Good businesses. Better numbers.

Summary: Great businesses rarely announce their transformation loudly; the shift first appears quietly in the numbers. This story explores how improving margins and capital efficiency can reveal companies that are evolving from merely good businesses into far stronger and more valuable ones before the market fully recognises the change.

Summary: Great businesses rarely announce their transformation loudly; the shift first appears quietly in the numbers. This story explores how improving margins and capital efficiency can reveal companies that are evolving from merely good businesses into far stronger and more valuable ones before the market fully recognises the change. “Good is the enemy of great.” Jim Collins, an American author best known for his management classic Good to Great, wrote these words in 2001. They have since become perhaps the most quoted line in business literature. Fund managers invoke it in presentations, managements borrow it in annual reports. And yet for all the agreement around the phrase, few investors have the answer to the question it raises: If good companies can become great, how does one find them? Many believe in relying on instinct. Studying management, reading annual reports, attending concalls and watching the business closely. Over time, that may help one develop a feel for when a company is changing. But pure instinct, without a framework, is hard to repeat and even harder to fully rely on. Busy investors cannot track every promising business in that depth. Therefore, a framework that shows when a business crosses over from good to great is not only useful but also imperative. We have developed, tested and applied our own in this story and unearthed a list of stocks that could be the market’s next GOAT(s). Where greatness shows up The two most telling financial indicators are margin expansion and rising capital efficiency. Others like revenue growth, cash flow and balance sheet strength, matter just as much, but they do not always reveal a business changing in character. A company can grow sales by cutting prices or improving cash flow by delaying investment. It can look busy without becoming better. Margins and return on capital employed, or ROCE, are harder to flatter for long. When both improve together, they hint at something more powerful: the company may have gained pricing power, moved into better products, crossed a scale threshold or entered a more profitable line of business. This is when the business is not just expanding but actually improving. Such shifts rarely occur in a single quarter. They build over the years and are usually the result of a deliberate change in strategy. The market, anchored to what the company used to be, is often slow to recognise what it is becoming. That lag is where the opportunity lies. Proof in the return payoff To test whether spotting this dual inflexion actually generates superior returns, we ran a historical backtest. For each year starting FY16, we looked for companies (with a market cap of above Rs 500 crore) where the following two things took place together: Average operating profit margins had improved over the last two years compared with the preceding three years. Average ROCE had risen by at least 300 basis points. We then built an equal-weighted portfolio of such companies at the end of every financial year and tracked its performance over the next five years against the BSE 500. This was done on a rolling basis, spanning all possible five-year windows across FY16-25. In simple terms, for the 2016 to 2021 return period, for instance, we selected companies whose margins and ROCE had improved on average over FY15 and FY16 compared to FY12 and FY14. We then measured how those stocks performed over the next five years. The logic was to find companies where the business economics had already started to improve, invest at that point and measure what happened next. A striking result: the strategy beat the BSE 500 in four of the five holding periods. Put differently, an investor entering this strategy at the end of any financial year from FY16 would have had an 80 per cent chance of beating the market, often by a handsome margin. Improving margins and capital efficiency over a period, therefore, signal that something meaningful may be changing inside the business. Spotting this point of change and investing at the right time has been shown to deliver handsome returns. Once you spot such a business, the next thing to validate the thesis is to assess what is driving the change.  Case studies in how good gets better 1) Navin Fluorine is a good example of moving up the value chain. Its mainstay was refrigerant gases, a cyclical, commoditised business with margins that had a ceiling. In FY13, refrigerants accounted for nearly 60 per cent of revenue, and operating margins were just 13 per cent. It was a good business, but not a great one yet. Then the mix began to change. The company gradually built its speciality chemicals business and a contract research and manufacturing services (CRAMS) business, for global customers, seeking complex chemistry partners in India. By FY25, these businesses had become far more important, while refrigerants accounted for only 43 per cent of revenue. Operating margins had risen to 25 per cent, almost double the FY13 level. ROCE moved up as well. This was not a fluke. The business slowly became more valuable. The numbers showed the direction before the market fully rewarded it. 2) Solar Industries is the other kind of story. For most of its life, it was India’s largest manufacturer of commercial explosives. It supplied to mines, quarries and infrastructure projects. The business was solid, cash-generative and respectable. Then, the defence changed the plot. India’s push for domestic defence manufacturing opened a large new earnings pool. Solar had the rare combination needed to enter it: explosives expertise, manufacturing capability, regulatory approvals and a long record of reliable supply. As defence contracts scaled, the company’s economics improved. Defence is structurally more profitable than the commercial explosives market. Buyers are less price sensitive. Entry barriers are higher. Competition is limited by technology, approvals and trust. ROCE, once in the low 20s, climbed towards 40 per cent. Neither of the two companies announced their transformation with a drumroll. The change first appeared in the business mix, margins and capital efficiency. Investors who noticed early were paid well. Pitfalls to stay clear of 1) Don’t mistake a cycle for greatness This is where investors can get trapped. At the top of a cycle, everything looks wonderful: margins and ROCE rise sharply. Then the cycle turns, and the apparent improvement disappears. Tata Steel’s FY21 and FY22 numbers are a useful warning. A global steel upcycle, driven by post-Covid infrastructure spending, production curbs in China and strong demand from construction and automobiles, sent steel prices sharply higher.  Tata Steel’s financials looked spectacular. EBIT margins expanded from 6 per cent in FY20 to 22 per cent in FY22. ROCE surged from 3 per cent to over 33 per cent. On a screen run in late 2021, Tata Steel would have looked like one of India’s great business transformations. But the driver was largely external pricing, not a permanent change in business quality. When Chinese production resumed and demand normalised, steel prices cooled. Margins compressed, and ROCE fell back. The stock gave up a large part of its supercycle gains. The lesson is to never stop at metrics alone. Ask what caused

This article was originally published on June 01, 2026.