The ART of Valuation


(Abhishek Basumallick) #212

The percentage will depend on the conviction you have on the company. If you are very highly convinced, then have a larger trailing stop. If less conviction, then a lower one. The idea is that you do not want to sell out if you really like the prospects of a company. However, you are using this as a tool to ensure you do not give up your gains if the overall market corrects and brings down your stock along with it.


(ishikaghose) #213

Understood! Makes a lot of sense. Have been wondering for a long time how to use one tool to set a “fair” price to sell. I will try and use this as one tool. Appreciate the time and promptness in replying


(vishal kumar) #214

A related question but maybe off topic:-

How to do averaging up in this case?
If conviction level is high and stop-loss is triggered(at 30%) do we consider it as buying opportunity ?
If conviction level is low…but business is promising…but near term risk is more…sell and wait for better price or?

Thanks


(Chirag) #215

As I understand the concept of “stop-loss” is used only in trading scenarios.

For an investor (not a trader) if the fundamentals of the company have not changed then a 30% lower price is an ever better buying opportunity.


(ishikaghose) #216

But as an investor I would not want to continuously invest in a single company. There comes a point when my percentage allocation to any particular company has reached the maximum. I would then try to book some profits. As Mr Basu Mallick has pointed out this trailing approach allows me to stay invested in the company and also try not to lose out on gains if the market corrects. My understanding.


(Chirag) #217

There comes a point when my percentage allocation to any particular company has reached the maximum.

I have been in this situation!

I thought of the following 2 solutions to mitigate it:

  1. I realized that i was buying with every 3 to 5 percent fall. That I realized was too small. So I decided to buy with every 10% fall.

  2. If the stock is falling try to time by waiting even longer. i.e. let the stock correct 25 to 30 percent.

Sadly #2 strategy did not work so well. Either I got impatient or missed many opportunities.

#1 is working well. I also consider the technical supports along with the 8 to 10% fall criteria.


(ishikaghose) #218

I suppose there are as many strategies as there are shares! I think we all have to try and see what works for our shares, our sentiments and our needs.


(Chirag) #219

Agreed

Main reason I share my thought process (scenarios) if to get comments/criticism from the forum members so that I can learn from others and augment the scenarios that I am trying to follow!


(Value Seeker) #220

This is my story as well! The trick is to have a reading of the market (+ Luck) to average down. Never an easy task and of course hindsight 20/20 is a b**** :slight_smile:


(Jaclyn) #221

Something which I experimented recently is to look for companies which are moving sideways for > 6 months, particularly those which trade at rich valuations.


(yourraj) #222

It is really nice thanks for exploring and sharing the TIP


(Arun S G) #223

Looking a year back since this post was made, the price of Astral has increased 100% since 2014-15 when this stock was sold.

Narration Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Trailing
EPS 7.02 6.41 8.43 12.08 14.62 15.73
Price to earning 35.71 72.11 50.64 46.30 63.31 60.62
Price 250.74 462.36 426.90 559.32 925.49 953.85

Another example of high PE stock discussed was Cera -

Narration Mar-15 Mar-16 Mar-17 Mar-18 Trailing
Price to earning 47.99 28.00 36.75 42.33 30.26
Price 2,496.60 1,796.85 2,938.09 3,262.79 2,380.70

Cera stock has essentially remained flat from March 2015 till now, although in March, it would have given a 25% gain in 3 years. In other words, Cera has undergone a time correction which is perfectly aligned with its stagnant profit in the same time period.

Astral on the other hand has risen over the same time period maintaining the high P/E, and the reason is not far to see. It has been able to grow its profit during the time 2015-18 over two and half times.

The message from market seems to be, as long as growth in profits is seen, high P/E can be maintained.


(Abhishek Jain) #224

hi all,
can i fetch the historical PE levels from screener.in or from any other website? Please do let me know


(AtulD) #225

Hello,

You can use “ratestar.in” to know the historical PE/PB.
You can also get “Historical PE 3Years” and “Historical PE 5Years” from screener.


(vkp) #227

HELO SIR
I am new in the investing. i search for pe ratio of v2 retail. in screener it is 19. in moeningstar it is 21 and in some other side it is 41. and the eps of last year is 9 and the price is around 260. please guide me thanks


(Ronak) #228

Hello VKP,

I think the reason for the differential PE Ratios is due to exceptional loss which the company incurred during the financial year ending 2017 - 2018. If you look at the Qtrly results filed (Link below), you will find that a sum of 26.61 Cr was incurred as exceptional loss - Some of sites prefer to use normalised EPS and others prefer reported EPS and hence the difference

https://www.bseindia.com/xml-data/corpfiling/AttachHis/229be50d-a191-4745-a918-c022174e056d.pdf


(vkp) #229

hello sir
I somewhere read that we should invest in those company where the ROE is higher than cost of capital. here i confused in cost of capital. please define and give the example of cost of capital…
thanks.


