The ART of Valuation

(Donald Francis) #101

There is no holy grail. Everyone please understand the attempt is not to present Future Value creation or EPA model as the end-all. It is another very useful decision-making parameter to keep in the head - and I stick my neck out to say that most investors (like me) do not have this firmly entrenched in their heads - else I was bound to have heard a lot more on this in the last 3 years :slight_smile:

Let me illustrate it the other way taking a value-destruction or very little future value-addition example from our own VP Portfolio - Manjushree Technopack.

Those who are familiar will recall that we made a very quick 3x - 32 to 100 in 4-5 months here in 2009. And since then Manjushree has reached 200+ in 2014. **Its a cool 7x in 5 years and most people will take that right. **But as we all know we have much better examples of value creation in the same time frame by Astral, Ajanta & Mayur and even Atul Auto.

If we look closely at Manjushree we will realise that Mr MArket is valuing its mostly for its steady-state franchise of being the largest PET bottler in South Asia. It isn’t paying up really for any Future Value being created. Because there isnt. Value is being destroyed as in most years Manjushree adds negative EPA - RoIC at 9-10% is less than its Cost of Capital today. in the early years Founders funds were enough to fund the business and that was EPA accretive not any more.

Now where would you allocate more Capital? When it was available at 4x valuations with drastically improving margins - it was a great opportunistic call - and went from 30 to 100 in no time. Now it may not make that great a sense fro the next 3-5 years, isn’t it.

(Donald Francis) #102

There is also the good counter-points to all the fuss I am making about getting the concept of EPA firmly entrenched in our heads.

Take Shilpa Medicare for example. You might have seen pretty average RoICs of 16-17% in last few years, 2013 being worse! Naturally EPA added was nothing to write home about. However 2014 would present an altogether different picture. So familiarity with the business for a number of years is essential for a balanced view. It does have a couple of good years and then consolidates.

But if you look at the stock performance in less than 1 year. Shilpa we got in at ~150 when we went to AGM last Aug (?) and in less than a year it is more than 3x at ~450. Obviously there has been superior business performance in 2014 driving that. But is that performance enough to account for the valuation accorded? not really.

So despite all the numbers (good-looking or average) - what is Supreme is Value to the 100% buyer of the business. ( may be it is on account of superior IP/knowhow in the company, locked in strategic customer relationships, moving up the value chain and more.

Shilpa is such a business - my conviction is such in that business i.e. - that it is currently my highest allocation and even if the business does flattish for next 2 years, I will be happy to sit tight and actually keep buying more (if there are corrections).

Now that is something very very difficult to capture/transfer. That thread - Value to 100% buyer of the business - becomes very important to open discussions on.

Think I have covered all that was in my head in last 1 week as I pondered on next refinements in our ART of Valuation journey.Over to everyone for extended comments/counterpoints. Now that my argument is complete and presented reasonably well I hope - I ask all to pick holes in this, as necessary.

(P Sharma) #103

Donald thanks a lot. You have managed to bring out the concept of EPA out very clearly. In my mind till now it was a fuzzy conceptand i must confess that i never applied it like you have shown above.

I was content with using RoIIC for the businesses i was following to monitor the underlying trends.However, where the EPA scores is to compare disparate businesses.This is simply because ROIC and RoIIC only deal with the returns on capital without comparing the actual capital being deployed in the business.

A great portfolio management tool.

This also clarifies to me Warren Buffet’s thinking on venturing into the utilities business.

He has simply been taking his free insurance float( free as the insurance businesses have been making underwriting profits for many years now),leveraging it and then earning a spread on it allowed on it by the regulator.The brilliance of this model is that all of this money is almost free.WACC is close to zero.

EPA = invested capital*(ROIC-WACC)

He kept pumping up the invested capital( he had lots of it) which cost him close to zero( only the interest part on the leveraged amount)and earning a decent spread allowed by the regulator. This has led to Berkshire creating a lot of value for the shareholders.

Compare this to someone with lesser capital trying to emulate this.This can only be achieved by pumping up the ROIC or being very creative with raising cheap capital.

This brings us back to where we started.We should look for businesses which have the opportunity of deploying capital at high ROIC and also have the ability toto raise capital cheap.

Would be very interesting to apply this EPA model to banks, NBFC’s etc( money lending businesses) as all the three variables on the right hand side of the equationdetermine their survival/prosperity.

