The ART of Valuation

(Ayush Mittal) #21

Hi Donald,

Its beautiful to go through the learnings and thought process/discussions we have had and which all helped in stepping up the learning curve to be able to say this co is better over the other. You are penning it down beautifully…look forward to more :slight_smile:



(Donald Francis) #22

Hi Jatin.

There is no right or wrong track. We are exploring this together. Yes, I am on a track :slight_smile: - but that objective is to first document our journey and what we learnt, and also illustrate how we learnt - hoping that will be as insightful for others, as it was for us.

We would like you to continue exploring your track. Like your enthusiasm - that is the most important ingredient for success, we feel. As we would like Dhwanil to explore his track, and expect a Rudra and others to come in soon :slight_smile:

Thanks to seniors like Abhishek who has taken it upon himself to gently guide and moderate all the different tracks, leaving me free to think/construct the flow for the next Valuation ART #.

Somewhere down the line, we will see commonalities emerging from the different tracks. And we will try and hopefully distill all of that in a concise, meaningful way - for easy absorption by all.

(Donald Francis) #23


We are very fortunate. I was very fortunate that just when I had found you and Hitesh and Abhishek to spar with on a regular basis - we also had folks like Mr D and Mr M challenging us and guiding us to step Up!!

Putting this down is not easy:)…but very enjoyable too…almost feel like going back 3 years…to those days!!


(Donald Francis) #24


Excellent! All agreed. Not much to add from my side, except this.

We must always have adequate Margin of Safety. We can’t overpay.

This thread is ONLY about UNDER-PAYING!! Having that refinement in our mental models to be very very convinced that we are under-paying is the ART side of Valuation!

Nay, this isn’t easy. Fortunately we have access to some very refined ART Investors! All we have to do is keep progressing, stick our necks out and take a few risks, and keep asking for more from these guys - get their mental models out in the open :-). And be smart enough to grasp the clues they throw at us.

And it’s not about fishing in the dark:). There is probably a process towards progressive refinements coming in - provided we have the discipline!!

Probably, subject matter for Valuation ART #3.

(Donald Francis) #25

Feel it may be illustrative to reproduce at this stage, the response to a pointed question (in the ValuePickr Public Portfolio thread)from Atul in Dec 2012.Just so everyone can attempt getting clued in to thinking about businesses differently and appreciate somewhat why Mr Market values them differently!

At a very practical level :slight_smile:

Q: When do we say a particular stock is fairly valued/richly valued?

A: Some comments from my side. I will try to use ValuePickr Portfolio companies as examples. See if these help

1). Balkrishna, Suprajit, Gujarat Reclaim - are all well-managed manufacturing companies. With strong, capable managements that have demonstrated great long term record. However these are what I would call Category B businesses. There iscyclicality in demand, some years are pretty good, some years are tough, margins do come under pressure. Overall things sort of even out decently achieving kind of 20-25% CAGR growth. But if you think about it, visibility is poor beyond the near-to-medium term.

Think about how Mr Market prices these kind of companies.

[Current Edit: If I remember correctly, all above were quoting ~10x or thereabouts then, and we recommended an EXIT as we saw imminent deterioration in business performance and found Valuations over-priced]


2). Then there are what I would call Category A businesses. These are much more predictable. Size of opportunity is big. Demand visibility remains strong, you don’t see a pattern of cyclicality and you CAN see them clocking higher growth rates for a number of years into the future. Mayur and Astral may fall into this category.

Think about how Mr Market prices these kind of businesses. Is there a discernible difference in business quality between these 2 categories?

[_Current Edit:_If I remember correctly, all__above were quoting ~12x or thereabouts then, and we recommended a HOLD. We anticipated steady business performance and found valuations fair]


3). Then there are Category A+ businesses. There is significant intellectual property involved. Once a certain size/profitability is reached and you have a decent track record established, usually these kind of companies go from strength to strength. Can you see an Ajanta Pharma or a Poly Medicure there. Why not a PI industries? Perhaps a Kaveri Seed Company can reach there??

How does Mr Market usually price these kind of companies??

**How are the odds of business performance stacked for these companies??**If you can see that difference clearly - that shouldgive you some clues to differentiating among these businesses. And therefore buy, hold or sell clues too! if you can say whether Mr Market is NOW (12 months forward, 24 months forward) valuing them cheaply, fairly or richly - w.r.t. that future picture.