(Chandragupta) #230

Cost of capital is a theoretical concept with little practical utility for outside investors like you and me. To choose companies, it is better to use tangible return metrics like ROE, ROIC, Margins, Growth Rate etc. and valuation.


(Dinesh Sairam) #231

I would say RoCE / RoIC should be higher than the Cost of Capital (Or RoE should be higher than the Cost of Equity), as RoE alone can be artificially inflated by the use of excessive Debt. Besides, Debt itself is a form of Capital, so it makes no sense to exclude it from a calculation of Cost of Capital.

Cost of Capital

Anyway, the Cost of Capital for a company is quite simply the total implied interest on the means of financing it is currently using.

Imagine that a company is running entirely on Debt (It’s not possible – just imagine it). A bank charges them 12% Rate of Interest on the entire Debt. How much should the company earn by way of returns if it employs the Debt into Assets/Business? Clearly, the RoCE should be more than 12%, or the business will go bankrupt.

Debt is fairly straightforward. Most businesses are funded by Equity i.e. Money taken from investors in exchange for a stake in the company. Here, the “interest” isn’t charged every month or year, but it comes in the form of expected dividends + capital appreciation for the investors who lent the Equity capital.

So, the ‘Cost of Capital’ for a company is the Cost of Debt (Interest on Debt) and the Cost of Equity (Minimum Dividends/Capital Appreciation expected by investors) put together in the respective proportion:

image

(Source)

Cost of Debt

  • The Cost of Debt is calculated based on the company’s Credit Rating and the relevant implied market interest rate (Corporate Bond Trading Data can come in handy). Say, if a company is Rated AAA in India, its Cost of Debt is likely to be in the 8.20%-8.50% range, because most Debt instruments issued in India by AAA-rated firms trade in that range.
  • If the company itself has issued Debt in the market and it is being actively traded, then you can just take that yield directly.
  • If none of this is available, you can simply look at how much the company pays by way of interest on its outstanding Debt and take that instead.

Cost of Equity

There are several ways to calculate this “Equity interest” or how much the investors in the company expect from an investment in the company .The most famous method is the Capital Asset Pricing Model. The formula goes like this:

Capital-Asset-Pricing-Model-Formula

Where Ra = Cost of Equity, Rrf = Risk-free Rate, Ba = Beta and Rm = Market Returns.

  • In India, the ‘Risk-free Rate’ is the long-term yield on Government bonds. I usually consider the 30-year yield, which is about 7.77% now (Source)
  • ‘Beta’ is the comparison of how volatile the stock is compared to the market. Although this involves more calculations, you can easily get this figure from simple google searches. If you are taking this route, consider the ET website, which shows 3-year Beta (Ex: Reliance Industries’ 3-year Beta is 0.96)
  • ‘Market Returns’ refers to the returns earned in the broad market indices over the long term (In India, NIFTY or SENSEX). In India, this figure should be closer to 12-13% (NIFTY and SENSEX). I personally use 13% just to be on the safer side.

Cost of Capital Calculation Example: Reliance Industries

Cost of Capital - Reliance Industries.xlsx (39.0 KB)

Economic Value Added

The excess Returns on Capital Employed over Cost of Capital is usually termed as ‘Economic Value Added’. Here’s a recreation of the EVA analysis shown in Pidilite Industries’ latest Annual Report:

Economic Value Added - Pidilite Industries.xlsx (11.9 KB)


#232

Thanks @dineshssairam for explaining how to calculate cost of capital with such detail. Very helpful for novices like me.
I tried to calculate the cost of capital for Astral Polytechnik using the above approach. Can you please let me know if this is the right way.

Cost of debt:
Astral has AA- credit rating.
From their latest annual report they have
a) 84 crs term loan in Indian currency at interest rate 7-10%(Im considering 9% in my calculation)
b)35 crs Buyers credit @ interest rate 0.25 - 3% (Im considering 3% in my calculation)
c) 58 crs loans in foreign currency @ interest rate 2-4%(Im considering 4% in my calculation)

A weighted average of the above gives the cost of debt to be 6.2%

Cost of Equity:
Risk free rate = 7.7%
3 yr Beta for Astral = 0.75%
Rm= 13%
Cost of Equity = Rf+ Beta(Rm- Rf)
With above values, cost of equity is 11.7%

From screener,
Equity capital employed =1170Cr
Debt capital employed = 231 cr (as of Q2 2019)
Total capital employed= 1401 Cr

weighted average of cost of capital = 10.78 %

Their return on capital employed is 24%
That gives an EVA of (24 - 10.78)= 13.22

When one compares this with cost of capital of pidilite industries,it is lower as pidilite doesn’t have any debt capital. Probably it is good for companies to have some debt capital if they want to lower the cost of capital. Would like to know your views. Thanks.