(Hitesh Patel) #104

Interesting write up donald. Thanks for elucidating on the EPA aspect.

Ajanta definitely seems right up there. Its now unknown for pharma companies to go up something like 50-100 times within 10-20 years.

Another one definitely looking out for is Symphony. From the figures over the past few years, ROIIC would be much higher than a lot of other companies.

For those not initiated, any company which increases its sales consistently over the years with improving margins with negligble increase in debt (preferably reduction in debt) is something worth applying the magnifying glass to.

(Muthukumar) #105

Hi Donald, VP gurus,

Thanks for the excellent model of EPA and helping to walk through the process/model including beginners like me in this thread.

Was trying to use EPA model in for housing loan lending companies like Gruh, Repco, and Can fin homes to see the result of it. EPA and EPA/sales are coming as -ve. How do we use the model for banks and NBFC’s.

Also having top allocation of shilpa medicare in my portfolio as well. EPA model is showing -ve for this and future plans/growth progress may override the model i feel. How we can prioritize the model vs. possible future growth.

Any quick way to find a business which are having higher EPA/Sales. So far i was getting Fluidomat which has got 9.77% vs. Ajantha’s 8.36%. May be good to know the which listed business taking the top rank :slight_smile:



(Ananth) #106

Donald, Kaveri Seeds throws much better EPA/Sales number than Ajanta Pharma. Why are you not considering it in the picture ? Is it because of valuations ?

(K.S.Varadaraju) #107


Beginer’s question. When I look up in screener the RoIC is given for ajanta, mayur and astral as 71.65,76.76 and 44.65 . In the table above they are 28.23,35.94 and 24.62. can somebody clarify please



@ Ananth


This data pertains to FY13. We need to run for FY14. In fact we have to run for last 3-5 years and check the trend. I might be wrong here but EPA/Sales ratio does not has any meaning if the company can't employ incremental high capital over a long period sustainably. That can happen if the company's market share is improving or stagnant coupled with higher growth or if the market size opportunity is high.

Growth Rate
Market Size Opportunity
Market Share
Dividend Payout
Accelya Kale
Not Sure
Decreasing? 123%
Swaraj Engines
27% High Flat 74%
VST Tillers
Ajanta Pharma
30% High Increasing? (Rank 39 from 40)
Mayur Uni
18% Medium high?/Monopoly?
Astral Poly
30% High/Monopoly?
Amara Raja
* The above table is for illustration purpose only and may be erroneous.

Now going by the table also we can't just buy. This is what makes investment so interesting and dynamic. High EPA/Sales ratio for Accelya Kale is misleading. The RoIIC is negative and the company is doling out huge dividend as they can't allocate high incremental capital. Same goes for Swaraj Engines. At least Swaraj has decent sales growth.

I like Amara Raja, Ajanta, Mayur and VST Tillers in these respects.


- Dahez, Savli plant coming up. Management expecting higher sales. Margins 30+ and RoIIC 70%+ Kicker is trading at 17x TTM.

Amara Raja - Done capex and got to love duopoly market coupled with high market opportunity size. Exide can't match ARBL.
Mayur -

PU plant is going to come up. In the last con call, the management mentioned about new plant that is under construction. The "best in class" RoIIC with higher sales expected.

VST Tillers

- Hosur plant is operational and company concentrating on mending the skewed Tillers/tractor sales revenue ratio.

(Donald Francis) #109

It’s great to see some energy back into this very valuable thread.

But please remember this thread is about the ART of Valuation. EPA is an important but only an additional Valuation measure. It.s NOT THE HOLY GRAIL. As someone had rightly objected its just another number-ratio based thing - essentially the Science part - only 20-30% of the job - and only that much should be read into it. The Science part as always is more about what to avoid. AVOID negative or low EPA generating businesses - period. But always correlate with the UNDERVALUATION, if any for superior EPA businesses, so that we can take advantage of Mr Market’s analmolies, from time to time.

A consistently good business will show consistent growing EPA additions over the years. Some Businesses like FMCG with very high ROICs will show super EPA/Sales - that doesn’t mean we put everything into them. Catching Undervaluation along with positive EPA business is more important.Catching a (positive EPA) Business in Transition (where Sales keep increasing, Margins keep increasing and Debt keeps reducing - sometimes it is as simple as that) )- is much much more important)- as the outperformance (in last 4 years)by Mayur, Astral, Ajanta over most other businesses have shown.

