Atoms to Bits – Wealth Creation in the digital era

Reliance, Adani Transmission & Adani Enterprises

Biggest, Fastest& Most Consistent WealthCreators

Key Conclusions of Motilal Oswal 26thAnnual Wealth Creation Study

• Reliance, Adani Transmission & Adani Enterprises–Biggest, Fastest, & Most Consistent Wealth Creator,respectively, between 2016 and 2021.Adani Enterprises is also the top All-round Wealth Creator.

• Financials sector is the largest wealth creating sectorbetween 2016 and 2021.

• Expect Financials and Technology sectors to spearhead Wealth Creation for quite some time in the future.

• Value migration from Atoms to Bits is inevitable.

• Replicability, friction-free delivery and near-zero marginal cost make Bits companies highly scalable.

• Successful hyper growth is possible only if there is large opportunity, terrific product-market fit, wide distribution, network effects and favorable unit economics.

• Current accounting standards fail to fully communicate intrinsic profitability – and hence value – of Bits companies.

• India is at the cusp of harnessing digital potential.

• Buy into sure winners in digital, successful digital transformers, and classical Indian IT companies.

Motilal Oswal Financial Services Ltd. today announced the Motilal Oswal 26thAnnual Wealth Creation Study, 2021.

Every year for 26 years now, Mr. Raamdeo Agrawal, Chairman of Motilal Oswal Group, commissions an Annual Wealth Creation Study.

The Motilal Oswal 26thAnnual Wealth Creation Study has two parts:

1) Findings on Wealth Creation during the 5-year period 2016-2021 (March ending)

2)  Theme 2021: Atoms to Bits – Wealth Creation in the digital era

Key Conclusions of Motilal Oswal 26thAnnual Wealth Creation Study

• Reliance, Adani Transmission & Adani Enterprises–Biggest, Fastest, & Most Consistent Wealth Creator,respectively, between 2016 and 2021.Adani Enterprises is also the top All-round Wealth Creator.

• Financials sector is the largest wealth creating sectorbetween 2016 and 2021.

• Expect Financials and Technology sectors to spearhead Wealth Creation for quite some time in the future.

• Value migration from Atoms to Bits is inevitable.

• Replicability, friction-free delivery and near-zero marginal cost make Bits companies highly scalable.

• Successful hyper growth is possible only if there is large opportunity, terrific product-market fit, wide distribution, network effects and favorable unit economics.

• Current accounting standards fail to fully communicate intrinsic profitability – and hence value – of Bits companies.

• India is at the cusp of harnessing digital potential.

• Buy into sure winners in digital, successful digital transformers, and classical Indian IT companies.

Part 1) Wealth Creation Study findings

The Motilal Oswal 26th Annual Wealth Creation Study 2021analyzes the top 100 wealth creating companies during the period 2016-21. Wealth created is calculated as change in the market cap of companies between 2016 and 2021 (March ending), duly adjusted for corporate events such as mergers, de-mergers, fresh issuance of capital, buyback, etc. The Study identifies the Fastest, Biggest and MostConsistent wealth creators. Further, it analyzes key trends in wealth creation, provides insights into winning companies and distills strategies for successful equity investing.

Study Highlights – Wealth Creation

Top 100 Wealth Creators created INR 71 lakh crores wealth during 2016-21

This is the highest ever quantum of Wealth Created. During 2016-21, Sensex CAGR was somewhat muted at 14%, but pace of Wealth Creation was healthy at 24% CAGR. This reinforces the point that Wealth Creation happens in all kinds of market conditions. So, investors are better off focusing on which stocks to invest in, rather than timing the markets.

Reliance Industries is the Biggest Wealth Creator for the third successive year

Over 2016-21, Reliance industries emerged the largest Wealth Creator for the third time in succession, with total Wealth Created of a whopping INR 9.7 lakh crores.This is by far the highest ever, beating its own previous record of INR 5.6 lakh crores in 2014-19.

Adani Enterprises is the Most Consistent Wealth Creator

Over 2016-21, Adani Transmission has emerged the Fastest Wealth Creator with price CAGR of 93%.Another Adani group company – Adani Enterprises – ranks the third Fastest Wealth Creator.INR 1 million invested equally in 2016 among the top 10 fastest Wealth Creators would have grown to INR 17 million in 2021; return CAGR of 77% v/s just 14% for the Sensex.

Adani Enterprisesis the Most Consistent Wealth Creator

We define Consistent Wealth Creators based on the number of years the stock has out-performed in each of the last 5 years. Where the number of years is the same, the stock price CAGR decides the rank.