[Current Edit:If I remember correctly Ajanta and Poly Medicure were quoting ~12x or thereabouts then, and we had recommended a BUY. We found these much Undervalued]


It is an ART form - BUT, the more stronger that ODDS (probable business performance) picture for you, the more parallels you can cite from studying Mr Market’s preferences, the more businesses/stocks you get familiar with - the better will be that Feel, and we believe the better will be your Calls.

(Hitesh Patel) #26

Very interesting discussion and great participation from all the guys who penned down their thoughts.

Coming to the topic theme… art of valuation…

I think all the theoretical aspects have been put up and discussed threadbare.

One thing which I have been following of late due to the market run up and due to the run up in stocks in our universe is to focus on valuations of stocks posting their 52 week highs or more importantly all time highs… If stocks posting their all time highs are on closer inspection appearing attractive on conventional valuation methods then it makes sense to dig deeper.

Most of the category A+ businesses as donald mentioned earlier in the thread have been recognised by markets and now onwards less likely to be re rated and hence may not offer significant upsides.

There will be some category A or a category B+ business which are likely to migrate a few notches higher and that might be the trick to eke out higher returns from our universe of companies. In some the market perception is undergoing subtle change towards that direction but the full impact may not yet have been played out in these businesses… Latching on to these companies undergoing perception change even mid way in their upward journey may provide better returns than the fully or near fully valued category A businesses.

Obvious examples that come to mind are kaveri seeds, dhanuka agritech etc… Even things like jb chem where cash seems to be viewed differently than a few months ago might be interesting to revisit. Symphony seems to be on its way to category A business and the E part of the PE conundrum might show a good jump.

I will be discussing the merits of these companies individually on their respective thread rather than cluttering it here.

(Donald Francis) #27


Mr D: Time has come to become more aggressive. It’s not enough to sort your businesses into categories. Even within categories there is that one which stands apart, you have a hunch probably is by far the best. You have to pit your Portfolio picks against the other :slight_smile: one by one, rank them all the way down.

Now this was getting interesting and tough. We were being really challenged and this got us thinking real hard.

Among Category A, we had to choose between a Mayur and an Astral for the longer term. Remember that discussion (Check Mayur Uniquoter thread around Sep/Oct 2012, for pointers). Similarly we had to rank Poly Medicure, Ajanta Pharma, PI Industries and Kaveri Seed in category A+ businesses.

We evolved the Conviction Rating (CR) and Valuation Rating (VR) models guided by Mr M as illustrated in ourCapital Allocation Framework. We modeled CR on 5 parameters - Business Quality (BQ), Management Quality (MQ), Fundamentals (FM), Industry Position & Track Record (IPTR) and Growth Prospects (GP), and assigned weights to each.


We went on to sub-parameterise each of BQ, MQ, FM, IPTR and GP that allowed us to think more deeply about why one business may be ahead of the other. I really needed this logical breakdown effort to think more intelligently/deeply/comprehensively about businesses and found it extremely rewarding - because for the first-time many incremental aspects (that MUST be included) got ingrained consistently into my thinking/decision-making (via the modeling :-)).

In no particular order : such as Equity dilution track, ability to fund growth, reducing debt with growth, incremental return on capital, RM volatility correlation to OPM, consistent reduction in working capital, management depth, attractiveness as an employer, self confidence - doing things differently, fair compensation, sector attractiveness - market fancy, and the like.


We presented our full-blown model to Mr D within a month. He was pretty impressed and complimented us on the novel way in which we had attacked his challenge with gusto. I remember he said we had exceeded his expectations :-), but this is only a good start, no more. All the credit for the modeling goes to Mr M - without him we couldn’t have done some justice to Mr D’s challenge in so short a time!

Mr D: We are not done yet. Every time you have a new prospect for the Portfolio, it must find its own slot/ranking at least one notch above the least ranked. It has to dislodge at least one of the existing - adding to the bottom of the pile, isn’t much use, right:-).

This seemingly innocuous challenge (new entrant must dislodge at least one business from current perch on the ladder) perhaps has been the most rewarding for us. While our mental models may yet be half-baked, this one test has ensured the quality of ValuePickr Portfolio hasn’t deteriorated, not yet at least :-).

Never cease to be amazed by Mr D! His sophistication and his clarity! His never-waning enthusiasm to see folks like us reach the next level.


We had made a good start. This is a PROCESS and we had just got started on an exciting process :-). Refinements are incremental, we have miles to go! Everyday there is new learning.

Repeating the process over and over again, having the discipline to stick to this regimen, doing it every time with full honesty and integrity (no lip-service please) - maybe there lies the clue to UNDER-PAYING!! Consistently!!

