The ART of Valuation

This was also the time when we had had a few good successes. However most of us seemed to be stuck on under-valued differentiated businesses.

A 25-30% ROE business with positive operational cash flows, low debt, growing at 30%, and available at 5-6 P/E was a formula that was working great for us. We could generate the 30-35% annual CAGR we desired from these businesses.

And before Mr D’s “processor-type” challenge, that’s where we exactly were. Even an Ajanta Pharma got into our Portfolio when it was available 6x earnings with major improvements in OPM :-). It’s another matter that we articulated the Capital Allocation framework with Mr D’s intervention, however Mayur and Astral continued to hog the really high-allocations. Within a year, we saw Ajanta out-performing every other business in the Portfolio and we sat up and said hey, why the hell did we not allocate much more to Ajanta?

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VALUATION ART #2

High Conviction vs High Undervaluation. Right!

Getting to grips with “High Conviction” was easy for us. All of us were capable of putting in enormous amount of homework/dig up data/local scuttlebutt/field reports to establish that. Hard work no doubt, but simple enough. No ART in that :-).

Getting to grips with “High Undervaluation” was not so simple. This was mostly the ART part!

**How do I decide which business is intrinsically more valuable? **It is easy for me to KNOW a ~5-6 P/E, ~30% RoE ~30% grower is a STEAL! But it gets more complicated when anything is available >10x - say 12x and 15x or more.

Mr D: Well, historical valuations do provide some pointers. But it is far more enriching to think about it from a buyer of the business perspective. Suppose someone has the 5000 Cr needed to buy out an entire business, which type of business is he going to value more?

Is he going to value and pay more for Mayur or Astral or Ajanta Pharma or Poly Medicure or PI industries or Kaveri Seeds? Think about it, and there lies the clue! And you will not find the answer from your Excel spreadsheets/ratios mind you. (He knew about my exhaustive number-crunching excels :-))

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In many cases some of these businesses were growing splendidly. Some of them outstripped others just by the phenomenal growth they were recording.

But if we were to have say all things being equal (say Execution track, Growth record, Management pedigree, Financials), two things became clear immediately:

1.The lesser the number of variables in the business, the greater are its ODDS of delivering consistent business performance. In essence, the more predictable a business is, the more valuable it is.

2). The higher the intellectual capital brought into the processes, systems and by extension the products/services of the company - the more valuable it is.

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No marks for guessing now that we started seeing why a PI industries should be much more valuable than the 12-15x it used to quote at. Same goes for a Poly Medicure at 12x or a Kaveri Seed at 10-12x, and an Ajanta Pharma at 12x!!

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