MARCELLUS CCP

IAPM Assignment

Group 7 - IAPM (C)

Muskan Nandrajog - A007
Rashi Agrawal - B006
Abhishek Deswal - B036
Tushar Chawla - I010
Meghna Talreja - I024
Angad Sehdeva - I036
Q.1. What is the core investment philosophy and portfolio selection process of
Marcellus CCP ? What is your take on it?

Marcellus Consistent Compounder Portfolio, launched in 2018, is a PMS strategy that invests
in a concentrated portfolio of heavily moated that project healthy earnings and growth over a
long-time horizon.
The aim is to contribute money into smaller number of companies that generate robust and
healthy earnings over a long period of time with low volatility.
They select high-quality companies with strong pricing power, which helps maintain a
significant difference between returns on invested capital and cost of equity.
The fund managers use in-depth primary research, quantitative frameworks such as forensic
accounting and capital allocation assessment to select companies from the wide index and
further shortlist the companies based on healthy cashflows and proven track records.
The basic idea is to hold the stocks for longer periods of time with little or no churn.
The two-stage process involved in selection of the investment portfolio are-
1. Filter based approach- Use of twin filters of Forensic Accounting Screening and
Fundamental Parameters such as ROCE, revenue growth etc to shortlist an investible
universe of 30-35 stocks. It focuses on identifying cash generating companies with
potential to grow rapidly.

2. In-Depth Bottom-Up Research- In-depth bottom-up research is conducted to assess

competitive moats to build a portfolio of investable stocks. The fund looks over the
current competitive advantage of the companies like their Moat score as well as their
Free Cash Flow growth rate along with revenue growth. Along with assessing the
current scenario they also asses the longevity and sustainability of the current
advantages of the companies.
In our opinion, the fund not only has companies that are clean in terms of accounting but are
also market leaders in their respective industries. Moreover, the fund focuses on companies
FCFE compounding that has been healthy, consistent and accelerating.
Marcellus CCP has created strong entry barriers for their competitors through their brand
equity and strategies. The companies selected by the fund have created moats for several
years which are difficult to break. A well-researched portfolio of 12-15 stocks is a low risk
bet to earn massive wealth over the long run.
The company’s selection process of is advantageous as it suggests that through its twin
filtering it can construct a portfolio that gives 20-30% annual returns along with better return
than the index and by holding it for a long period it displays the volatility similar to a Govt
bond.
Marcellus’s Longevity Framework includes four components-
1. Free Cash Flow Growth- Assessing the reliability and quality of their cash flows

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2. Moat Score- Assessing their competitive advantage
3. Lethargy Score- Assesses the efforts made by the company in the last three years to
deepen their moats and to expand it
4. Succession Planning Score – Assessing the future of the company’s senior
leadership position and the passing of the baton to the next generation
These steps ensure clean, healthy, cash generating and competitive companies that have
potential to create enormous wealth in the long run.
The fund along with filters uses the expertise of the managers to avoid portfolio
concentration, historical inconsistencies and excusable blips to construct a portfolio of
ultra-high-quality stocks.

BSE500

Twin Filters- Forensic

Accounting and Fundamental
Parameters

Bottom
-up
In-
Depth

Analys
is

12-15 Consistent
Compounders

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Q.2. Explain and Analyze Marcellus Longevity framework. Why and How did they
decide to exit Marico and Abbott?

Marcellus’s Longevity Framework includes four components-

1. Free Cash Flow Growth- Assessing the reliability, quality and growth of cash
flows through metrics like:

a. Revenue growth
b. ROCE
c. Capital reinvestment rate

2. Moat Score- Assessing competitive advantage and strength of today’s pricing power

3. Lethargy Score- Assesses the efforts made by the company in the last 3 years.
Three aspects of lethargy tests are:

a. Incremental deepening of existing moats

b. Investments towards adding new moated revenue growth drivers
c. Attempts at radical disruption of industry’s future

4. Succession Planning Score – Assessing the future of the company’s senior

leadership position and the passing of the baton to the next generation

Reasons for exiting Abbott:

a. Market share loss in key products like Duphaston and Thyronorm.

b. Low visibility on new product pipeline in foreseeable future to offset the weakness in
some of its existing products like Duphaston, Thyronorm

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 c. High churn in top management layer
d. Increased in Marcellus’ conviction on ICICI Lombard’s competitive advantage

Reasons for exiting Marico:

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Q.3. How does Marcellus make exit calls from portfolio stocks that ideally are meant to
be held for a long time?

