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Equity Valuation Techniques
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manish_okhade
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Quote manish_okhade Replybullet Topic: Stock valuation technique
    Posted: 04/Apr/2009 at 10:02am
In this forum i am trying present my thoughts on stock evaluation. Hoping that it will attract senior members in Investing field to comment and advise if i am wrong anywhere. Though i have greatly benefited so far using this simple technique as of now.  Note that it's never been multibaggers but returns were dec ent i.e. 20-30% per annum.
 
There are follwoing aspects to be considered:
 
1) Qualitative aspect - Its based on pure understanding of business fundamentals. Sheer judgment is entirely based on one's knowledge of the associated macro factors like scalability, moat, Mgmt quality etc. Best way is to read and read and read more to be judgmental here.
 
2) Special situation - Like present TATA Steel, Jet airways, infrastructure companies. I find these are pure high risk calculated bets. One must put a small % of portfolio not to exceed >5-10%. Again evaluation of these companies is very tricky, yet unable to find a logical way to evaluate them , quantitatively one can but not qualitatively as again its very subjective issue.
 
2) Quantitative aspect - Good metrics like high RoE, Low Debt, Increasing profit margin etc to be consdered. But if we consider the business which is old and consistant in average earning (Marioco, Brittania etc) then following method helps, Brittania is considered below:
 
Mar '04
Mar '05 Mar '06 Mar '07 Mar '08
EPS
47.33 62.26 61.26 45.02 79.92
CAGR % 13.99%
P/E by 2012 15
EPS Growth rate 10%
2009 2010 2011 2012
EPS 87.912 96.7032 106.3735 117.010872
Prise by 2011 1755.16308
Current Prise 1435
CAGR 6.94%
Target/Buy Prise 1150
CAGR 15.13%
P/E - FY12 9.82814657
 
In above method its assumed that past data can be correlated to future growth (Biggest wekness of this method but works with seasoned companies well).
 
So if i buy Brittania at target cost of 1100-1150 then i am buying it at P/E of 9.8 in FY12 which is by any means a cheap as Brittania is assumed be never go so low in PE and it assumed to maintain its very realistic worst case EPS growth rate of modest 10% which is 4% less than last 5 yrs CAGR.
 
How above workes? Read below:
 
In past one year
52wk H/L (Rs) 1519.85 - 991.25
 
So if i buy Brittania at 1100-1150 and sell it when P/E shoots to unrealistic high of 25+ then i guess i am not loosing the money.
 
I find above simple and pretty neat to estimate fair prise with inbuilt safety. Only thing is it fails with small cap which is exploding in P/E by 80-90% per annum like TITAN.
 
Moreover above investment is considered with a horizone o 3 yrs (or as rightly said short term failed investment is long term investment Smile).
 
 
 
 
 


Edited by manish_okhade - 09/Apr/2011 at 11:35pm
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basant
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Quote basant Replybullet Posted: 10/May/2009 at 3:22pm
Interesting. Seems I missed this post. Actually I also employ a similar technique just that I use RoE/ RoCE as a guide to indicate whether the growth that we are assuming will come alomng or not.
 
Though estimating the future is risky but it is important to be approximately correct then precisely wrong.
 
Plus if we are analysing cyclical services we can use Dividend yield to protect the downside and RoE to indicate growth. When we get such stocks at a PE of 20% of RoE then the possibility of making money outwerighs the probabilty of losing it.
 
 
'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in
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Quote subu76 Replybullet Posted: 10/May/2009 at 3:50pm
Basant Sir,
 
But wouldn't you expect the ROEs of cyclical companies to fluctuate wildy? After all that's what cyclical industry is all about.
 
My understanding is that for cyclical companies P/BV is what Graham type value investors look at.
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Quote subu76 Replybullet Posted: 10/May/2009 at 3:59pm
Originally posted by manish_okhade

But if we consider the business which is old and consistant in average earning (Marioco, Brittania etc) then following method helps
 
Hi Manish,
 
Based on my theoretical reading:
 
Your preference for quality and predictability is the way to go....it's very hard to lose in these stocks if bought at reasonable p/e. You will underperform the market during bull phases but then such investors are focused on absolute returns rather than relative returns. This is the way to create long term wealth IMO.
 
Valuing long time businesses in non cyclical areas where there is'nt a lot of churn or new players (like say VAS is) is probabily simpler and more realistic.  
 
