Clearly, India’s private sector is doing something right. Despite the doom and gloom nature of public discourse on the subject, the numbers seem to tell a different, more upbeat, story especially when analysed over a long timeframe. Between 1990 and 2012, the market capitalization of top 25 companies increased at a compound annual growth rate (CAGR) of around 25% to reach $576 billion. This increase made India the ninth-largest global market—a stellar achievement compared with the 9% CAGR of the top 25 NYSE-listed companies over the same period. Interestingly, despite a healthy gross domestic product growth in India of around 17% between 2010 and 2012, markets have remained generally flat for the past two years.
In order to understand the dichotomy between public perception and actual performance, it is useful to analyse the market performance over last two decades. This historical appreciation enables a deeper and more accurate understanding of how and where the private sector has created value.
Consistency and resilience have been the most important characteristics of companies involved in the private sector’s value creation story since 1990. The following decades have seen their share of high-performing “shooting stars” that have been brought back to earth with a thud by the end of the period. Nearly 75% of the companies that found a place in the top 25 list in terms of market capitalization in 1990 had fallen off the table by 2000. Fifty per cent dropped out in the following decade.
Over a 20-year period, only nine companies have managed to remain consistently in the top 25. Resilience is also a rare quality. From 2000-10, not one of the 14 companies that slipped out of the top 25 was able to regain its position. Given how difficult it is to regain momentum, the issue is how should one identify early warning signs? Perhaps precisely because of these challenges, the Indian market has amply rewarded firms that are consistent and resilient. They account for a disproportionate share of value creation with these nine Indian firms accounting for 48% of the total market capitalization in 2010.
Another feature of the consistent performers is that they have very low volatility of returns when compared with the overall market. The Indian market has not seen consistent value creation from stocks with comparably more volatile returns. Thus, trying to consistently pick a low volatility-high value creation stock (multi-bagger), is a tricky approach.
Eleven out of 22 sectors accounted for 85%of the market capitalization of the top 500 firms. Of these, three sectors alone (materials, software and services, and energy) have accounted for around 45% of the market capitalization in the past two decades. In this scenario, the question is how can multi-business conglomerates and investors select the “winning” sectors.
Added to this challenge is the phenomenal growth of listed public sector units (PSUs). Today, PSUs account for around 40% of the market capitalization of the top 25 companies, up from just 10% in 1990. This indicates a clear upward trend in their fortunes driven by continued monopolies, privileged access to resources and huge transformation efforts. It is, therefore, critical for investors to examine the unrealized value creation potential in the remaining unlisted PSUs, and how listing these might change the dynamics of the Indian bourses.
Existing family businesses are another source of potential value creation. In 1990, enterprises controlled by the top five business families made up more than a quarter of the total market capitalization. Currently, the figure is at a still-robust 17%. These groups have historically extracted much of their market value from their flagship firm. Looking ahead, the question is whether family conglomerates will finally turn their attention towards maximizing the potential of their non-core companies. A change of thinking in this area will have a significant impact on future value creation.
Toshan Tamhane is a partner, and Adil Zainulbhai is a senior partner and chairman at McKinsey’s India office.