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TM

Thematic Study
TM

16 January 2003

A Study on Wealth Creation

(1997-2002)

The Seventh Annual Study

Top-10 Wealth Creators (1997-2002)

The fastest
ADJUSTED RANK COMPANY MKT. CAP. CAGR (%) APPRECIATION (X)

The biggest
WEALTH RANK COMPANY CREATED (RS CR) APPRECIATION (X)

1 2 3 4 5 6 7 8 9 10

Wipro Satyam Computer Services e-Serve International Infosys Technologies Moser Baer (India) Zee Telefilms Sri Vishnu Cement Aftek Infosys CMC Amtek Auto

133 122 110 97 83 80 78 75 73 70

68 54 41 30 21 19 18 16 16 14

1 2 3 4 5 6 7 9 8 10

Wipro Hindustan Lever Infosys Technologies Oil & Natural Gas Corpn Reliance Industries ITC Satyam Computer Services Ranbaxy Laboratories Dr Reddy Laboratories s Hero Honda Motors

38,322 27,111 23,690 9,568 8,401 8,294 7,523 6,797 6,597 6,065

68 2 30 1 2 2 54 3 12 11

Looking ahead ... all times, in all markets in all parts of the world, the tiniest change in interest rates changes the value of At every financial asset. The fall in interest rates on long-term bonds will have a deep impact on the valuations of other financial assets, particularly stocks Corporate earnings are likely to be positively impacted by the sustained drop in interest rates - not only through own interest cost reduction but also through suppliers' interest cost reduction Value is, however, not immediately reflected in market prices as "Investors are habitually guided by recent experiences and extrapolate them into the future" If viewed as a disguised bond, the BSE Sensex is a far superior compounding instrument than the 10-year Government bond

Raamdeo Agrawal (Raamdeo @ Mo t i l a l Oswal.com )/Abhay Kantak (Abhay@MotilalOswal.com)

Motilal Oswal Securities Ltd., 81-82, Bajaj Bhawan, Nariman Point, Mumbai 400 021 Tel: 22812500 Fax: 22816161

Wealth Creation Study

Contents
Objective, Concept & Methodology The Wealth Creator Group vs BSE Sensex Wealth Creators ~ Business Analysis Wealth Creation Process of Growing Companies Wealth Creators ~ New Economy vs Old Economy Importance of Interest in Wealth Creation The American Experience The Indian Corollary Appendix I: 'MOSt Inquire 85' ~ Wealth Creators Appendix II: 'MOSt Inquire 85' ~ Wealth Creators (Rankings) 3 4 5-8 9 10-11 12 13-16 17-23 24-25 26-27

January 2003

Wealth Creation Study

Objective, Concept & Methodology

Objective
The foundation of Wealth Creation is in buying businesses at a price substantially lower than their intrinsic value. The lower the market value than the intrinsic value, the higher is the margin of safety. In this year study, we continue our s endeavour to cull out the characteristics of businesses, which create value for their shareholders. As Phil Fisher says, It seems logical that even before thinking of buying any common stock, the first step is to see how money has been most successfully made in the past. Our Wealth Creation studies are attempts to study the past as a guide to the future and gain insights into How to Value a Business.

Concept
Wealth Creation is the process by which a company enhances the market value of the capital entrusted to it by its shareholders. It is a basic measure of success for any commercial venture. Wealth Creation is achieved by the rational actions of a company in a sustained manner.

Methodology
For the purposes of our study*, we have identified companies that have the distinction of having added at least Rs100crore to their market capitalization after adjusting for dilution during 1997-2002. Only 85 companies fulfill this criterion. We have termed the group of Wealth Creators as the 'MOSt-Inquire 85'. The Wealth Creators have been listed in Appendix I and II. Ranks have been accorded on the basis of Speed of Wealth Creation, that is, the compounded growth in Wealth Created during the period under study.

* Capital O l and Trends databases h ave b e e n use d for th is st ine udy

January 2003

Wealth Creation Study

The Wealth Creator Group vs BSE Sensex

This study pertains to the period from April 1997 to March 2002. During this period, the BSE Sensex rose at a modest CAGR of 0.64% while the Wealth Creators' Index appreciated at a CAGR of 46.4%. The chart below depicts the relative performance of the MOSt-Inquire 85vs the BSE Sensex during the period under review. Despite having fallen by 61% from the peak of 1,745 in March 2000, the Wealth Creators' Index managed to outperform the Sensex by 477% during the study period.
WEALTH CREATORS' INDEX (31.3.97 TO 31.3.02)

Performance in absolute terms

2,000 1,600 1,200 800 400 0


Performance relative to Sensex

1,745

1,700 1,275 850 425 0 M-97

1,662

S-97

M-98

S-98

M-99

S-99

M-00

S-00

M-01

S-01

M-02

S-02

GROWTH: SENSEX vs WEALTH CREATORS MAR-97 MAR-98 MAR-99 MAR-00 MAR-01 MAR-02

BSE Sensex YoY Growth (%) Wealth Creators' Index YoY Growth (%) 5-Year CAGR (%) Sensex 5-Year CAGR (%) Wealth Creators

3,361 (0.2) 100 -

3,893 15.8 153 52.6

3,740 (3.9) 440 188.4

5,001 33.7 1,454 230.4

3,604 (27.9) 505 (65.2)

3,469 (3.7) 672 32.9 0.64 46.4

The market capitalization of 'MOSt-Inquire 85' increased by Rs2lakh crore during the study period while the rest of the market was in a destructive mode with Rs1.2lakh crore getting eroded in the study period. The net wealth created was Rs0.8lakh crore.

