Investing Basics - Feel free to ask the most basic questions

[dineshssairam]

@AtulD

Many thanks for the help and inputs. I have created first ever valuation excel using DCF.

That’s amazing! Kudos to you.

@AtulD

How to forecast growth of the company assuming the comapny is doing good ? I know, this can vary person to person. But can one define/assume the ranges for sectors and companies?

I keep several things in mind when projecting growth:

1. The historical growth. The most obvious one. It doesn’t hurt to see what the company has accomplished so far in the past. In fact, in the absence of a place to start, I usually start with a 7-year historical average growth (i.e. for the first 5 years of projection).

2. Industry growth. Once again, fairly obvious. The apple does not fall far from the tree. Find out the historical growth rate in the industry and divide it by the growth rate of the company. Take this ‘multiple’ and multiply it with projected industry growth rates given in research reports (Always make sure that you compare at least 2-3 reports). This could serve as a good benchmark.

3. The Self-sustainable Growth. This one’s given as ‘Return on Equity * (1 - Dividend Payout Ratio)’. As in, if a company has an RoE of 20% and pays out a dividend of 30%, the company’s SSGR is 20%*(1-30%) = 14%. In theory, this is the rate at which a company can grow its Revenues without raising additional funds (Debt or Equity). This, of course, works as a very good upper-limit for growth.

4. The logical growth. This is the growth that logically follows your story and consequently, the most important one. For example, I had assumed a set of growth numbers for my erstwhile valuation on Avenue Supermarts. My story was that the company would plan for aggressive expansion in the first decade and then slowly settle down (This was also the CEO’s vision for the company). You can look at how I ‘justified’ my growth assumptions here:

Avenue Supermart: a compounding machine?

That’s a great question. And it’s important that you ask that question. In my model, Growth and Capex are linked. So, it holds that I have to justify at least one of these figures (I personally find Growth easier to justify than Capex). Here, I recall watching a lecture by Prof. Damodaran, where he addressed the question of justification of assumptions. One of his students had valued Netflix, but he felt like something was wrong, so he consulted the Professor. The Professor was of course quick …

I understand that this may not work for each and every company. But always try to find a logical source to compare your assumptions with.

A few pointers:

1. For the Terminal Period, growth cannot exceed the long term Risk-free Rate in the country. In fact, it should be lesser than, say 90% of the long term Risk-free Rate in the country. I generally use half of it.

2. Useful Data Sets is a great resource for valuation inputs and verification.

3. You can always turn to the global authority in valuation for any of your questions:

Session 31: Cash Flows & Growth Rates