Question on Value Investing....Sanjay Bakshi's Lecture

I found following info in one of Sanjay Bakshi's Lecture (http://www.capitalideasonline.com/articles/index.php?id=694 ):-

Could someone please explain me how did he arrive at numbers 175 and 95?

Let me just give you very quick example. Here are two companies

Company A
Company B
Capital invested
Rs 100 cr.
Rs 100 cr.
Return on Capital
35%
10%
Price/Book
10x
0.20x
Market Cap
Rs 1,000 cr.
Rs 20 cr.
PAT
Rs 35 cr.
Rs 10 cr.
Price/Earnings
29x
2x
Dividend Payout
20%
20%
Dividend
Rs 7 cr.
Rs 2 cr.
Dividend Yield
0.7%
10%

Both companies have same amount of capital invested -- Rs. 100 crores. Return on capital -- 35 percent in A and a pretty mediocre 10 percent in B. A sells for 10 times book, B sells for 20 percent of book. Market Cap â 1,000 crores for A and 20 crores for B. PAT -- 35 and 10. Price to earnings -- 29 and 2. Dividend payout -- same in both the cases. Dividend actual payment 7 crores and 2 crores. Dividend yield -- 0.7 percent and 10 percent.

Now, one looks like a growth stock, the other looks like a value stock. Now, if you keep the assumptions intact, if you assume that the future will be pretty much as what is been displayed on this slide then obviously company A well turn out to be, not only a better company, but also a better investment.

Company A is no doubt a better business than company B because it earns a higher return on capital and has a rational dividend policy because it retains most of its earnings and so long as the return on capital is high, this money will build up and like an internal compound machine should eventually show up in increased market valuation.

Now, if the model assumptions hold, and if we assume that 5 years from now the same assumptions apply, then over those five years A will produce a 175 percent return, while B will return 95 percent. So A would have been not only a better business but also a better investment.

Every year the book value increases by 28% so the final book value should come to around 2.7 times initial book value. If you include the dividends they too grow at 28% annum they should come to some where around 60 crores. So the total returns for company A are 175%. Do the same exercise for company B.

Thanks Anant…if I look at 100 compunding at 28% for 5 years the Final Value comes to 343 which itself comes to 243% as return…

Hi Sreekanth,

The book value in the 5th year is 268 and in the 6th year is 343. We need to add the retained earnings at the beginning of the next year

year 1+ Earnings
retained
1st year 2nd year 3rd year 4th year 5th year 6th year
Book value 100 128 163.84 209.7152 268.4355 343.5974
Earning 35 44.8 57.344 73.40032 93.95241 120.2591
Earning Retained 28 35.84 45.8752 58.72026 75.16193 96.20727
divindend paid 7 8.96 11.4688 14.68006 18.79048 24.05182
P/E
Market capilta 1000 1280 1638.4 2097.152 2684.355 3435.974







Hi Sreekanth,

The book value in the 5th year is 268 and in the 6th year is 343. We need to add the retained earnings at the beginning of the next year

year 1+ Earnings
retained
1st year 2nd year 3rd year 4th year 5th year 6th year
Book value 100 128 163.84 209.7152 268.4355 343.5974
Earning 35 44.8 57.344 73.40032 93.95241 120.2591
Earning Retained 28 35.84 45.8752 58.72026 75.16193 96.20727
divindend paid 7 8.96 11.4688 14.68006 18.79048 24.05182
P/E
Market capilta 1000 1280 1638.4 2097.152 2684.355 3435.974







Hi Srinivas…by the same logic…in the second case 100 growing at 8% would mean that after 4th year its value is 136 and even with dividend accumulation it doesn’t come close to 195…:frowning:

136 * .2 = 27.2 (since price/book is .2)

current market cap = 20 cr

increase in market cap = 27.2 - 20 = 7.2

dividends = 2 + 2.16 + 2.33 + 2.51 + 2.72 = 11.72

total returns = 27.2 + 11.72 - 20 = 18.92

in percentage terms (18.92/20)*100 = 95% roughly

Thanks alot Anant for the explanation

what is your timeline on the holding period?

The risk here is you guys are assuming at the end of 5 years it will still trade at a high pe and pb… The value buy is cheap… Future is always uncertain… Anyday we should go for heads I win tails I don’t lose much

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