Now that EPA (and its limited utility) is well entrenched in our minds,**request everyone to carry forward the EPA investigations - which we must -**in the originalBusiness Value Driversthread. Last time round I had sort of lost the plot :).

This ART of VALUATION discussion must be more about understanding Superior Business Quality, why is something much more valuable to a 100% owner of the Business than what the initial look at numbers may suggest - Shilpa is a good example to think through some of this things.

Understanding the Business intimately - is the holy grail. And there are no shortcuts to that - like most things in Life :slight_smile:

(Donald Francis) #110

@ Muthu/Ananth and others

Like Ashwin has already pointed out, what we shared was for illustrative purpose only. You can download the Excel sheet to check for EPA addition over the last 10 years. That will give you a much better handle.

Also we are interested in catching what is called Mota-Mota trends. Is the trend positive over the years. Has it been a generally improving trend or flat or deteriorating? We should get things roughly right as our Gurus are fond of saying, rather than precisely wrong:)

The Excel I shared uses EPA calculations as defined by the Copeland Valuation book - which is like a Valuation Bible. Everyone interested in understanding Business Value Drivers must read that book. Especially valuable when you want to start thinking like the 100% owner of a may be using slightly different calculation for Invested Capital and hopefully it is using EBIT as numerator and not PAT. We can ask Pratyush to check.

For those interested, the exact formulas es explained in the Copeland Book is enumerated in the Business Value Drivers thread. Lets carry forward the EPA calculations/investigations for any good business that we know of - in that thread.

Anant - as mentioned before I didn’t have time to play around with data for many companies - I first just had to get and lay out the concept right for all of us. Yes & Yes I am interested in what Kaveri’s EPAs looks like over the years, and Cera’s and Amara Raja’s and more and test if this is fit for use for NBFCs (as Muthu asks) and the like - that would be real swell :). I am probably more interested to separate the wheat from the chaff next between a Page and a Nestle and other high-pedigree discovered businesses.

Ashwin - Can you please repost your data in the Business Value Drivers thread? Others welcome to join in the fun investigations there.

(Vinod MS) #111

Hi Donald,

Thanks for coming up with really precious pearls time and again…its amazing how you keep running for more knowledge with lots of enthusiasm.

The excel sheet helps in driving home the concept…I’m still working with it. It needs time to digest this stuff.

I’m fine with the numerator in ROIIC -NOPLAT is fine if we adjust for one time profits/expenses.

The questions in my head:

  1. Some of our companies have obscene ROIIC numbers. Why do these businesses require less incremental capital? Is it because their plants are well depreciate due to aggressive depreciation policies adopted earlier? How will fresh capex affect their ROIIC?

  2. How come incremental working capital is low even when sales increase? Is it because we are taking end of the year figure which do not really represent the true story? Should we instead fix the incremental working capital as a % of incremental sales to make a fair comparison between companies?



(Abhishek Basumallick) #112

I think it is very important for people to go through what Donald has mentioned in this particular post. I see a lot of discussion on EPA, RoIIC etc etc.

Investing, in my experience, is never as easy as looking at historical numbers or ratios. If it were that easy/simple, you would see “algorithmic value investment funds”. The reason you don’t see that is because there is no surefire algorithm or formula or ratio that will help in identifying a good investment. We need to try to understand the story the numbers are trying to tell us. That is why this thread is called the ART of Valuation.

When I speak to very senior investors, all of them have an innate sense of how the market (or a particular stock) looks. That I believe comes from being a keen observer and participant in the markets. Some people have a knack for it. Others can and have developed it. But nothing substitutes experience of being in the markets.

Another important factor is to gauge the expectations that the market has of a stock/sector. Performance, more often that not, will derive from outperformance / underperformance from the expectations.

The only way to be a good investor is to understand a business well.

** …Understanding **

grail. :))

(JatinK) #113

Hi Donald & others,

After all the discussion here, we concluded that Ajanta, Kaveri and Poly are better business than Mayur, Astral and Atul Auto.

However, look at the prices now. Market is valuing Mayur, Astral & Atul Auto a lot higher on PE multiple than Ajanta, Kaveri and Poly.

Why is that? Is it being irrational now? Or we wrong in our conclusions?

(Kunal) #114

As we know all business you mentioned are fundamentally sound and fully discovered stock there is important factor between two groups you mentioned.

