits. The total capital deployed by the company consists of equity and debt. ROCE is a metric that measures the efficiency of capital deployment for a company, calculated as a ratio of ‘earnings before interest and tax’ (EBIT) in the numerator and capital employed (sum of debt liabilities and shareholder’s equity) in the denominator.
The higher the ROCE, the better is the company’s efficiency of capital deployment.
Why use a ROCE filter of 15 percent?
Return On Capital Employed (ROCE) is a financial ratio. It determines a company’s profitability and the efficiency with which the capital is applied. A higher ROCE indicates a more cost-effective use of capital. It is also called Return On Total Capital (ROTC).
Capital employed can also refer to the value of all the assets used by a company to generate earnings. By employing capital, companies invest in the long-term future of the company.
ROCE = Earnings Before Interest & Taxes (EBIT) ÷ Total Capital Employed
We use 15 percent as a minimum because we believe that is the bare minimum return required to beat the cost of capital.
What is ROE?
Return on Equity (ROE) is a key aspect in fundamental analysis. It is also very important to look at while evaluating a company.
ROE is a measure of a company’s financial performance. It indicates the relationship between a company’s profit and the equity shareholder’s return. It shows how much profit a company generates with the money (capital) shareholders have invested.
ROE is also an indicator of how effective management is at using equity financing to fund operations and grow the company.
The higher the ROE, the more efficient the company’s operations are at making use of those funds. Since every industry has different levels of investors and income, we can not use ROE to compare companies outside of their industries very effectively.
ROE of 15 percent :
We prefer Return on Equity over Return on Assets because this is a fairer measure of banks’ ability to generate higher income efficiently on a given equity capital base over time.
Why Use a revenue growth filter of 10 percent every year?
India's Nominal GDP growth rate has averaged 13.8 percent over the past ten years. Nominal GDP growth is different from real GDP growth as unlike the latter, nominal GDP growth is not adjusted for inflation. In simple terms, it is (GDP) evaluated at current market prices(GDP being the monetary value of all the finished goods and services produced within a country's border in a specific time period).
A credible firm operating in India should, therefore, be able to deliver sales and growth of at least that much every year.
We should look for companies that have delivered revenue growth of 10 percent every year for 10 consecutive years.
Look at the balance sheet of Asian Paints Ltd: Asian Paints Ltd, Balance Sheet. The company is generating profits with exponential growth from 836 Cr. in 2010 to 3139 Crore in 2021.
Loan growth of 15 percent:
Given that nominal GDP growth in India has averaged 13.8 percent over the past ten years, loan growth of at least 15 percent is an indication of a bank's ability to lend over the business cycle. Strong lenders ride the down-cycle better, as the competitive advantages surrounding their ability to source lending opportunities, credit appraisal, and collection of outstanding loans ensure that they continue their growth profitable either through market share improvements or by upping the ante in sectors that are resilient during a downturn.
Why choose revenue growth and ROCE as the financial metrics to measure 'greatness'?
Charlie Munger, vice chairman of Berkshire Hathaway, stated in his lecture at the University of Southern California in 1994,
'Over the long term, it's hard for stock to earn a much better return than the business which underlies it earns.'
Munger meant that the returns generated by any company's share price in the long term cannot be significantly more than the return on capital employed generated by the company in its day-to-day business.
What Drives earning growth?
Intuitively, one might imagine that 'earning growth' is an independent metric - the more products or services you sell, the more revenues you book and the more profits you deliver.
Rather than considering earning growth as an independent metric by itself, it is more useful to see earnings growth to be an outcome of two independent parameters - growth in Capital Employed in a business and the firm's ability to generate a certain Return on the Capital Employed(ROCE)
As a result "Earnings growth" can be achieved either by growing capital employed whilst maintaining ROCE or by growing ROCE through enhanced operating efficiencies whilst maintaining the firm's capital employed.
Warren Buffet in his 2007 letter to shareholders defined three categories of businesses based on return on capital:
High earnings businesses with low capital requirements.
