Last Updated on December 29, 2021 at 4:51 pm
When it comes to stock selection, two questions are always on the top of my head: (1) Is there a simple way to find out how good a business is? At least I must be able to identify stocks that I should not invest in. If I can do this in a visual manner from balance sheet data it would be awesome. (2) Is there a way I can identify a good business from price information alone?
The Earnings Power Box by Hewitt Heiserman Jr is the answer to the first question (in my opinion of course) and low volatility investing is the answer to the second. In this article, I present the Earnings Power Box graphs for the top 10 stocks of Nifty Quality Low Volatility 30 Index based on the free stock analysis spreadsheet to value stocks in multiple ways!
As readers may be aware, I am a fan of strategic indices, also known as smart beta indices, also known as factor-based indices. Factor investing is when one or more criterion like alpha, quality, low volatility, value are used to build a basket of stocks. This could simply be an individual stock portfolio or an index on which a mutual fund or ETF is based on.
- Are Nifty Smart Beta (strategic) Indices better than the Nifty Next 50?
- Low volatility stock investing: Does it work? Higher returns at lower risk?
Momentum investing where stocks with a recent price increase is also a type of factor investing: Momentum Stock Investing in India: Does it work? At least in the large cap segment, there is a strong correlation between momentum and low volatility investing.
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What is NIFTY Quality Low-Volatility 30 Index?
This has 30 stocks from NIFTY 100 and NIFTY Midcap 50 indices. Stocks with low price volatility in the last 365 days and higher profitability (ROE), lower leverage (debt to equity) and stabler earnings (EPS growth) are part of the index.
These are the top stocks of this index as on May 31st, 2019
- HDFC Bank Ltd. 5.82
- Hindustan Unilever Ltd. 5.00
- ITC Ltd. 4.91
- Wipro Ltd. 4.66
- Infosys Ltd. 4.61
- Britannia Industries Ltd. 4.49
- Asian Paints Ltd. 4.47
- Tata Consultancy Services Ltd. 4.27
- Marico Ltd. 4.00
- Housing Development Finance Corporation 3.79
The stocks in red (50% of the top 10) are also part of the Nifty 100 Low Volatility 30 Index – 30 stocks from Nifty 100 with low price volatility in the last 365 days. I could have just gone with the low volatility index for this study but figured another factor like quality is a bit more aesthetically appealing!
What is Hewitt Heiserman Jr.’s Earnings Power Box?
This is a plot of two metrics: the Defensive EPS (earnings per share) vs Enterprising EPS. The idea is to spot where a company falls in. 
This is based on the Earnings Power Valuation Model (doc file) and it was developed into an Excel calculator by Rs. Srivatsan. His guest post is a good starting point to understand the idea: It’s Earnings That Count: Forget the next Infy; Can you identify the next Satyam?
Srivatsan has defined enterprising and defensive EPS as follows:
Enterprising EPS = (Enterprising Income)/(Shares Outstanding)
Defensive EPS = (Defensive Income)/(Shares Outstanding)
Enterprising Income = Net Income – (15% x total capital)
15% here is the weighted average cost of capital (WACC) and is an expected return. You can modify this for each FY and for each stock in the free stock analysis spreadsheet
15% x total capital = enterprising interest.
Defensive Income = Free Cash Flow – change in working capital since last FY.
For more commentary, see Pros & Cons of Finding Stocks with Earnings Power for Long-Term Profits.
This method was earlier used by Lokesh to identify 50 stocks with solid earnings power: Ability to self-fund and create value
So once we plot the graph it is a simple matter to check in which quadrant the data points lie and how it has changed with each financial year. In the graphs below, the year refers to March 31st of the corresponding financial year.
HDFC Bank
Hindustan Unilever
ITC
Wipro
Infosys
Britannia Industries
Asian Paints
Tata Consultancy Services
Marico
Housing Development Finance Corporation
Summary
- HDFC Bank: For conservative investors, generates cash but not above weighted average cost of capital
- Hindustan Unilever: Great business with authentic earnings power
- ITC: Great business with authentic earnings power
- Wipro: Same as HDFC bank
- Infosys: Same as HUL, ITC (almost)
- Britannia Industries: As Infy
- Asian Paints: Same as HUL. ITC
- Tata Consultancy Services: Same as HUL. ITC
- Marico: Has moved to a better spot in recent years
- Housing Development Finance Corporation: More aggressive than the rest but not a bad buy per se
I hope you would agree that factor investing and a simple price based investing is a wonderful way to spot good businesses without worrying balance sheet jargon. Naturally, it would not be fool-proof but is a simple way to buy stocks without breaking our heads.
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