January 2003

Wealth Creation Study

Wealth Creators ~ Business Analysis

Nature of business
The trio - IT, FMCG and Pharmaceuticals -continues to dominate the list of Wealth Creators. Combined, these sectors have contributed 73% to the Wealth Created in the 1997-2002 study compared to 70% in the 1996-2001 study. The share of the Banking sector to the total Wealth Created has increased from 3.4% in last year's study to 5.2% in the current study. The fastest Wealth Creator has been the IT sector, comprising of 16 companies, creating Wealth at 99% CAGR during the study period.
WEALTH CREATORS: CLASSIFICATION BY INDUSTRY NET INDUSTRY WEALTH CREATED SPEED CAGR (%) 1997-02 NO OF COS. CONTR. TO WEALTH CREATED (%) ROCE 2002 (%) ROCE 1997 (%) (RS CR) CAGR (%) 1997-02 NP SALES

IT FMCG Pharma Petrochemicals Oil & Gas Banks & Finance Automobiles Media Cement Chemicals Metals Diversified Shipping Telecom Power Others Total * RoE instead of RoCE

76,381 43,800 25,340 14,843 11,830 10,488 6,065 3,243 1,943 1,572 1,278 912 905 588 289 1,643 201,120

99 19 32 16 7 27 62 111 10 18 14 13 14 20 2 35 38.0

16 11 17 4 3 5 1 1 3 5 4 3 1 3 1 7 85

38.0 21.8 12.6 7.2 5.9 5.2 2.9 1.6 0.9 0.8 0.6 0.4 0.4 0.3 0.1 1 100

32.2 45.4 28.0 16.8 62.0 16.0 * 87.8 24.0 12.5 15.2 18.0 19.8 16.6 16.8 11.2 20 25.1

22.7 34.0 24.0 18.4 20.7 14.9* 32.0 32.5 18.2 15.1 17.5 25.3 14.5 11.6 12.2 18 19.6

63.1 28.2 27.5 15.6 25.4 20.8 55.8 27.5 7.6 8.6 17.5 36.7 0.7 nm 5.6 25.7 24.2

28.0 10.6 21.0 32.9 15.4 17.7 42.2 35.4 6.8 14.5 19.3 4.2 4.2 14.6 8.0 17.4 22.1

Management: MNC vs Indian


The percentage of MNCs figuring as Wealth Creators declined from a high of 50% in the 1993-1998 study to a low of 19% in the current study. The homegrown IT and Pharmaceutical companies have displaced the MNCs as a major Wealth Creating class. With the recent wave of delisting by several MNC subsidiaries operating in India, the question is, "Will MNC stocks attract investor fancy?"
WEALTH CREATORS: MNCs vs INDIAN COMPANIES NO OF COMPANIES WEALTH CREATION STUDY MNCs TOTAL MNCs % OF TOTAL % WEALTH CREATED MNCs OTHERS

1997-02 1996-01 1995-00 1994-99 1993-98 1992-97 1991-96

16 19 21 43 50 19 38

85 71 100 100 100 45 100

18.8 26.8 21.0 43.0 50.0 42.2 38.0

22.8 29.7 14.8 50.2 47.3 38.4 35.7

77.2 70.3 85.2 49.8 52.7 61.6 64.3

January 2003

Wealth Creation Study

Speed vs size
The speed of Wealth Creation is correlated to the size of market capitalization. Thus, if one wants speed in Wealth Creation, then it is imperative to buy companies with modest market capitalizations and whose businesses have the potential to create value for shareholders on a consistent basis. The mean size of the Wealth Creators in 1997 and the pace at which Wealth has been Created are Rs1,403crore and 38% CAGR, respectively. Wipro, the biggest and fastest Wealth Creator had Rs573crore as its market capitalization. Bigger size requires bigger incremental investment opportunities, which are few and difficult to harness.
WEALTH CREATORS: CLASSIFICATION BY MARKET CAPITALIZATION MARKET CAPITALIZATION MEAN SIZE NO. OF COS (RS CR) MEAN SPEED (%)

>= 1000 >= 500 < 1000 >= 250 <500 < 250 All Companies

6,339 688 342 91 1,403

16 14 13 42 85

15.3 38.1 28.1 48.9 38.0

Business activity
A common feature across all the Wealth Creation Studies, including the current one, is that companies, which have consistently Created Wealth for their shareholders, have adopted an extremely focused business policy. The current study also displays a similar trend, as 96% of the Wealth Created was by companies that adopted a focused business approach. In last year's study, not a single diversified company succeeded in creating wealth for its shareholders. Total focus may not be a sufficient condition but is a necessary one.
WEALTH CREATORS: CLASSIFICATION BY BUSINESS ACTIVITY 2002 2001

Diversified Focused 96% 0%

Focused Diversified 4% 100%

January 2003

Wealth Creation Study

Product attribute
All the current and past successful Wealth Creators have erected high entry barriers through superior technology or strong brand building. In the current study period, 73% of the Wealth Creating companies have one of these attributes as the differentiating factor. We also observe that the share of commodity companies has been increasing from 14% in the 1994-1999 study, to 17% in the 1995-2000 study, to 21% in the 19962001 study and to 27% in the current study. The share of commodity companies in the current study has been the highest of all studies.
WEALTH CREATORS: CLASSIFICATION BY PRODUCT ATTRIBUTE 2002 2001

Brands Technology 24% 49%

Commodity 21%

Technology 20%

Commodity 27%

Brands 59%

WEALTH CREATION STUDY

BRANDS (%)

COMMODITY (%)

TECHNOLOGY (%)

1997-02 1996-01 1995-00 1994-99 1993-98 1992-97 1991-96

49 59 47 27 26 43 27

27 20 17 14 24 4 20

24 21 36 59 50 53 53

1997-02

WEALTH CREATED (RS CR)

WEALTH CREATED (%)

Brands Technology Commodity Total

87,357 80,211 33,553 201,120

43.4 39.9 16.7 100.0

January 2003

Wealth Creation Study

Capital allocation
The change in the value of a company is strongly influenced by the superior rate at which invested capital has been deployed. The large capital input in Reliance Industries stands out. The future productivity of capital would decide the value of the company. The remarkable change in ONGC's RoCE has not led to a corresponding change in market price, probably because the market is unwilling to discount the dramatic change in financials in the recent past.
WEALTH CREATORS: CLASSIFICATION BY CAPITAL ALLOCATION (RS CR) MARKET CAP. MAR-97 MAR-02 M.CAP M.CAP/ CE

CE

ROCE (%) 2002 1997

Wipro Hindustan Lever Ranbaxy Laboratories Infosys Technologies Hero Honda Motors Dr Reddy Laboratories s Satyam Computer Services ONGC ITC Reliance Industries

2,025 1,752 434 1,967 559 1,108 1,808 2,484 2,619 27,627

39 68 19 49 88 34 26 68 43 14

19 50 16 41 32 13 24 22 37 12

573 18,697 3,159 731 599 489 129 29,410 8,792 11,820

39,554 49,604 10,180 24,714 6,664 8,401 8,419 38,978 17,096 31,687

38,981 30,907 7,020 23,983 6,065 7,911 8,289 9,568 8,305 19,867

19 18 16 12 11 7 5 4 3 1

WEALTH CREATION STUDY

2002 ROCE > 1997 ROCE NO. OF COMPANIES % WEALTH CREATED

1997-2002 1996-2001 1995-2000 1994-1999

55/85 41/71 50/100 65/100

84 91 65 56

In all our Wealth Creation Studies, we have observed that better capital allocation has been consistently rewarded.