Think about that :-). We are certainly hoping vibrant discussions on this thread will tremendously add to current learning!

(Donald Francis) #28

I had sent out a query to some senior investors. Here’s the query and a brilliant throught-provoking response received from a very respected senior and VP well-wisher.



Need guidance - to take our ART of Valuation discussion forward. [Link]

How do the best investors think about the right valuation for an emerging business (and therefore the gap) before consensus emerges about that business in the market?


Interesting thoughts, with very good insight.

I have no idea how good investors make their decisions because Iâm not yet there but I can say for myself. I have never penned my thoughts on this but when looking at emerging stocks, two things I mentally get a hang of are:

1.How does this company make money

2). What can go wrong for this business.

I will not discuss (2).

On (1), I sort of mentally slot where the stock belongs to - what I call as (A) Laborious stocks (B) Average stocks and © Smart stocks. The origin of doing so has something to do with school or hostel days where all of us have classmates of different types.

You have very studious and extremely hard-working guys who generally do well in a class directly proportional to their study hours, night-out effort and time. Rank toppers & gold medalists generally come from this segment. Most disciplined & regimented guys also come from here. Some of the dumbest guys are also placed here because of family & peer pressure etc. they keep slogging with poor results. All these areLaborious stocksâ Type A. They typically constitute 20-25% of the universe.

Then you have guys who are average studying types, will make same mistakes whenever faced with a googly question in the exam or viva. General tastes, fashion, fads etc. You wonât find any Sachin Tendulkars here. These areAverage stocksâ Type B that typically constitute 60% of the universe.

Then you have few who study little but are actually much sharp, fast grasping power, excellent subject understanding of fundas and output they deliver_in relation to the inputs gone in_. Iâm referring to only fair study means, no shortcuts or hanky panky stuff. These areSmart stocksâ Type C. They may not be rank toppers and sometimes they can even be laid back but my experience shows they have done fairly well in life (not always in conventional sense of the word). May be when you think back, youâll find some real life examples.



It is this Type C â Smart stocks that I always look for when scanning emerging stocks that are yet to arrive (in terms of marketâs institutional discovery and consistency of results) but have some advantage. Scale up, Network effect and expanding of Moats are easier to achieve with this Type C stocks.

Pardon my saying but most of your ValuePickr stocks are the Laborious types including Manjushree, Vinati, Mayur, Balkrishna, GRP, Indag, Astral etc and even Kaveri that you are putting in A+ category. There is nothing wrong in being with laborious stocks and with right traits they make very good money so long as they preserve their traits just like gold medalists and most disciplined guys display. Mayur is a case in point. HDFC bank is a very laborious stock and very disciplined at that, so they can be really rewarding if you find them early and they themselves donât goof it up.



Ajanta Iâll not comment as I donât understand it well.

I can slot PI in Type C where results can be disproportionate.

Last year, Alembic was a very easy Type C and we made an easy kill there, doesnât always happen. Two Type C that Iâm betting on at the moment are JB Chemicals and Accelya Kale, though from much lower levels. One Type C where Iâve_probably_gone wrong is IL&FS Investment Managers.

While dealing with Type C Stocks, one important caveat is that management quality & integrity should not be suspect. Second is when analyzing such a stock, we should be looking at the outcome of big would-be picture. Third is we should have a handle on the right metric to value such a business, not necessarily the PE or PB.



The term âProcessor stocksâ never occurred to me thus far, but itâs a nice way of looking at it and they are a subset of Laborious stocks.

Discl: I have no position in any of the stocks mentioned above,except for the last 4 named stocks.On Laborious stocks, to take the cricket analogy forward, I’m reminded of Australian fast bowler - Glen McGrath who can keep bowling the same outside the off stump nagging line to the batsmen the whole day - so disciplined and so immaculate. If VP stocks are those Glen McGrath,I don’t want to give an impression that these stocks will not be good vehicles to ride, as historic CAGR shows they have given superlative returns, and may continue to do so by all means.

(Manish Vachhani) #29

Great thought provoking discussion on the Art of Valuation. Thanks Donald for starting this new dimension to the journey of investing.

(Dhwanil Desai) #30

Donald and Abhishek,

Excellent flow and great constructs indeed! This is turning out to be one of the most thought provoking discussions we have had on Valuepickr. Donald, kudos for your ability to put complex things succinctly and clearly. It can not happen without clarity of thoughts!