Marcellus CCP identifies a portfolio of 12-15 investable stocks with high pricing power that
helps them keep a wide gap between the returns on capital and the cost of equity. The
portfolio delivers healthy returns and volatility as low as a government bond.
The investment decision depends on the twin-filter based approach that screens stocks based
on forensic accounting filters and fundamentals for sustainability. Post that further
shortlisting is done through in-depth bottom-up research of each company to find ultra-high-
quality stocks.
Marcellus’s Longevity Framework includes four components-
1. Free Cash Flow Growth- Assessing the reliability and quality of their cash flows
2. Moat Score- Assessing their competitive advantage
3. Lethargy Score- Assesses the efforts made by the company in the last three years to
deepen their moats and to expand it
4. Succession Planning Score – Assessing the future of the company’s senior
leadership position and the passing of the baton to the next generation
The difference between ROCE and COE is the firm's free cash flow to shareholders. If these
organisations are able to maintain this large disparity while simultaneously increasing their
capital employed, they will continually provide a robust profits growth over extended periods
of time, independent of changes in their internal or external operating environments.

The aim is to hold the stocks for a long period of time to generate enormous wealth.
The fund aims to hold the stocks for a long-time horizon of 8-10 years, where it can earn
healthy returns and display volatility similar to that of a government bond. The portfolio
benefits from the size, tenacity, and resiliency of Indian middle-class households by
participating in the evolution of their basic day-to-day demands.

The portfolio managers do not believe in timing the market or share price movements.
Moreover, the shares held by the fund have a lower correlation of the share prices with the
broader market movements.
The Consistent Compounders portfolio is based on the premise that the portfolio's average
annual earnings growth is likely to remain healthy regardless of changes in the external
environment, and that short- and long-term P/E movement is not a significant contributor to
the portfolio's healthy compounding rate.
However, the strategy has certain factors that drive its sell decisions-
 Longevity- Exiting a stock because of a decline in the Marcellus research analysts'
assessments of the company's competitive edge and strength.

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 Portfolio Concentration- Optimising portfolio concentration through an exit when a
new stock is added to the portfolio because of a rise in conviction regarding the
competitive advantages' strength and duration of the new firm
 Rebalancing- The process of selling certain shares of stock as part of a portfolio
rebalancing in order to be consistent with the belief in sustainable fundamentals of the
stock in comparison to the fundamentals of other stocks in the portfolio

The PMS Strategy incorporates the fact that high ROCE companies provide competitive
advantage over others and provides a healthy growth rate. However, a high ROCE is not
the only factor. The most efficient way for a company to have a sustainable compounding
effect on its profits is to have a high ROCE along with a high rate of capital reinvestment.
In the recent times, the fund has exited several stocks-
 Marico (2020)- There was structural deterioration in growth prospects of the
company along with elements of lethargy in certain segments
 Abott (2022)- Loss in market share along with high churn and low visible future
product pipeline