January 2003

Wealth Creation Study

Wealth Creation Process of Growing Companies


A consistent finding of our Wealth Creation Studies, including the current one, is that most of the Wealth has been Created by companies that have seen their earnings grow faster than 25% annually.
WEALTH CREATORS: CLASSIFICATION BY EARNINGS GROWTH EARNINGS GROWTH NO OF COMPANIES CONSTITUENT (%) WEALTH CREATED (RS CR) % OF WEALTH CREATED

>25 20-25 15-20 <15 Total

41 10 10 24 85

48 12 12 28

159,011 4,417 16,418 21,275 201,120

79 2 8 11 100

But again, companies that fulfill the earnings growth criteria, need not always be successful in Creating Wealth. Earnings growth is a necessary condition for Wealth Creating companies, but not a sufficient one. Age analysis of wealth creators Wipro, belonging to the 51-60 age group, has contributed 19% of total Wealth Created while HLL, belonging to the 61-70 group, has contributed 15% of total Wealth Created. Barring these two exceptions, we observe that most of the Wealth (46%) has been Created by companies that are less than 30 years old. The maximum Wealth (29%) has been Created by companies in the 11-20 age group. The maximum number of companies also exist in 11-20 years group. We can infer from this that most of the Wealth has been Created by relatively young companies.
WEALTH CREATORS: CLASSIFICATION BY AGE-GROUP NO. OF YEARS NO. OF COS. WEALTH CREATED (RS CR) % WEALTH CREATED

0-10 11-20 21-30 31-40 >40 Total

10 36 10 8 21 85

24,908 57,713 10,534 21,028 86,963 201,120

12 29 5 10 43 100

40 30 No Of Cos. 20 10 0 0-10 10

36

10

7 3

7 3 61-70 71-80 1 81-90

11-20

21-30

31-40

41-50 Age ( Years )

51-60

January 2003

Wealth Creation Study

Wealth Creators ~ New Economy vs Old Economy

We have classified the technology, media and telecom sector companies as New Economy companies and the rest as Old Economy companies.
WEALTH CREATORS: NEW ECONOMY vs OLD ECONOMY OLD NEW

Number of Companies in Inquire-MOSt 85 Earnings CAGR (%) (1997-2002) Market Cap CAGR (%) (1997-2002) P/E 1997 (x) P/E 2002 (x)

65 22 17 15 11

20 62 96 13 29

Earnings of New Economy companies have grown at a CAGR of 62% as compared to 22% for Old Economy companies. The P/E multiple of New Economy stocks has expanded from 13x in 1997 to 29x in 2002 while that of Old Economy companies has contracted from 15x to 11x over the same period. The CAGR in market capitalization for New Economy companies has been 96% compared to 17% for Old Economy companies during the study period. New Economy companies continue to score handsomely over Old Economy companies despite the meltdown in technology stocks.

January 2003

10

Wealth Creation Study

Return on equity In contrast to New Economy companies, Old Economy companies have displayed steady improvement in RoE. After reaching a peak of 23.6% during the study period, the RoE of New Economy companies has almost converged with the RoE of the Old Economy companies in 2002.
ROE (%)

24 20 16 12 8 1997

Old Economy 22.1

New Economy 23.6 19.2 19.6 19.3 19.0

17.4 12.7 15.6 13.7 15.7

17.3

1998

1999

2000

2001

2002

Net profit/Sales After four years of a one-way journey upwards for the net profit margins of New Economy companies, 2002 has been a year of correction. Net profit margins fell by almost 200bp from their peak levels in 2001. Though at less than half the New Economy companies, net profit margins of Old Economy companies have been showing signs of gradual improvement.
NP/SALES (%)

Old Economy 22 16 10 4 1997 8.5 5.1 9.4 7.0 1998 9.3 8.1 1999 7.8 2000 15.2

New Economy 21.3

19.0

7.8 2001

8.3 2002

January 2003

11

Wealth Creation Study

Importance of Interest in Wealth Creation

"Investing means laying out money today to receive more money in real terms after taking inflation into account, tomorrow". What is the value of a stock? The present worth of all dividends to be paid upon it John Burr Williams. Factors critical to determining the value of a stock n Dividends (which are dependent on long-term earning power of the company) n Discount rate (the rate at which future dividends will be discounted to the present value) There is no such thing as absolute value in this world. You can only estimate what the thing is worth to you. No value, whether of bonds or equities, is absolute. It is always related to the riskfree rate that Government securities offer. Therefore, if the interest rate on Government securities rises, the prices of all other securities must adjust downward to a level that brings the expected rate of return to parity and vice-versa. What an investor should pay today for a Dollar to be received tomorrow, can only be determined by first looking at the risk-free interest rate.
SENSITIVITY OF PRESENT VALUE OF THE FINANCIAL INSTRUMENT TO CHANGES IN INTEREST RATE EQUITY AS BOND VALUATION

Tenure (Years) 100 Discount Rate (%) 2 18 14 25 6 3 6 7 8 9 10 11 5 447 427 408 390 373 357 10 653 597 546 499 458 420 20 1,353 1,132 949 798 673 569 30 2,739 2,097 1,613 1,246 968 756 50 10,925 6,976 4,494 2,924 1,923 1,282

Face Value (Rs) P/BV (x) RoE (%) Earnings Growth (%) Pay-out (%) Interest (%) Terminal P/BV (x)
BOND VALUATION

Tenure (Years) 100 Discount Rate (%) 1 18 0 100 6 6 7 8 9 10 11 5 151 145 140 135 130 126 10 188 177 167 158 149 141 20 238 217 198 182 168 156 30 265 236 213 192 175 161 50 289 252 222 199 179 163

Face Value (Rs) P/BV (x) RoE (%) Earnings Growth (%) Pay-out (%) Interest (%)

1. 2. 3. 4.