On your point of “UNDER PAYING”, I am all with you and strongly feel that in spite of varying style and preferences of various value investors, one thing that should be sacrosanct is “margin of safety”. That is the reason, I am not comfortable making investment at a price which has lot of “built in” expectations and margin for error is limited (Ref. discussion on Page valuation).

The idea of a new entry into portfolio should find a place one notch above the least ranked stock in portfolio is immensely powerful especially from capital allocation efficiency perspective. To further imbibe into your thought process and to make it process oriented and keep the discipline, we must resort to checklists. I came across fairly exhaustive check list shared by value investor Rohit Chauhan on Safal Niveshak. One can tweak it to one’s comfort depending upon parameters one wants to capture and detailing one wants to do. However, I am increasingly realizing that such checklist/scoring matrix is a must to ensure that decision making is least prone to “biases” and subjectivity. Thiswill also ensure (only if carried out with full integrity and honesty as you very rightly mentioned) that capital allocation happens to stocks which are better than existing portfolio of stocks and not based on heuristics ( I am tempted to recommend reading Thinking fast Thinking slow By Daniel Kanhman to understand how in so many instances we resort to heuristics to replace a structured decision making process to proxy complex situation with “simplistic” variables!).

(Vinay) #31

Kudos for the knowledge.

Hitesh & Ayush seems to me in Type C category.

(Subash Nayak) #32

Thanks Donald for starting the best thread of vp so far.

Till now, all I was looking in a business is is a consistent ROE, ROCE >20, low debt, good management, good sales/ebit/np growth each qtr yoy, and a fair valuation, and a reasonable logic for such performance to continue in medium term future. Just now started to incorporate high dividend payout to my stock selection.

What you started is a discussion a notch or two higher than the way I was selecting stocks. Here you are not just looking at the number and leaving the sustainability part for “lazy evaluation”, but rather by looking at the moat/intellectual property/stickiness of business, you are trying to divide them into buckets>

I can clearly see why PI Industry should be in “Type C” category, especially because of its CSM business, which we all know has a huge order book (for next 3-4 yrs), is sticky nature as its customer dont change CRAMS partner unless in extreme situations, is based on high trust environment. Plus the cashflow generating out of CSM business can be used for building new plants in CSM segment, and boosting agrichem business, which we know has huge potential in future.

What I dont get is why Alembic was a “Type C” stock (I am invested in it from 100 level, and it was a pure undervaluation play for me), and why JB Chem/Accelya are “Type C” stocks. May be you can get reasoning for these 3, so that we can get the framework for identifying “Type C” stock.

Also why “ILFS Inv Management” was a “Type C” stocks and why it failed. As per my knowledge it was the only listed PE firm (and hence a concept stock), and it failed because of its investment in Real Estate cos.



(P Sharma) #33

A very interesting discussion. It is also very interesting the analogy of various kinds of students being compared to various kinds of companies.

My takeaway from this analogy is that we should look for companies which have laid the building blocks for disproportionate future growth. Laborious stocks will produce a rupee worth of incremental growth for the extra rupee of incremental input. It is not a one to one relationship but an extra rupee wouldn’t produce two rupees of incremental growth in this category.

Smart companies will produce disproportionate growth. This is a moat type company which will be able to rapidly expand because of its brand, IP or network.This is not very different to smart( moat as one is usually born this way) students who have a great grasp of the fundamentals and can combine diverse disciplines to answer complex problems. PI and Polymedicure clearly are in this group. Having built the base e.g Poly medicure can have a disproportionate growth if some large OEM order comes in. Another stock to be included in this category is Amararaja. It has done the hard work of building a dealer network and brand building. It is in the process of expanding capacities.It will capture a larger part of the market share with lesser incremental effort as in a two cornered fight, the spoils to the winner are disproportionate.

A great beginning to a very enriching discussion.

(Mallikarjun) #34

Thanku Donald… The threads under Capital Allocation are addictive…

Most of the compounders are Type A and Can we say some of our Opportunistic bets are Type C…

Regarding margin of safety; Can we associate quality of business, growth with Margin of Safety…

Since valuepickr or any large player can influence a stock valuation, how does Mr D and other veterans remain rational/objective… Steps they take to remain balanced…

Is it due to vast experience or do they just know what works/will work on the street…(Sometimes we can’t point the exact reason)…Will be grateful to hear from them…



(Vinod MS) #35

This thread will take the award for best thread in VP - this looks like a type-C thread :slight_smile:

Feels like we are in some mythical land searching for the secret treasure of knowledge.

