The Coffee Can Portfolio Comes To India Through Ambit
In the Indian context, we can build the coffee can portfolio using straightforward investment filters.
The filters are:
1. Identify 10-25 high-quality stocks and then leave the portfolio untouched for a decade.
Both in backtesting and in the live portfolios, it was found that this simple approach delivers consistently aggressive results.
This type of portfolio not only outperforms the benchmark consistently, but it also delivers healthy absolute returns, and, more specifically, it performs extremely well when the broader market is experiencing stress.
Steps to construct a Coffee Can Portfolio:
The author limits his search to:
- Companies with a minimum market capitalisation of ₹ 100 crores (from a total of 5000 companies), as the reliability of data on smaller companies, is susceptible. There are around 1500 listed companies in India with a market cap greater than ₹100 crores.
- Look for companies that over the preceding decade have grown sales each year by at least 10%.
- Generated a Return on Capital Employed (ROCE ) - pre-tax of at least 15%.
These 3 criterias should be fulfilled for a stock to be a part of the coffee can portfolio.
1. Why ROCE?
ROCE = EBIT/(Debt and Equity).
It is the metric that measures the efficiency of capital deployment for a company.
2. Why use ROCE of 15%?
It is the bare minimum required to beat the cost of capital.
The risk-free rate of return is typically 8% and an equity risk premium of 6.5 to 7 % brings ROCE to 15%.
The equity risk premium is derived from the US equity market + India's credit risk premium.
3. Why should we use a revenue growth filter of 10% every year?
We should look for companies that deliver revenue growth of 10% every year for 10 consecutive years.
Why 10% revenue growth?
This is because the nominal GDP growth rate has averaged to 13.8% over 10 years + adjustment for inflation.
Very few listed companies fulfill this requirement. So we have kept it to 10% growth every year for 10 consecutive years.
For financial services company:
1.Return on equity (ROE) has to be 15% -
For banks, ROE is a fairer measure than ROA. It shows their ability to generate higher income efficiently on a given equity capital base over time.
2.A loan growth rate of 15% -
Given that nominal GDP growth in India has averaged 13.8% over the past 10 years, loan growth of at least 15% is an indication of a Bank's ability to lend over business cycles.
Strong lenders ride the down cycle better, as competitive advantages surrounding the ability to source lending opportunities, credit appraisal, and collection of outstanding loans ensure that they continue their growth profitably either through market share promised improvements or by upping the Ante in sectors that are resilient during a downturn.