Longer the tenure, higher is the impact. Equity being a very long-term (perpetual) instrument, the compounding effect is maximum. Equities deliver higher value for the same term because retained profits are re-invested at a higher rate. Higher the gap between the coupon and the risk-free rate, the more superior is the discounting machine. Shorter the tenure, more important is the selling price.

January 2003

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Wealth Creation Study

The American Experience

At this juncture, I am reminded of Mr Warren Buffett article that appeared in s Fortune in 2001, where he has tried to analyze the movement of the American market over 34 years from 1964 to 1998. December 31, 1964 December 31, 1981 December 31, 1998 Dow 874 Dow 875 Dow 9,181

During the periods 1964-81 and 1981-99, the GNP of USA grew as under: 1964-81 373% 1981-98 177% What is the reason for the markets to remain stagnant at around 875 during 1964-1981 and then move up 10 times during 1981-1998, while the GNP grew by 373% in the first period and by a much lower 177% in the second period? Mr Buffett believes that the market contrasting move was caused by extraordinary s changes in two critical economic variables: 1. Interest rate (discount rate) 2. Expected corporate profits and by a related psychological force that eventually came into play: 3. Extrapolation of the recent past well into the future

Interest rate Long-term US Government bond rates 31.12.1964 ... 4.20% 31.12.1981 ... 13.65% 31.12.1998 ... 5.09% The tripling of interest rate between 1964 and 1981 pulled down the value of US equities dramatically and the trend reversal where interest rates fell from 14% to 5% between 1981 and 1998 pushed up the equity value to much higher levels. The value of equities during this period was impacted by the change in the expectations relating to corporate profit, a discussion on which follows.

January 2003

13

January 2003

10-YEAR BOND YIELD IN THE US (%)

Wealth Creation Study

14
15.2 10% 17 years 4.7 Dec-73 Jun-78 Dec-82 Jun-87 Dec-91 Jun-96 Dec-00

18

14

10

4.2

2 Dec-64

Jun-69

Wealth Creation Study

Expected corporate profits By definition, markets discount/(and can discount), only expected profit. In USA, during the period 1964-1981, corporate profits fell significantly because of high interest cost. Hence, investors lost their confidence in the profitability of the American corporate world. During the period 1981-1998, the trend reversal in interest rates enabled higher corporate profitability despite lower GNP growth. The steep decline in interest rates made a Dollar of future profits appear that much more valuable. Mr Buffett has gone about establishing a linkage between US corporate profits and the American GNP. He says that the aggregate profits of American corporates have been ranging from 4% of GNP to 6.5% of GNP. He believes that American corporate profits as a percentage of GNP would remain in the 4-6.5% band. In 1981, aggregate corporate profits fell to 3.5% of GNP and in 1998, they grew to about 6% of GNP. It is generally agreed upon that the GNP of the US would post a positive growth of at least 5% over 10-20 years. Hence, corporate profits, which are directly correlated to the GNP should also show positive growth and if one agrees with Mr Buffet, oscillate between 4% of GNP and 6.5% of GNP. Yet, markets repeatedly ignore situations like the one in the US in 1981 for psychological reasons. Market psychology People are habitually guided by the rear view mirror, in most instances by the vistas immediately behind them. The dramatic changes in the above two fundamentals explained only part of the story of the more than 10-fold rise in the Dow Jones during 1981-98 from 875 to 9,181. The other important factor is market psychology. Once the bull market gets under way and once you reach the point where everybody has made money, no matter what system he or she follows, a crowd is attracted into the game that is not responding to interest rates and profits but simply to the fact that it appears to be a mistake to be out of stocks. In effect, people superimpose an I cannot miss the party factor on top of the fundamental factors that drive the market. A man natural inclination is to cling s to his beliefs, particularly if they are reinforced in recent markets; a flaw in our make-up that bears on what happens during secure bull markets and extended periods of stagnation.

January 2003

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Wealth Creation Study

Dow as a disguised bond A bond comes with a certain maturity and a string of interest coupons. A stock, on the other hand, is a financial instrument that has a claim on future distribution made by the company, i.e. dividends. The set of owners receiving the dividends will change but the financial outcome depends on the size and timing of the coupons. Estimating the size of the coupons gets very difficult for individual stocks but is easy for a group of stocks. If the Dow were earning 13% on the book and if somebody were willing to invest in equities for sometime, he would in effect be buying a 13% bond called Dow at par. This bond would be likely to do much better than the 9.5% Government bond.
G-SEC YIELD vs DOW YIELD (%)

8 7 6 5 4 3 2 1 Dec-91

US Bond Yield

Dow Y ield

4.2

3.2

Jul-93

Feb-95

Aug-96

Mar-98

Oct-99

Apr-01

Nov-02

In essence, the depressed corporate profits/profitability in 1981 was reflected in the low discounting for equities. Just the reverse happened in 1998, when high corporate profits were discounted at high P/E multiples.