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Q.4. What makes Marcellus disregard PE multiple while making investment decisions?
Do you agree with such approach?
At Marcellus, they consider the price of a stock to be a function of its P/E multiple and
earnings. The P/E multiple is non-compounding and oscillating in nature whereas the
earnings can compound over time.
Marcellus believes in investing in stocks that have superior earning growth over the long
term. The P/E ratio does not indicate two critical elements that may decide a company’s stock
price in the long run – the reinvestments required to expand the business of a company, and
the longevity of cashflows from operations of the company. In their Consistent Compounders
Portfolio (CCP) they highlight that CCP’s outperformance is correlated with superior
earnings growth which indeed is driven by high ROCE and high reinvestment rate.
Moreover, they have used data to show that for stocks in the BSE100 universe they found no
significant correlation between their starting period valuations and their long-term
returns. This data was collected and analysed for different phases of the market –
 Phases with rapid P/E expansion
 P/E compression
 Strong earnings growth
 Weak earnings growth
It was observed that no matter the phase of the market, there was strong correlation
between earnings growth rates and share price returns. Therefore, if an investor can build
a portfolio consisting of consistent compounders, such a portfolio would outperform the
broader market and deliver healthy returns in all types of market phases regardless of the P/E
multiples.
We agree with Marcellus’ approach of focusing on strength of companies to produce
compounded earnings instead of looking at P/E multiples. Apart from the lack of correlation
between the stock’s earnings growth rates and their starting period valuations, there are
various other drawbacks too for valuating stocks by just looking at their P/E in isolation like:
 Susceptibility of the P/E ratio to manipulations in earnings reported by companies.
 Companies engaging in serial acquisitions can have boosted profits inflating their P/E.
 Inflated revenues lead to inflated profits which can lead to inflated EPS figures and
therefore incorrect P/E ratios.
 Interest rates also impact the P/E ratio as seen recently when historically low interest
rates provided a booster dose to company’s earnings thereby skewing their P/E ratios.
 Non-operating cash flows like sale of any asset or strategic one-time sale leading to
one-time cash flow which ultimately will lead to high P/E ratios.
 Moreover, by focusing purely on P/E an investor will certainly rule out investing in
currently loss-making company even though there might be potential for turnaround
in its story.
In conclusion, there is no single P/E level that may explain the attractiveness or the lack of it
of a stock. The P/E ratio is to be used along with other factors like expected earnings growth,

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changes in business environment and strategy and the ability of a company to tap the always
growing opportunities.
Q 5. Overall, do you see Marcellus CCP have an edge over market? Will it outperform
broader market in future? Why?

Yes, we think Marcellus CCP has an edge over the market and will outperform the broader
market in the future. The following points highlight what we think is essential to their
outperformance strategy.

Why is their philosophy effective?

As discussed above, the investment philosophy trims companies at various levels to ensure a
healthy combination of 12 – 15 companies by identifying red flags. Forensic Accounting
ensures companies with inherent governance and accounting issues are removed from
consideration. Sustainability filters help identify investments with longevity, growth
prospects and high cash generation avenues. Their in-depth bottom-up research filters
companies with a clear vision driven by the management and ensures proper adherence to
earnings guidance. On-ground 3rd party checks and frequent management meetings give
them the true reality of a company and help avoid deceptive reports. All these factors
combined will help the fund manager drill down to 12-15 consistent compounders giving
phenomenal returns to an edge over the market.

How have they outperformed?

With their focus on above strategies, we can co-relate their share price and earnings growth to
their choice of benchmark, Nifty 50. For Share price, they have been consistently
outperforming the market since their inception by a huge margin. Since Dec 2018, Marcellus'
CCP portfolio has increased in value by 24% CAGR compared to Nifty 50's 14% CAGR
(using their current portfolio allocations). As Warren Buffett said in April 2022, he blamed
the financial industry for motivating risky behaviour among investors, and he finds
speculative bets "obscene". In FY21, Marcellus CCP has been underperforming the index a
tad bit due to the obnoxious environment.

Their Exit strategy

Marcellus' executives have developed an extraordinary exit plan based on the company's
strength and overall sustainability in comparison to its competitors. As per Marcellus' belief,
they either entirely or partially quit a stock in order to rebalance their portfolio based on the
fundamentals of a particular stock in relation to the fundamentals of other companies within
the portfolio. When a company's moat factor in the industry changes, they tend to rebalance
and re-organize their portfolio accordingly.

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How do external interactions effects fund value?
Because they invest in dominant franchises with ROCEs of approximately 40%, they are
drawn to firms with uninterrupted free cash flows. Most importantly, if Marcellus notices
these free cash flows being hoarded or transferred into unrelated ventures, they will interact
with the promoters to better understand their capital allocation. If they are not convinced by
their allocation plan, Marcellus provides a new allocation approach to them. If the firm does
not follow the planned allocation strategy within six months, they will contemplate quitting.

Apropos the aforementioned points, we strongly believe Marcellus CCP will have an edge
over the market in the foreseeable future.

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Annexures :

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