One metric that you might want to add more explicitely in your studies is 10 year ROE. I think that's what you meant when you referred to earnings increasing at a consistent rate.
 
Originally posted by manish_okhade

Special situation - Like present TATA Steel, Jet airways, infrastructure companies. I find these are pure high risk calculated bets.
 
One point here is that Graham type value investors who really really abhor losing money (more than they want to make money) try to avoid companies with financial risk at all costs. Allmost all the folks interviewed here  http://www.bengrahaminvesting.ca  say the samething.
 
My understanding...again based on theoretical reading is that special situation is not about companies facing a cyclical downturn..like Tisco is....that is normal business cycle. Special situation is a company facing temporary headwinds which will not have any long term impact..e.g ITC tax case, Phaneesh Murthy episode in Infosys, Reliance brother slugging it out, Brittania/Danone board room battle etc.
 
Another aspect (again theory) ...that you referred to somewhat tangentially...is relative valuation. How is the stock valued relative to it's peers, to the entire market in terms of p/e, p/bv,p/cash flow etc. It has been observed that for large well followed companies valuation differences are made up quicker than for smaller ones.


Edited by subu76 - 10/May/2009 at 4:31pm
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basant
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Quote basant Replybullet Posted: 10/May/2009 at 4:58pm
Originally posted by subu76

Basant Sir,
 
But wouldn't you expect the ROEs of cyclical companies to fluctuate wildy? After all that's what cyclical industry is all about.
 
My understanding is that for cyclical companies P/BV is what Graham type value investors look at.
 
We are buying cyclical services and not cyclical commodities. So companies that serve cyclicals do not see that kind of volatity as the cyclical comapnies themselves. Also buying a 40% RoE company at 6 times PE when the whole world has cracked up brings enough margin of error on the table and that is why we look at payout also.
 
Some examples of cyclical services are Voltas and  Blue STar for Retail and Real estate; Thermax for Steel, Power and Cement; L&T for construction and infrastructure,
 
These are  companies who serve the main segments and can choose to do or not to do business with any of them. ALso we look at the RoE for the last few years and take a weighted average rather then buying them on the basis of one year's RoE.
 
'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in
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manish_okhade
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Quote manish_okhade Replybullet Posted: 10/May/2009 at 9:01pm
Hi Subu,
 
"One metric that you might want to add more explicitely in your studies is 10 year ROE. I think that's what you meant when you referred to earnings increasing at a consistent rate."
 
10 yr RoE is fine as per WB teachings when you are looking for life time stocks. I tried this but the companies which meet this criteria are not looking very interesting to me e.g. Bharat Electronics. In USA there are many businesses who have long term clout but in India at least i find it hard to spot such types of companies. India has yet to mature in terms of having very very long term players. Isnt US democracy is 500 yr old!!!
 
So i focus more on 3-5 yr horizon only so not look at past 10 yr RoE but if its readiyly available the definitly good to glance.
 
"Another aspect (again theory) ...that you referred to somewhat tangentially...is relative valuation."
 
What i mean here if you try to see bargain in tough situation still good and safe stocks are not available cheap in terms of business metrics like P/E, P/B etc. so one has to look at relative past evaluation. For example Marico used to trade at P/E of 30+ in bull and in strong bear phase it came down to P/E of 20+ which is again not cheap but if your calculation for growth rate is realistic then only it looks cheap. 
 
Thanks for sharing the url, it s good.
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Quote subu76 Replybullet Posted: 10/May/2009 at 12:05pm
Hi Manish....
Thanks for your clarifications. I think your points about the shalowness of out markets makes sense.
 
Do have a look into the wealth creators reports from Motilal Oswal guys. It's a great read.


Edited by subu76 - 10/May/2009 at 12:14pm
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Quote subu76 Replybullet Posted: 10/May/2009 at 12:12pm
Originally posted by basant

 
Some examples of cyclical services are Voltas and  Blue STar for Retail and Real estate; Thermax for Steel, Power and Cement; L&T for construction and infrastructure,
  
 
Wah Basantji...a blue chip like L&T at PE around 10 is a great choice.
 
IMHO the L&T stock selection mirrors WB's selecton of GE.
 
 
 


Edited by subu76 - 10/May/2009 at 12:42pm
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