January 2003

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Wealth Creation Study

The Indian Corollary

Indian conditions in 2002 appear very similar to the American conditions in 1981. Indian corporate profits are depressed because of high interest cost and this is reflected in low P/E multiples. For Indian companies, interest forms the second most largest item after raw material cost. It is higher than labor cost. The structure of the aggregate P/L account of Corporate India is presented below:
P/L ACCOUNT: INDIA INC. 1999 2000 2001 2002 (RS CR) 2003E

Sales Raw Material Labour Cost Other Expenses EBITDA Interest Depreciation PBT Tax PAT Ratios (%) RM Cost/Sales Labour Cost/Sales Other Exp./Sales EBITDA/Sales Interest/Sales Depreciation/Sales PBT/Sales Tax/Sales PAT/Sales

810,882 350,102 58,185 209,037 193,558 119,421 32,478 44,191 12,130 32,061 43.2 7.2 25.8 23.9 14.7 4.0 5.4 1.5 4.0 20.2 0.5 9.4 4.0 0.5 4.2 7.7

949,313 423,761 66,795 236,885 221,873 134,196 38,234 53,647 15,627 38,020 44.6 7.0 25.0 23.4 14.1 4.0 5.7 1.6 4.0 19.8 0.5 9.5 4.0 0.5 4.3 8.4

1,118,570 523,602 80,152 272,571 242,246 148,236 40,421 58,014 17,666 40,348 46.8 7.2 24.4 21.7 13.3 3.6 5.2 1.6 3.6 18.4 0.5 9.2 3.6 0.5 4.6 8.3

1,338,608 577,306 94,709 378,561 288,032 171,688 48,592 67,752 25,420 42,333 43.1 7.1 28.3 21.5 12.8 3.6 5.1 1.9 3.2 17.9 0.5 8.8 3.2 0.5 4.4 6.8

1,539,399 677,335 107,758 431,032 323,274 184,728 58,500 80,046 28,016 52,030 44.0 7.0 28.0 21.0 12.0 3.8 5.2 1.8 3.4 17.2 0.6 9.7 3.4 0.6 5.7 10.8

Components of RoCE (%) PBIT/Sales Sales/CE PBIT/CE Components of RoE (%) PAT/Sales Sales/CE CE/Net Worth PAT/Net Worth

January 2003

17

January 2003

10-YEAR G-SEC YIELD IN INDIA (%)

Wealth Creation Study

18
8%

14.5

11.5

6% drop in G-Sec Yields in 2 years


6%

8.5

6 years

2 years

8% drop in G-Sec Yields over 6 years


D-93 S-94 J-95 M-96 D-96 S-97 J-98 M-99 D-99 S-00 J-01 M-02 D-02

5.5 S-91

J-92

M-93

Wealth Creation Study

Interest rate Till about 1996-97, when the peak of 14% for 10-year Government bonds was achieved, interest rates were strictly regulated by the Reserve Bank of India. The rates have since dropped to 12% in 1998 and then at an accelerated pace to 6% in 2003. The extent of interest rate fall in India and the US is the same but the time taken for this to happen in India is a third of that in US. At this juncture, we must not forget that the price to book of Dow Jones in 1981 was 1x whereas the Sensex is currently trading at 2x its book value. Expected corporate profits Interest cost as percentage of sales declining India Inc interest cost as a percentage of sales has declined from a high of 14.7% s in 1999 to 12.8% in 2002. With interest rates headed southwards or expected to be maintained at current levels and the economy poised to grow at higher rates, further savings in interest cost will be realized by companies in the coming years.
INTEREST COST AS % OF SALES

16 14.7 13 11.5 10 7.6 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003E 13.4 11.7 10.9 11.3 12.9 12.0 13.5 14.1 13.3 12.8

Asset-turnover ratios on the rise Indian companies have realized the importance of capital allocation. The overcapacity in the economy will see to it that existing capacity is utilized better as the economic growth accelerates. This would lead to a higher asset-turnover ratio.
ASSET TURNOVER RATIO (X)

1.5 1.20 1.1 0.92 0.7 0.90 0.84 0.86 0.82 0.49 0.3 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003E 0.47 0.48 0.50 0.49 0.56 1.14

January 2003

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Wealth Creation Study

Net Profit Margin to improve We believe that after four years of continuous decline, India Inc's net profit margin (NPM) should show a strong improvement. The best net profit margin of 6.8% was achieved in 1995.
NPM (%)

8 6.8 6 4.2 4 4.3 4.0 5.0 4.7 4.0 4.0 3.6 3.2 2 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003E 3.4 6.1 5.0

Return on Equity to increase The expected improvement in the asset-turnover ratio on account of higher capacity utilization and higher NPM would lead to a rise in RoE till new capacities come on stream.
ROE (%)

16 13.2 12 10.7 8 13.1 11.6 9.1 9.2 7.7 8.4 8.3 13.5 12.1 10.8

6.8 4 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003E

Higher RoE and lower risk-free rate of return from bonds would make equities more attractive.

January 2003

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Wealth Creation Study

Sensex as a disguised bond Currently, the Sensex offers a 2.5% dividend yield. It earns 18% on the book, which is likely to grow at 10% in the next 10 years (last 10 years growth was 16%). It trades at 2x book giving an effective yield of 9% against a 6% yield for the 10year Government of India paper. We have attempted to calculate the theoretical intrinsic value of the Sensex with the following assumptions.
SENSEX VALUATION ASSUMPTION EXPECTED SENSEX VALUES

Years Terminal P/BV RoE (%) Initial Profit (Rs) Profit Growth Rate (%) Payout Ratio (%) Discount Rate (%)

10 18 297 10 25 6 Discount Rate (%) 2.0 22 10 9 8 7 6 5,443 5,927 6,462 7,053 7,706

Return on Equity (%) 20 5,064 5,515 6,013 6,564 7,173 18 4,685 5,103 5,565 6,075 6,640 16 4,306 4,691 5,116 5,587 6,107 14 3,926 4,279 4,668 5,098 5,574 12 3,547 3,867 4,220 4,609 5,041

Return on Equity (%) 22 Profit Growth 15 Rate (%) 14 13 12 10 9,285 8,936 8,604 8,289 7,706 20 8,609 8,291 7,989 7,703 7,173 18 7,932 7,646 7,375 7,117 6,640 16 7,256 7,001 6,760 6,531 6,107 14 6,579 6,357 6,145 5,945 5,574 12 5,902 5,712 5,531 5,359 5,041

Profit Growth Rate (%) Discount Rate (%) 18 10 9 7,046 8,396 14 5,184 6,155 7,414 9,089 13 4,799 5,693 6,850 8,390 9,361 12 4,443 5,264 6,328 7,743 8,635 11 4,112 4,867 5,844 7,144 7,962 9 3,522 4,159 4,982 6,076 6,765