Based on this, over 2016-21, Adani Enterprises has emerged as the Most Consistent Wealth Creator. It has outperformed in all the last 5 years, and has the highest price CAGR of 86%.

Adani Enterprises is also the Best All-round Wealth Creator

We define All-round Wealth Creators based on the summation of ranks, under each of the 3 categories – Biggest, Fastest and Consistent. Where the scores are tied, the stock price CAGR decides the All-round rank.

Based on the above criteria, Adani Enterprises has emerged as the Best All-round Wealth Creator, followed by group company Adani Transmission.

Other key takeaways

• Wealth Creation Classification by Industry:The Financials sector has regained its top spot in Wealth Creation, after briefly losing it in the previous study period to Consumer & Retail.

• Wealth Creation by Ownership – PSU v/s Private:PSUs’ (public sector undertakings) Wealth Creation performance during 2016-21 was the worst ever: (1) The number of PSUs in the top 100 Wealth Creators is only 2; and (2) Wealth Created by these 2 PSUs is less than 1% of total.The only 2 Wealth Creating PSUs are Gujarat Gas and Indraprastha Gas.

• Wealth Destroyers:The total Wealth Destroyed during 2016-21 is INR 11 lakh crores, 15% of the total Wealth Created by top 100 companies. Five of the top 10 Wealth Destroying companies are PSUs.Financials sector is both the top Wealth Creating and top Wealth Destroying sector. The former is thanks to the private sector banks and NBFCs, and the latter mainly to public sector banks.

Part 2) Theme 2022: Atoms to Bits – Wealth Creation in the digital era

What is Atoms to Bits

Globally, value is migrating from Atoms (businesses dealing in physical matter) to Bits (businesses which are digital in nature). This has already played out in a big way in the US. The digital ecosystem in India is right for Atoms-to-Bits to play out here.

Atoms v/s Bits

Unlike Atoms, Bits deal in intangible assets, enjoy very low cost of replicating their offering, and benefit from network effects. As a result, Bits can scale up very rapidly compared to their Atoms counterparts.

Key success factors for Bits

Given high initial losses, the success of Bits companies centers around rapid growth in order to achieve critical mass. Their key success factors are –

1.    Large opportunity size

2.    Product-market fit

3.    Wide distribution

4.    Network effects

5.    Favorable unit economics

6.    Operational scalability.

Losses of Bits companies tend to be optical

Atoms use financial capital to acquire physical assets which reflect in their balance sheet. In contrast, Bits mainly use human capital to self-generate intangible assets (e.g. technology platform), which gets fully charged to the income statement, resulting in optical loss. Cash flow is the leveler between Atoms and Bits financials.

Valuation of Bits

We suggest 3 valuation methodologies for Bits companies, which can then be averaged to arrive at the final value –

1.    DCF (Discounted Cash Flow)

2.    Comparables, with special emphasis on PSG (Price/Sales to Growth)

3.    Last private equity valuation.

How to play Atoms to Bits

Investors should focus on Digital Business Designs

Whether a business is physical, digital or phygital, the key to success is a Digital Business Design. In their book, How digital is your business?, the authors write, “… you must remember that Digital Business Design is about business first, design second and digital third.” They identify two determinants of Digital Business Design –

1.    Quality of Business Design and

2.    Degree of Digitization.

The matrix below offers a framework for how to play the Atoms to Bits theme. The challenge for investors is to identify:

1.    Digital Business Designs i.e. Strong business design with high Degree of Digitization;

2.    Digital Aspirants who are likely to attain Digital Business Design; and

3.    Dotcoms who are likely to improve their Business Design.

Bet on digital enablers with great managements

A second way to play the Atoms to Bits theme is by investing in digital enablers (i.e. IT service providers), run by great managements. These companies will be catering to players in all the above four quadrants, and may well prove to be the biggest beneficiaries of Atoms to Bits.

Framework to play Atoms to Bits – Look for Digital Business Designs and Digital Enablers

Quality Business Design Image.png

In closing …

• Value migration from Atoms to Bits is inevitable.
• Replicability, friction-free delivery and near-zero marginal cost make Bits companies highly scalable.
• Successful hyper growth is possible only if there is large opportunity, terrific product-market fit, wide distribution, network effects and favorable unit economics.
• Current accounting standards fail to fully communicate intrinsic profitability – and hence value – of Bits companies.
• India is at the cusp of harnessing digital potential.
• Buy into sure winners in digital, successful digital transformers and classical Indian IT companies.