Type-C may not be exactly related only to Moat/IP. It looks like a high conviction+high undervaluation concoction. The larger picture may be just hiding out there like the example of Warren Buffet’s investment in American Express.

Shilpa looks like a Type-C. I had placed JB under opportunistic bet, but looks like it can turn out to be more than that especially if the company can keep building brands like Rantac.

Symphony was surely a Type-C at 270 levels and maybe even now.

Hooked to this discussion.


(Kunal) #36

** especially market. **

Network effect needs to be backed by long term sustainable business model. Look at what happened to Nokia, Nortel etc to understand that network effect can as quickly get destroyed as it is created.

Most of the new technology stocks(intangible assets holding cos) are highly valued like eagle sailing on sky. Do you remember Technology Bubble 2000 ? That will give you answer.

Some creations in this world is far from our understanding. So we better not predict it. For eg. Women’s mind, Universe and its boundary, Technology stocks (not all but most).

(Vinay) #37

Some common traits which I can perceive for category C type of businesses-

1). Scalable Business having unique Intellectual Property.

2). Requires very little or no capital to grow, as a result most of the cash generated is free.

3). Deeply Integrates with the businesses of its clients such that it becomes indispensable part of its business.

4). Company’s revenue forms very small percentage of the cost for its clients, but adds much value to its clients business.

5). Repeat businesses from the same clients.

6). Enjoys huge operating leverage. Once a certain size is reached costs does not increase in the same proportion as revenue growth.

Businesses referred- Accelya Kale, DRG, IKYA

(Dhwanil Desai) #38

The whole idea of Type C stock and comparison with “smart” student is very interesting and conveys the central idea so effectively! It is pleasure to learn the diversity of metaphors and mental models successful investors use! My hunch is that many of the Type C stocks will be clouded by uncertainties. It is important to distinguish between uncertainty and risk. Uncertainty does not ALWAYS mean risk! However, market more often than not ALWAYS considers uncertainty as risk. For example, JB Chem which decided to keep large chunk of cash on the books created an uncertain environment where investors and market were not sure how and when the cash will be deployed in the business. But management made it clear that cash will be deployed for the growth of pharma business. However market was still looking for “proof” and in absence of proof it discounted the value of the business heavily. As management started walking the talk, and slowly but steadily started deploying cash in business, market has started to realize that “perceived risk” no longer exist or the odds of risk materializing is low. Eventually, it will give “due respect” to hard cash…! Same is the case with Piramal. At current price of PEL, one can get exposed to number of positive black swans and a share in high quality businesses on extremely favourable terms . Having said this, senior investor is so right in saying that management integrity is absolutely must in some of these situations. Market is full of value traps where “uncertainty” has materialized into risk due to lack of management integrity.

The whole idea of investing in Type C stock can be very very rewarding! So, again great concept.

In the wake of recent actions taken by FMC of

-marginalizing FT representation on board

-clear indication of no financial liability for MCX on account of NSEL

-Today’s FMC order asking FT to reduce its stake from 26% to 2%

Can we consider investment in MCX Type C opportunity? MCX (or for that matter any DOMINANT exchange" in general) is a very high quality business with expanding moat (network effect as “winner takes all”) which is still scratching surface in India. Can we systematically understand the current uncertainty and its repercussions to evaluate whether there exist significant risk or not. But I will take that up separately on MCX thread.

(Atul Garg) #39

Beautiful Discussion. Loving every part of it. And yes, one of the Best threads here. Threads on Business Quality and Capital allocation are equally powerful. One point that stuck me the most is “for every new entry in the porfolio, an existing one has to go.” Very Powerful. Needs a lot of hardwork and a structured framework & approach to accomplish this.

Things are very dynamic. On one side are type C and type B stocks (well, I love B types, they have been working wonderful so far, And we all know seniors who compensate smartness with hardwork:), which can be kept for(ever) long-long time and then there are PSU bets based on political environment and sugar cycle plays. I understand we need “to experiment”, but I am struggling with it and not very clear how this fits with the idea “for every new entry in the portfolio, an existing one has to go”. Any thoughts here…?

(Donald Francis) #40

Mr D meant, if you have 5 businesses in the portfolio you can add a 6th for sure. But the minimum ranking for the 6th business has to be at least #5. Don’t add a 6th or 7th or 8th business at the bottom of the pile lazily, or mechanically.

Any new entrant should challenge you to think through very clearly why it belongs to the top rungs. It must have enough in it to be able to seriously challenge the incumbents and move up by moving at least one down :slight_smile: