The never-ending search for "Alpha" continues...
In their ever-present quest for returns; investors, fund managers and the entire investing community look for stocks that can give an extra edge to the portfolio. The website Investopedia defines "Alpha" as "a term used in investing to describe a strategy's ability to beat the market. Alpha is used in finance as a measure of performance, indicating when a strategy, trader, or portfolio manager has managed to beat the market return over some period."
People go to great lengths to earn "alpha", some even take undue risks and ruin their returns in the process. Hence, it becomes of paramount importance to generate alpha without taking undue risks.
Look no further; a colorful answer is here!
Few stocks or sectors can boast of constantly beating benchmark indices over long periods, like paint stocks do. Paint sector in India is worth Rs. 500 bn (Source: Asian Paints FY20 Annual Report). According to industry experts, it has grown at 10% CAGR over past 15 years. This is much faster than global growth rate of 2% CAGR. Paint industry in India is second largest in Asia after China and 7th largest globally.
While there exists no index (sadly!) that exclusively tracks paint companies, we have plotted returns of all four major paint companies. We have considered following four paint companies:
- Asian Paints (APNT)
- Berger Paints (Berger)
- Kansai Nerolac (Kansai)
- Akzo Nobel (Akzo)
We have chosen these four companies as they constitute ~70% of total paint industry.
If we look at the chart below, we see that returns of all four companies have individually beaten SENSEX over long term periods - 5 yr and 10 yr CAGR.
Source: Asia Index Private Limited, Screener.in
Even if we extrapolate this comparison to all major BSE sector indices, we find that paint companies win the race hands down. No index even comes close!
No wonder paint company stocks can be considered as the best stocks to buy today.
Source: Asia Index Private Limited
Let us examine reasons for this stand-out performance. These are also the reasons we believe that outperformance will continue for a long time.
Sector and macro-reasons
Per capita paint consumption in India (3.3kg) is among the lowest in the world - global average 15kg, Germany 18kg, USA 10kg, China 13kg, etc.
Rapid urbanization has led to up-trading from cement paints, lime paints and distempers to emulsions. Urban dwellings generally use paints rather than limestone, mud, etc. that is used in rural areas.
Steady shift in market from organized to unorganized players post GST implementation. Initial GST rate of 28% applicable to the industry was subsequently toned down to 18%.
Repainting of homes is more of a sentimental decision for Indians and repainting before festive period or weddings is considered to be socially important.
Paint companies are entering auxiliary segments such as water-proofing solutions, adhesives, putty, wood finishes, etc. Most of these segments are under-penetrated, leaving scope for organized sector penetration and subsequent premiumization.
Categories like paint involve significant expenditure on part of consumers; hence consumers (especially urban) aren’t willing to risk ruining their walls or interiors by using sub-standard coatings.
Company-specific or financial reasons
- Given that paint sector in India is an oligopoly (4 players dominate the industry), there is a tendency not to under-cut each other. Called as a "tit-for-tat" strategy, it helps all companies to grow in their markets of dominance without injuring the other player.
- Asian Paints is dominant player in organized paints segment in India with 59% market share. It is the price maker in decorative segment and other players simply follow suit.
- "Competitive collaboration" in pricing helps all companies shield themselves against variations in raw material prices.
- Each company has established a niche for itself either in products or strategy.
Presence across all price points
Through its high R&D spends, APNT has won the battle of “perception” among its target audience – customers and painters
APNT has increased focus on lower-end products to eliminate unorganized and marginal players
It has also extended into categories such as home improvement and adhesives
Its premium products are cheaper compared to competition
Berger has expanded its product offerings to specialty liquid coating, wood coating and construction chemicals
Berger has expanded to lesser geographies globally and turned them profitable rather than spreading itself thin at the cost of imprudence.
The Indian entity leverages its parent’s expertise in and client relationships with automotive OEMs
Consequently, Kansai commands 60% market share in automotive paints and 40% market share in powder coatings
Given the sticky nature of industrial client relationships, it creates entry barrier for new entrants
Kansai has ramped up its A&P expenses to 8% of revenues against ~4% for competition to establish its brand presence
Company has focused more on premium products with its brand “Dulux”.
Akzo Nobel’s parent is the world’s largest paint company, hence the Indian entities piggybacks on the parent’s R&D and technological prowess
Paint company stocks in "goldilocks" zone - Low risk and high returns are the reason why they can be considered as the best stocks to buy today
Owing to the reasons mentioned above, paints stocks offer a low-risk, high return way of long-term wealth creation. These are not just "defensive" stocks but those stocks that offer "superlative" returns and "all-weather" performance. There are a few stocks/sectors which offer such a combination. This is not to say that other stocks/sectors don’t offer opportunities for wealth creation. But paint stocks are a "must-have" in your portfolio if you are keen on generating that alpha. The key is to decide which of the four and at what price. You may leave this part to us (at Research & Ranking) and paint your portfolio green!
Click here to invest in a well-researched portfolio of 20-25 best stocks to buy today for long term wealth creation.