Businesses that require capital to grow and generate decent ROCE.
Businesses that require capital but generate low returns on capital.
B2C Companies perform well, are fundamentally strong, and survive financial crashes
A B2C firm is one that sells its product or services directly to the end consumer, unlike a B2B firm that sells to another business, which in turn sells it forward after adding more value to it.
Build a portfolio from B2C sectors like consumptions:
Autos
Homebuilding materials
staples consumption
Discretionary consumption
Banking
Pharma
IT
Focus on companies with more structural rather than cyclical plays:
A long-term investor who wants to successfully invest in structural stocks needs to follow a thorough bottom-up analysis of the stock and sector under consideration.
Avoid companies that borrow lots of money to grow.
Prefer companies with intangible strategic assets.
Strategic assets are those that give a firm a platform over which it can build a stack of initiatives like raw material, great distribution, pricing power, supply chain, etc., and hence sustain competitive advantages. The Coffee Can philosophy, however, prefers companies whose strategic assets are a combination of such tangible strengths alongside intangibles and hence difficult to replicate no matter how much money a competitor is willing to spend.
Such intangible assets can either include intellectual property, licenses, or culture-oriented aspects like:
Hiring, incentivizing, empowering, and retaining top-quality talent
Using IT(technology) investment not just as a support function, but as a backbone of the organization to ensure all aspects of the business are process-oriented and efficient.
Proactive looking after the company's channel partners, vendors, and employees at times when they undergo personal or professional crises.
Conclusion:
For the vast majority of equity investors in India, investment becomes a complicated affair, not only because they are surrounded by substandard advisers, but also because they are fed incorrect theories. The most common one is: to make higher returns from stock markets, one must take higher risks.
From investors like Warren Buffet, Akash Prakash, K.N Sivasbramanian, is that to consistently generate healthy returns from equity investing, one has to invest in high-quality companies and then sit tight for long, without losing sleep about where the share price is going.
The Coffee Can Portfolio filter of great companies.
Look for companies above Rs 100 Crore Market Cap. Market Capitalization > Rs. 100
Sales growth >10 %
Return on equity > 15 %
Average return on capital employed 10Years > 15 %
B2C and strong fundamental companies
Such a portfolio beats benchmarks across all time periods. The portfolio also performs well during stressful periods.
You can use the below filter while screening stock on screener.com. Or you can use this screener - Coffee Can Shares Screener
Sales growth >10 AND
Return on equity > 15 AND
Average return on capital employed 10Years > 15 AND
Market Capitalization > 1000OR
Sales growth 10Years > 10 AND
Sales growth 7Years > 10 AND
Sales growth 5Years > 10 AND
Sales growth 3Years > 10 AND
Sales growth > 10 AND
Average return on capital employed 10Years > 15 AND
Average return on capital employed 7Years > 15 AND
Average return on capital employed 5Years > 15 AND
Average return on capital employed 3Years > 15 AND
Return on capital employed preceding year > 15 AND
Return on capital employed> 15 AND
Market Capitalization > 800
Why does the Coffee Can Portfolio perform so well?
This is because 'greatness, which the Coffee Can Portfolio seeks, is not temporary and is surely not a short-term phenomenon.
Great companies do not get disrupted by evolution in their customer’s preferences or competitors or optional aspects of their businesses. Their management teams have strategies that deliver results better than their competition can. These traits are rarely found outside great companies. So invest in above mentioned filtered companies or you can take a look at Ambit capital's coffee can portfolio, every year they update the market scenario and if any new share on the portfolio or the growth reports.
The Coffee Can Portfolio concept was introduced by - Ambit Capital and Sourabh Mukherjea’s book: Coffee Can Investing: The Low-Risk Road to Stupendous Wealth.
And you can read their current 2020 and 2021 - Coffe Can Portfolio and market report in detail :
Ambit Coffee Can Portfolio - February 2021
Ambit Coffee Can Portfolio - September 2021