8 10,148 7 12,482

6 13,954 10,146

n n

For given interest rates in 1990s, the Sensex was probably not very attractive Current profitability of Sensex companies (RoE-18%) and discount rate (6%) suggest substantial scope for appreciation
Sensex P/E (x) - LHS Interest Rate (%) - RHS 15 13 11 9 6 10 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 7 5

SENSEX P/E vs INTEREST RATE (%)

80 65 50 35 20 5 Dec-91

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Wealth Creation Study

Psychological factor Current shift from equities to debt: rear-view driving Currently, investors are staying away from equities and putting money into debt. Investors are busy buying Government of India bonds. This is rear-view mirror driving at its best. Bonds have given 35% return in the last two years. The probable fall in bond yields from current levels is limited. Investors in bonds can expect 6-8% return going forward.
MONTHLY INFLOW INTO DEBT FUNDS (RS CR)

8,100 6,100 4,100 2,100 100 -1,900 -3,900 Oct-99

Inflow s to Debt Schemes of Mutual Funds (LHS)

Sensex (RHS)

5,500 5,000 4,500 4,000 3,500 3,000 2,500

Mar-00

Aug-00

Jan-01

Jul-01

Dec-01

May-02

Oct-02

MONTHLY INFLOW INTO EQUITY FUNDS (RS CR)

5,000 4,000 3,000 2,000 1,000 0 -1,000 -2,000 -3,000 Oct-99

Inflow s to Equity Schemes of Mutual Funds (LHS)

Sensex (RHS)

5,500 5,000 4,500 4,000 3,500 3,000 2,500

Apr-00

Oct-00

Apr-01

Oct-01

Apr-02

Oct-02

Investment in debt funds is happening because of recent past experiences being extrapolated into the future. It is certain that in the longer term one can get only 6% return from a 6% bond. But it will take some time for people to realize this fact. As Phil Fisher says, "It is often easier to tell what will happen to the price of stocks than how much time will elapse before it happens".
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Wealth Creation Study

INDIA: 10-YEAR G-SEC YIELD vs SENSEX YIELD (%)

10-Year G-Sec Yield (LHS) 15.0

Sensex Yield (RHS) 10.0

12.5

6% drop in in 2 years

7.5

G-Sec Yields

10.0 8% 6 years 6%

5.0

7.5

2 years

2.5

8% drop in G-Sec Yields over 6 years 5.0 0.0 S-91 J-92 M-93 D-93 S-94 J-95 M-96 D-96 S-97 J-98 M-99 D-99 S-00 J-01 M-02 D-02

Bond-earnings yield divide to correct: when, is the question In the last 10 years, the Sensex profits have grown at a compounded rate of 16%, 4-5% higher than the nominal GDP growth rate (with the changing composition of the Sensex). The resultant divide in bond yield and earnings yield is glaring and needs to be corrected. While one does not know for sure how and when this will happen, that it will is certain. At all times, in all markets in all the parts of the world, the tiniest change in interest rates changes the values of every financial asset.

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'MOSt-Inquire 85' ~ Wealth Creators

Appendix I

SR. NO.

COMPANY NAME 2002

ROE (%) 1997

MARKET CAP (RS CR) 2002 1997 CE

MCAP/ CE

WEALTH CREATED RS CR %

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45

Aftek Infosys Amtek Auto Apollo Hospitals Enterprise Asian Paints (India) ACC Astrazeneca Pharma India Aurobindo Pharma Aventis Pharma BPCL Birla 3M Blue Dart Express Britannia Industries BSES Cadbury India Cipla CMC Dabur India Digital GlobalSoft Dr Reddy Laboratories s Electrosteel Castings e-Serve International Essel Propack FDC Finolex Cables Finolex Industries GlaxoSmithKline Consumer GlaxoSmithKline Pharma Godfrey Phillips India GTL Gujarat Ambuja Cements Gujarat Gas Company HCL Infosystems HDFC Bank Hero Honda Motors Hinduja TMT Hindustan Inks & Resins Hindustan Lever HPCL Hindustan Zinc HDFC IBP Indo Gulf Corporation Infosys Technologies ITC ITI

24.7 11.8 10.7 28.1 12.8 4.5 19.0 29.5 21.3 19.8 16.6 54.9 10.5 23.6 26.7 36.3 16.2 41.0 31.5 24.8 39.8 7.4 25.8 11.2 15.5 28.7 7.8 20.0 8.2 11.6 47.3 14.1 15.3 67.5 12.5 20.1 53.9 13.4 6.4 21.5 43.9 19.1 38.8 27.4 7.3

29.3 22.4 18.0 24.5 7.7 30.3 26.4 17.1 20.7 10.1 0.8 17.5 13.4 19.9 26.9 7.5 22.0 27.8 11.1 29.6 8.0 13.6 9.5 10.0 5.0 34.8 18.7 26.2 14.0 14.9 40.4 3.4 16.6 36.2 4.0 23.4 37.2 18.6 3.5 15.4 9.8 11.1 33.0 26.9 -28.0

284 296 511 2,106 2,633 182 443 932 9,894 351 212 1,453 3,056 1,715 6,105 824 1,588 1,863 8,401 295 629 865 201 480 368 1,713 2,529 388 741 2,947 674 384 6,616 6,664 858 432 49,604 9,861 1,527 8,332 1,958 970 24,714 17,096 178

12 10 42 1,121 1,814 71 33 739 5,441 225 52 446 2,741 646 1,164 53 690 326 489 65 14 145 62 253 181 795 1,527 141 147 1,848 160 85 930 599 63 53 18,697 7,530 830 3,276 210 524 731 8,792 62

93 211 274 169 889 36 542 69 4,441 70 63 392 608 152 627 39 223 119 1,074 370 -4 449 89 -62 -130 133 281 138 950 1,767 139 195 1,701 562 144 534 1,735 4,662 -68 13,308 -242 1,583 1,824 2,299 551

2.9 1.4 1.7 5.8 0.9 3.1 0.8 2.8 1.0 1.8 2.5 2.6 0.5 7.0 7.9 20.0 4.0 13.0 7.4 0.6 -157.0 1.6 1.6 -3.7 -1.4 6.9 3.6 1.8 0.6 0.6 3.7 1.5 3.3 10.8 5.5 0.7 17.8 0.5 -10.2 0.4 -7.2 0.3 13.1 3.6 0.2

216 211 339 984 637 111 387 193 4,453 126 152 1,008 289 1,022 4,980 771 894 1,538 6,597 238 614 428 140 294 242 919 625 246 262 987 514 299 4,686 6,065 778 278 27,111 1,748 697 4,985 1,748 240 23,690 8,294 117

0.1 0.1 0.2 0.5 0.3 0.1 0.2 0.1 2.2 0.1 0.1 0.5 0.1 0.5 2.5 0.4 0.4 0.8 3.3 0.1 0.3 0.2 0.1 0.1 0.1 0.5 0.3 0.1 0.1 0.5 0.3 0.1 2.3 3.0 0.4 0.1 13.5 0.9 0.3 2.5 0.9 0.1 11.8 4.1 0.1

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'MOSt-Inquire 85' ~ Wealth Creators

Appendix I

SR. NO.

