The ART of Valuation

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.

4 Likes

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

1 Like

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

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.

1 Like

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.

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.

7 Likes

12 posts were merged into an existing topic: Valuation of stock

My aim of this post is to understand how good we are in understanding business moats. The entire point of this thread was should we hold on to overpriced stocks (by conventional valuation metric) if they are very good businesses.

The team categorized the following:
B Category - Balkrishna industries, Gujarat Reclaim, Suprajit Engineering
A category - Mayur Uniquoters, Astral Poly Technik
A+ category - Ajanta Pharma, Poly Medicure, Kaveri Seed, PI Industries
Cyclicals – Vinati Organics, Balaji amines

B category companies were correctly identified as their margins were mean reverting (implying vulnerability to raw material prices), hence more cyclical in nature.

A category: Mayur uniquoters was incorrectly slotted here as it hasn’t shown any meaningful growth in sales since FY15. Astral on the other hand has managed to grow their sales well (albeit with margins fluctuating b/w 12-17% implying some degree of cyclicality).

A+ category: Ajanta, Poly Medicure and PI have shown business leadership traits with FY20 sales meaningfully higher than FY15. However, Ajanta and Poly Medicure haven’t gave meaningful stock returns because valuations were reflecting a lot of optimism in FY15-16 and growth didn’t pan out to that extent. PI has panned out better in terms of growth and given meaningful returns. Kaveri turned out to be a cyclical, definitely not a A+ category stock (still to attain its FY15 sales number)

Cyclicals: Vinati turned out to be more an A+ category stock with low sales growth but expanding margins. Balaji has been thrown to the wood chipper.

In essence, its clear that if one simply ignored valuations for A or A+ category stocks, returns would have been underwhelming (detailed work on valuations here). Out of all A or A+ companies, reasonable stock price growth was witnessed only in PI Industries and Astral Poly. This makes me ask a fundamental question, Is an overvalued high business quality business a better investment than an undervalued business with decent quality but superior growth profile?

15 Likes

Thank you. This is a good thread. Along with understanding the valuation / quality I think it is equally important to see how long you are willing to hold (only after assessing the quality and once you are sure that the company will weather multiple economic cycles). Post by Vishal (A Simple P/E Valuation Model that Works - Safal Niveshak) made me think deep into the entry price

https://drive.google.com/file/d/1zEq0QGxsWabxpM3lviLo3JxZoJ3xkG3t/view?usp=sharing

Please see the example of Asian paints (The FV based on diff EPS and what price one should pay now to get expected return is what I tried in here) - Based on one’s expectation the return expected etc can be changed and see what should be the entry price.
Disc : I have AP in my portfolio. (Not a recommendation)

Longevity of the business is something one need to assess and tune the return expectation accordingly (Based on the intuition).
Any feedback will be great help… any flaw you think this method of valuation has…
I understand that high PE stocks are high PE for a reason and above examples of Astral etc were really nice (one need to know the phase the company is in to see if they are fairly valued, under valued or over priced!)

This video from RARE might be helpful

6 Likes

Hi, I have one question on valuation. I dont know if this question should have been asked in this thread or different thread. But I thought of asking.

We have some industry like FMCG where valuations are high like PE of 60-70 etc. But there are other industry like NBFC or companies like Mannapuram/Muthut finance where PE is between 10-15. How do we know what is ideal PE for an industry. e.g. we have Pharma and Chemicals as flavor of the month. But I dont know if current PE of some of the stocks is low or high. Company like Alembic,Granules,Jubilant life are trading between PE of 15-20(approx) while chemical companies are trading between 25-35. So is there any way to check PE at industry level like what is ideal PE of an industry?

Valuation is a function of ROE, growth, longevity of growth and prevailing interest rates. I found this video from Samit Vartak on the nitty gritties of valuations very helpful, might be useful :slight_smile:

https://indianinvestingconclave.com/recordings/20

7 Likes

The answer to this is not static
Till 2014-15 FMCG companies weren’t trading at these 65-70 PE kind of valuations
Till 2013 end good small caps were trading at 7-9 PE
There was a period in the early part of the 2010 decade when it was believed that one should not pay more than 15 PE for large IT Services companies
Chemicals did not trade at a PE of more than 20 till some years ago

PE is not valuation, it is at best a short hand for valuation. The only way I can reliably value a business is to ask myself how will the financials change for the business over my investment horizon? This forces me to consider a lot of things -

What is the baseline growth for the industry? How is this changing and to what extent?
What does the unit economics for the particular industry/business look like? How can this change?
Competitive structure and the relative competitive position - market share, products, new product development
Risk of disruption over the medium term if not the long term
Risk of fuzzy accounting
Longevity of the business - directly impacts the terminal value one can assign
and many more perspectives

My experience has been that once you get down to doing structured work on analyzing the past and having a view on what the future might look like (given your understanding of the business) and have these views captured in a financial model that is representative of your investment horizon - 80% of the work is done. Once this is in place it is very easy to make changes to some assumptions and figure out how the financials could change as a result. While the exercise is not intended to be precise or even very accurate, this gives you a good enough framework to be able to make decisions consistently across time. When the corporate tax rate was changed in Sep 2019 all I had to do was change one cell in the model and the impact of this on the specific business could be quantified.

Very few investors (professional investors included) do this structured leg work over a sustained period of time. What we have is people reading some annual reports, checking what the average PE for the company/industry has been and having debates on metrics like growth rates, capital efficiency as if they are static variables that cannot change.

The very exercise of putting pen to paper or building financial models that capture your assumptions about a business brings tremendous clarity to whatever you do. Your decision need not be based purely on this (after all GIGO is a risk) but the exercise by itself is extremely useful in expressing a view on valuation.

Valuation should be a lot of hard work and a tangible exercise that can ensure consistency in decision making over time. After doing the leg work it becomes relatively easier to spot anomalies like a business getting priced for 8-10% growth while 15-18% growth might be the more realistic scenario. It can also become apparent that the particular business is more sensitive to near term earnings rather than what it can do over the next 10 years.

20 Likes

I think if u can share and explain this model with an example of a company (which you best understand so when learners ask questions you can easily answer and help them), you will do the investing community here a big favour in terms of their learning.

Thanks
RR

3 Likes

Hi frnd

This Sunday i did some brainstorming to formularize the effect of valuable variables such as ROCE, D/E, P/E on the stock price and how changes amongst these variables may causes change in returns. This exercise is for fun purpose only for fundamental level understanding of the maths behind these variables and to develop a visualization skill on how these inputs actually affect the balance-sheet of a business and how much returns an active investor may expect if he is somehow able to predicts the variables, even approximately right, for the next 5-10 years.
GROWTH ANALYSIS 28.06.2020.xlsx (21.7 KB)

6 Likes

Hi @rajput_delhi

Yogesh Sane had done some exhaustive work on this front. If you are interested in financial modelling then you can refer to the thread below. Also, members like @dineshssairam are also into using financial models to guide their decisions and he has also shared his sheet on the forum.

Spreadsheet Model for Valuation of a Company

3 Likes

Not just financial modelling in isolation for that there are many but how he captures his structured work of analysing past, future, biz understanding into the fin model.

Cheers
RR

@Donald I have been pondering on why stock picking is an art and not science. Thanks to you for covering that aspect in this thread.
Most of the links shared in this thread are taking to a private page including this excel sheet. Could you please give access to these tools ?

2 Likes

Cannot view the table !

Nice valuation related video

Good Reasons to Ignore Valuation by Brian Feroldi

similar thought process as Saurabh Mukherjea

4 Likes

Sitting in 2022 and reading the blog, I feel that Saregama is on a similar track.