Mayur, Astral, Atul Auto are directly or indirectly dependent on cyclical industries. (even though these have outperformed peers in tough time :slight_smile: )

When economy prospects are better, **cyclical **factor has higherprivilege. We can see the same in all boom phase 2008, 2000, 1992

This lead to our focus on new bets which is fundamentally sound yet cyclical in nature.


(Donald Francis) #115

Hi Jatin,

Good question. the very fact that you are asking this question shows that you are on the right path :). It’s uncanny how often this same basic question too many folks are asking me - if in, somewhat different flavours/forms. And my back-to-the-basics answer is always best put in my Guru’s words:

Remember a golden Peter Lynch tenet : The current stock price tells us absolutely nothing about the future prospects of a company, and it occasionally moves in the opposite direction of the fundamentals.


It’s for us to internalise this very very simple precept - as this gives us great opportunities (repeatedly) to take advantage of Mr Market’s follies.

All emerging businesses take some time to get properly understood - despite consistently strong performance. There were no takers for Mayur for 1.5 years - when performance was mind-boggling - that’s the best time to accumulate. And unfounded (misunderstood) fears on Astral forex/CPVC competition stopped it from being rated highly in 2011-2012 -nothing much has changed in the fundamentals since then - again that was a very good time to accumulate.

It takes time for Mr Market also to build up consensus conviction. When Mr Market will reward handsomely (or mindbogglingly handsomely) is not in our control. What is in our control is to study the fundamentals well, build more conviction in the business as it keeps performing solidly/management is seen walking the talk. These are usually the best times to keep accumulating the stock.

We have tried to highlight this aspect and document our experience in riding excellent businesses - how not to get out prematurely - how to keep accumulating - till there are clues that Mr Market is finally waking up to the true story/its sustainability/and the potential - and FI/FIIs start to participate!! 90% of folks we know jump off much before.

How to watch out for signs of Instituitional participation. How not to jump ship till that happens. How to keep Faith in the BQ/MQ is a big component in the ART of Valuation and is captured quite beautifully in this Valuation Stages for a Quality Emerging Business: We can All learn to Ride Well )- bulk of the work was done by young Utkarsh Patel exceeding our expectations - so much so that we needed only to summarise and add covering comments on what he had produced.

Every Question that a serious learner goes through in the journey till some sort of an individual investment philosophy gets honed - is probably captured in some or the other VP thread. Keep revisiting these GOLD MINES - especially the Capital Allocation section.


(Prasanna Sankaranarayanan) #116

Donald - I respect you a lot and I think your answer was satisfactory. Still, I do think Jatin’s question deserves a closer attention than what was paid so far.

I can clearly see Kaveri being in the discovery phase and think it will get PE > 30, years down the line. But the same cannot be said for Ajanta or Shilpa. At the risk of looking foolish, In-fact I would guess it is more likely that they get a lower PE than Astral or Mayur, even 5 years down the line.

It is just that historically pharma names have their PEs circulating in the below 30 range. Why is that? (a) Perhaps they show lower visibility?; (b) Perhaps Astral fits into some broader themes like ‘India growth story’ that can unfold for 20+ years to come?

With my limited experience I have no way to know. Perhaps if you guys speak to these mutual fund managers who buy into such PEs, we might have a better answer?

Genuinely curious.

(Donald Francis) #117

Addendum to Jatin’s/Prasanna’s actual question:

1). While I know your question had a different slant, but if you think about it closely, it comes down to Process. So we want all at VP to first imbibe the process and get it ingrained so deeply that you are not moved (unduly) to take Current Price - as THE indicator of future prospects of the business. FOCUS on the process first - if it requires 100 times repetition we will do that :slight_smile:

2). What is 50x today, some others could be at 70x, 80X 3 months 6 months or 1 year down the line. And what is highly in favour today may well run out of steam after a year. Who knows?

3). It is safe to say no one could have predicted Astral or Mayur or even Atul Auto would be pushed to these levels by Mr Market. In hindsight now, many factors can be attributed. I think what Kunal mentions about cyclicality may certainly apply to Atul Auto if not the others - but I personally have very little market experience and thus cycles-experience to comment on it.

4). We have based our Capital allocation process on sound theoretical base guided by practical experience of some of the most astute market practitioners. What is amazing is that in the 3-4 years since 2011 when we started following process, we haven’t taken a single mis-step. That counts more for me - than whether we are bang on on the best multibaggers that the market throws up. You win some of the best - the game is accomplished for you. As I have said many times before you do not have to chase all the ideas in the market. Do solid homework on a select few - that fit your investment process and hypothesis and be CONTENT.