COMPANY NAME 2002

ROE (%) 1997

MARKET CAP (RS CR) 2002 1997 CE

MCAP/ CE

WEALTH CREATED RS CR %

46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85

J B Chemicals & Pharama. Jaiprakash Industries Kotak Mahindra Finance LIC Housing Finance Lupin Mastek Merck MIRC Electronics Moser Baer (India) National Fertilizer Navneet Publications (India) Nestle India Nicholas Piramal India ONGC Panacea Biotec Pfizer Pidilite Industries Proctor & Gamble Ranbaxy Laboratories Raymond Reckitt Benckiser (I) Reliance Industries Rolta India Satyam Computer Services Saw Pipes Shipping Corporation of India Soundcraft Industries Sri Vishnu Cement Sterling Biotech Tata Elxsi Tata Infotech Tata Telecom Torrent Pharmaceuticals Unichem Laboratories Vysya Bank Wipro Zee Telefilms Zensar Technologies Total

22.1 12.7 10.7 20.0 21.7 30.9 29.7 20.0 23.4 3.7 26.9 65.3 17.0 20.9 28.9 28.0 20.0 35.3 15.8 9.3 15.5 13.1 29.2 23.3 10.6 11.3 25.6 3.4 10.6 40.0 10.8 16.8 21.7 31.2 12.3 34.2 2.4 14.8 22.0

25.4 3.0 9.7 18.4 13.1 13.6 26.7 13.9 29.6 0.9 24.6 21.3 9.1 10.1 23.4 18.8 19.2 21.3 16.7 7.1 1.8 17.7 15.6 18.0 21.2 25.2 15.8 52.3 128.9 9.3 28.6 2.1 23.4 2.9 21.6 7.1 14.2 26.8 30.7 47.7 19.1

247 425 845 541 470 504 510 287 1,221 1,226 329 4,941 1,029 38,978 203 1,055 447 1,088 10,180 618 588 794 31,687 692 8,419 291 1,921 689 340 255 3,132 240 386 242 455 171 553 39,554 6,922 319 346,662

67 243 196 405 68 43 293 36 18 638 114 2,063 418 29,410 21 272 208 787 3,159 386 582 657 11,820 76 129 188 1,016 84 19 26 380 45 262 43 169 45 314 573 164 21 119,295

92 385 -99 4,062 825 50 60 117 1,270 -2 50 -128 140 -524 106 82 135 37 442 626 41 35 29,802 363 1,779 84 -524 237 -21 163 339 4 120 11 -110 56 98 1,930 4,330 22 89,481

2.0 0.5 -6.6 0.0 0.5 9.2 3.6 2.1 0.9 -239.3 4.3 -22.4 4.4 -18.3 1.7 9.5 1.8 8.1 15.9 0.4 0.2 3.9 0.7 1.7 4.7 1.2 -1.7 2.5 -15.2 1.4 8.1 45.7 1.0 18.0 -2.6 2.2 2.5 20.2 1.6 13.5 3

181 133 545 135 350 463 217 160 711 589 220 2,877 585 9,568 182 784 248 308 6,797 232 193 137 8,401 598 7,523 103 905 594 320 226 2,800 194 124 177 286 124 137 38,322 3,243 278 201,120

0.1 0.1 0.3 0.1 0.2 0.2 0.1 0.1 0.4 0.3 0.1 1.4 0.3 4.8 0.1 0.4 0.1 0.2 3.4 0.1 0.1 0.1 4.2 0.3 3.7 0.1 0.4 0.3 0.2 0.1 1.4 0.1 0.1 0.1 0.1 0.1 0.1 19.1 1.6 0.1 100.0

Rashtriya Chemicals & Fertilizers 2.0

Sun Pharmaceuticals Industries 32.0

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Wealth Creation Study

'MOSt-Inquire 85' ~ Wealth Creators (Rankings)


RANK NO. COMPANY NAME 2002 P/E (X) 1997 PAYBACK RATIO (X)

Appendix II
WEALTH CREATED RS CR % MCAP CAGR (%)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47

Wipro Satyam Computer Services e-Serve International Infosys Technologies Moser Baer (India) Zee Telefilms Sri Vishnu Cement Aftek Infosys CMC Amtek Auto Aurobindo Pharma Dr Reddy Laboratories s Mastek Zensar Technologies Hero Honda Motors Sterling Biotech Panacea Biotec IBP MIRC Electronics Soundcraft Industries Sun Pharmaceuticals Industries Rolta India Hindustan Inks & Resins Lupin Digital GlobalSoft Hinduja TMT Tata Elxsi Cipla HDFC Bank Apollo Hospitals Enterprise Essel Propack Electrosteel Castings HCL Infosystems Gujarat Gas Company Tata Telecom Pfizer Britannia Industries J B Chemicals & Pharamaceuticals FDC Unichem Laboratories Blue Dart Express ITI Navneet Publications (India) Ranbaxy Laboratories Godfrey Phillips India Torrent Pharmaceuticals Astrazeneca Pharma India

45.7 18.8 49.2 30.8 5.7 51.0 50.0 11.4 24.5 11.1 7.3 18.4 42.9 31.0 14.7 12.4 8.4 10.0 8.4 22.4 18.5 6.6 10.0 6.7 20.1 18.4 14.3 26.0 22.3 20.9 22.2 3.5 6.9 11.4 15.4 22.8 7.2 5.9 52.6 5.6 11.7 8.3 10.6 40.2 8.1 9.1 60.1

