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Value-creating stocks (RoE > cost of equity) with growth attributes (earnings growth > nominal GDP) and better governance fall in the high-optimism zone thereby resulting in high valuations based on P/E ratios. However, factors such as concentration of institutional flows and behavioural biases such as unpopularity of a theme / industry (e.g. ESG theme and related sectors in the recent past), etc. could lead to value-creating growth stocks being available at reasonable or even at pessimistic prices. With this endeavour, we apply the following screening conditions to large cap stocks under our coverage. GARP (growth at reasonable price) screening conditions –

* “Markets can stay irrational longer than you can stay solvent” - The aforementioned adage is a critical risk factor in a GARP strategy as markets can continue to ignore a stock for various reasons and it can continue to look attractive on GARP parameters for extended periods of time without showing any performance. Hence, in our screener, we lay emphasis on the fact that there should be a hint of outperformance from the stock in the recent past (3 months / 6 months / 1-year performance). Apart from price momentum, we look at earnings momentum as well (upgrade/downgrade) and if the stock underperforms in terms of price and undergoes severe earnings downgrade (> 10%) as well then the stock is removed from the list irrespective of meeting the growth and valuation criteria.

* Value-creating growth companies (RoE > ke or ‘cost of equity’ and PAT growth > nominal GDP growth) – Criteria for value creation is satisfied by stocks that are expected to have FY24E RoE greater than their ‘cost of equity’ (ke). Also, there should be no material expected dip in RoE profile over FY22 to FY24. Earnings growth over FY22-24E should exceed nominal GDP growth (>12%) supported by sales CAGR of around 10% and more.

* Avoid paying high price for long-term growth beyond the explicit period – Using our proprietary ‘MILTGV’ framework (market implied long-term growth value) for reverse engineering stock prices, we identify stocks where the market is attributing less than or equal to 70% of the current market value to growth in earnings beyond FY24E or in other words stocks with MILTGV 80- 90%) from growth beyond the explicit period (beyond FY24E).

* Why MILTGV and not P/E ratio? – Assume two companies (company A and B) from the same sector with the same forward P/E of say 15x but with different ke’s of 12% and 16% for stock A and B, respectively, given their risk profiles. While the P/E framework indicates that the valuations of the two stocks are identical, investors intuitively perceive the extra riskiness of stock B. However, our MILTGV framework explicitly captures this as it discounts the earnings using the stock’s ‘cost of equity’ and thereby, indicating that stock B is more expensive than stock A given their risk profiles although their P/Es are identical.

* Qualitative factors – ‘Buy or add’ rating from our sector research teams. This criterion indicates that qualitatively the probability of material business risks and governance issues are low and also acts as another filter on valuations.

* No bankruptcy risk based on financial leverage ratio and robust operating cash flow generation. Regulated utilities and telecom are exempted from the financial leverage condition. Financials are also exempt from the financial leverage condition given the nature of their business.

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