5). Having said that - we have stuck our neck out saying that Ajanta, PI and Kaveri Seed are superior business than Mayur and Astral. I dont think its to soon to say the jury is out on that. Wait and watch what transpires in the next 2-3 years a) if these guys can continue to walk the talk and do a 25-30% CAGR b) then see if large scale instituitional conviction/action develops in the story

@ Prasanna - I will continue to say you are jumping the gun and delivering a verdict already. You are not an in-depth guy but take my advise and just this one instance do a PHD on Ajanta - just whatever is shared in the last 10 years AR of the company, Investor Presentations of late, Stock Story and the yearly Management Q&As, check out the magnificent journey and business transition this company has traversed in last 3 years -through even the eyes of VP discussions in the Ajanta thread- you are sure to change your opinion - I guarantee you that. A caveat - you have to do justice to my command!! You should be able to handle a quiz from me on the company. If you go thru this simple process, you also become a better analyst - capable of catching a business in transition, the next time you make a sincere effort!

Back-to-Basics: pay much less attention to the price -that’s mostly all NOISE ; focus on understanding the business - that’s pure SIGNAL

(Raj) #118

Gem of a quote…most of us fail here as our focus becomes stock price which is not the right way to look at.

(JatinK) #119

Hi Donald,

Thanks for the detailed explanation. However, I think you got my question wrong.

  1. I have absolutely no doubt on the ability of Valuepickr. The amount of work done (detailed analysis/ stock story/ management meet) for each stock is unbelievable. And the results, as expected, are in line.

  2. I completely believe in the potential of Ajanta, Kaveri, Shilpa to deliver 20-25% growth going forward.

  3. Agree with Valuation stages.

Having said that Ajanta, Kaveri can no way be called Undiscovered stocks now. There are a large number of brokerages following them, have decent FII/DII holding and have higher market cap and profits than Mayur or Astral or Atul Auto.

So, I was wondering why they are cheaper even though we feel their quality is better than later ones.

I have Got direction from your and others comments. Here are a few possibilities-

  1. Market is more interested in mid & small caps & ‘unique businesses’ now. So, maybe they are less interested in Ajanta (many other pharma stocks available) or Kaveri (many other Agrichem options available). Mayur, Astral gives that unique factor as well as good fundamentals.

  2. Cyclical as suggested by Kunal.

  3. Ajanta, Kaveri are lacking in dividend payout & liquidity improvement measures.

And, Donald, thanks for reminding the Peter Lynch quote-The current stock price tells us absolutely nothing about the future prospects of a company, and it occasionally moves in the opposite direction of the fundamentals.

(Donald Francis) #120

Hi Jatin,

I understand your question perfectly. Not the question the first time this question is being put to me.

I was waiting for you to put out unequivocally 1, 2, 3 just like you have.

Then it will time for you - yourself to put forward the 4th unequivocal oint

  1. Keep Faith - the most important, yet the least understood/internalised

You can know only so much…with all the brilliant effort that you put in…and there are many things that have to happen…have to play out!..some may play out, some may not, in some case alternate scenarios may play out…most of us do a poor job of mapping out alternative scenarios that can play out.

But that doesn’t mean we get stuck, or become confused, or change process mid-course even before all the stages have played out. Stick with the process with full honesty and integrity, keep faith to see through the stages.

Again I will re-iterate you are still in the trap of focusing on the Price. Some of the smartest brains at VP have already charted out which Valuation Stages are businesses like Ajanta, Kaveri or PI in about 6 months back, right.

You have the right to disagree with that assessment for sure - but first do justice to their assessment of which stage those businesses are in & why; rebut with complete honesty - after doing the due diligence on the Business. If you cant keep faith in a business like Ajanta - you have a poor understanding of Ajanta’s merits and why it stands out from the rest of the others.

You have the right to disagree with my verdict now:) but then you also have to take my Quiz on Ajanta. Tell me when you are ready. I will not spoon-feed any answers for sure, but give you clues to what you have no clue about, at the moment!

I have my hypothesis and I may be proven wrong entirely, but I can tell in 2 paras about what makes this an outstanding business to watch out for. Can you on any of the businesses - perhaps now you can about Astral - with hindsight. The trick is to strive to develop a keen foresight to reach that level of abstraction for every business that we own! We may be proved wrong - so we can challenge, be challenged and keep learning!