0.6 0.7 9.5 2.5 1.7 0.6 1.7 7.0 20.4 0.9 3.2 7.5 2.6 0.0 1.2 2.5 2.6 8.4 2.4 0.3 2.6 3.6 2.5 17.9 16.1 12.5 80.8 5.5 23.9 3.7 4.3 1.2 7.2 7.0 34.9 7.3 17.3 1.6 11.3 3.5 73.2 0.0 4.9 24.5 5.5 5.3 10.3

0.3 0.1 0.7 0.4 0.0 0.6 2.6 0.3 0.6 0.2 0.1 0.9 0.5 0.8 0.5 0.2 0.2 0.6 0.2 0.7 0.8 0.2 0.4 0.4 1.3 0.5 1.1 1.5 1.2 0.4 1.2 0.2 0.3 0.9 8.2 1.8 1.1 0.5 0.5 0.7 1.3 0.4 1.0 3.9 0.6 0.6 1.6

38,322 7,523 614 23,690 711 3,243 320 216 771 211 387 6,597 463 278 6,065 226 182 1,748 160 594 2,800 598 278 350 1,538 778 194 4,980 4,686 339 428 238 299 514 177 784 1,008 181 140 124 152 117 220 6,797 246 286 111

19.1 3.7 0.3 11.8 0.4 1.6 0.2 0.1 0.4 0.1 0.2 3.3 0.2 0.1 3.0 0.1 0.1 0.9 0.1 0.3 1.4 0.3 0.1 0.2 0.8 0.4 0.1 2.5 2.3 0.2 0.2 0.1 0.1 0.3 0.1 0.4 0.5 0.1 0.1 0.1 0.1 0.1 0.1 3.4 0.1 0.1 0.1

132.6 121.7 109.7 97.0 83.1 80.3 78.1 74.9 73.3 69.9 65.1 64.1 63.1 62.0 61.9 58.2 57.2 56.2 51.7 51.6 50.9 49.7 47.7 42.0 41.7 41.2 39.5 39.3 38.3 37.5 36.1 35.5 35.3 33.4 33.2 31.2 27.6 27.3 26.4 25.9 24.3 23.7 23.6 22.4 22.4 21.9 20.6

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Wealth Creation Study

'MOSt-Inquire 85' ~ Wealth Creators (Rankings)


RANK NO. COMPANY NAME 2002 P/E (X) 1997 PAYBACK RATIO (X)

Appendix II
WEALTH CREATED RS CR % MCAP CAGR (%)

48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85

HDFC Hindustan Lever Nestle India Reliance Industries Finolex Industries Cadbury India Dabur India Kotak Mahindra Finance GlaxoSmithKline Consumer Pidilite Industries Finolex Cables ITC National Fertilizer Shipping Corporation of India Asian Paints (India) Hindustan Zinc BPCL Nicholas Piramal India Jaiprakash Industries Merck Rashtriya Chemicals & Fertilizers Gujarat Ambuja Cements Birla 3M Saw Pipes Indo Gulf Corporation Tata Infotech GTL Procter & Gamble LIC Housing Finance Glaxosmithkline Pharma ONGC ACC Vysya Bank Aventis Pharma Raymond HPCL Reckitt Benckiser (I) BSES Total

7.2 31.3 31.0 9.8 4.1 29.8 24.9 15.9 13.9 8.6 7.3 14.4 30.1 5.1 18.6 22.5 11.6 21.3 3.6 11.9 25.5 16.8 25.5 11.0 3.3 18.8 6.8 14.9 3.7 57.5 6.3 20.2 8.1 14.1 7.0 12.5 37.9 11.0

0.7 3.4 39.0 4.5 8.9 20.8 1.6 7.8 10.9 6.5 2.7 26.1 56.5 4.5 13.4 28.1 12.7 16.5 3.3 18.5 5.2 6.4 79.4 4.0 5.0 4.1 8.2 20.0 6.6 31.9 14.7 2.2 4.2 38.2 48.1 8.3 33.4 13.5

1.6 3.8 3.7 1.2 1.0 3.8 2.2 1.9 1.7 1.0 0.8 2.1 1.9 0.8 2.4 1.7 1.5 1.8 0.8 2.0 0.9 1.7 6.9 1.5 0.5 1.9 0.2 2.3 0.7 4.8 1.4 10.6 1.2 4.3 0.8 1.8 5.6 1.9

4,985 27,111 2,877 8,401 242 1,022 894 545 919 248 294 8,294 589 905 984 697 4,453 585 133 217 232 987 126 103 240 124 262 308 135 625 9,568 637 137 193 193 1,748 137 289 201,120

2.5 13.5 1.4 4.2 0.1 0.5 0.4 0.3 0.5 0.1 0.1 4.1 0.3 0.4 0.5 0.3 2.2 0.3 0.1 0.1 0.1 0.5 0.1 0.1 0.1 0.1 0.1 0.2 0.1 0.3 4.8 0.3 0.1 0.1 0.1 0.9 0.1 0.1 100.0

20.0 19.1 19.1 18.6 18.5 18.4 18.1 17.9 16.6 15.7 14.8 14.2 14.0 13.6 13.4 13.0 12.7 12.4 11.8 11.7 9.9 9.8 9.3 9.1 9.0 8.1 6.9 6.7 5.9 5.9 5.8 5.7 5.4 4.7 4.4 3.9 3.8 2.2

Note: Payback Ratio = Market Capitalization of 1997 divided by sum of five years profit from 1998-2002. CE = Capital Employed

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Wealth Creation Study

N O T E S

For more copies or other information, contact Motilal Oswal - Inquire Phone: (91-22) 22812500 Fax: (91-22) 22885038. E-mail: inquire@motilaloswal.com

Institutional: Navin Agarwal.

Retail: Ravi Chadha, Manish Shah, Mihir Kothari

This document is for information purposes only. In no circumstances should it be used or considered as an offer to sell or a solicitation of any offer to buy or sell the securities or commodities mentioned in it. The information in this document has been obtained from sources believed reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

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