ValuePickr Forum

The ART of Valuation

Hi Donald,

Great start! As you very succinctly put it, it's time to leap to the next level. I have been currently compiling data for last 10 years on "high quality businesses" to understand

1) what attributes make a any business high quality of A+ category business

2) How rewarding it is to pay up for high quality businesses. How do they behave in a buoyant market and in a lackluster market.

Though, I am still compiling more data, here are some inferences from the analysis of the data compiled so far! I think there are few factors which are "must have" for a business to be qualified as A+. Of course, it goes without saying that high ROE/ROCE; free cash flow, low leverage etc are required as such.

1) Inherent strength of high quality business enables it to operate business with least capital deployed. All the companies which have strong moat, working capital requirement grow at much slower rate than top line growth. As moat gets stronger, many of them do business on OPM (other people's money!). This "float" is a great booster as every rupee earned generates infinite return! Have a look at the data below. 6 out of 9 companies have negative working capital. In last, four years, 6 out of 9 companies have reduced working capital (even if it was already negative to start with). Take example of GSK Consumer healthcare. It reduced working capital from 52 crore on sales of 1700 crores to -355 crores on sales of 3400 crores!

Company name P/E W.Cap 2009 W.Capital 2013 Revenue 2009 Revenue 2013 % change in Revenue % Change in W.Cap
Gillette India 82.55 52 30 673 1458 117% -42%
HUL 47.27 -1383 -2518 21868 28487 30% -82%
ITC 37.11 1200 1880 24363 44224 82% 57%
Pidilite 30.98 243 310 2132 3898 83% 28%
GSK Consumer 38 52 -355 1700 3367 98% -783%
Nestle 42.73 -102 -698 4471 8614 93% -584%
Asian Paints 40 240 330 6300 12600 100% 38%
P&G 42.56 -51 -101.54 774 1698 119% -99%
Colgate 36.21 -318 -469 1758 3324 89% -47%

Pricing power: Another attribute, which often get overlooked,but crucial is pricing power. Some times it is evident and sometimes it is dormant. However, if you look at all the companies above, all of them, as a whole, or in some large categories have ability to raise prices without impacting the demand. Here is what Buffet opined in 2011

âThe single most important decision in evaluating a business is pricing powerâ
âIf youâve got the power to raise prices without losing business to a competitor, youâve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then youâve got a terrible business.â
Hence while assessing the quality of business, if company can raise price for its product without affecting demand (Price for Maggie/Nescafe), chances are hight that it is a high quality business.
Opportunity size: As Donald mentioned, the opportunity size does matter.All these companies are in a business which have achieved scale 10 -20 times of what it was 20 years ago and can still grow 10 times in next 20 years! My hunch is that as the large opportunity size is important for high quality business so is the time for "repeat" buy! One may consume Maggie/Nescafe/Horlicks every month and buy it again. However, replacement for CPVC pipe or sanitaryware happens after a decade. This implies that market has to be sustained through new buyers and not through repeat buyers. And all people who have worked in marketing/sales would agree that it is tough to get your foot in for the first time!
Best Regards,
Dhwanil








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Some more qualifying comments to bring everyone on the same page about the intent of this thread.

This thread is about the ART of Valuation. It is NOT about the SCIENCE of Valuation :-). There is not much debate/discussion needed on the science part. Gurus have documented everything there is to document and it’s easy to grasp for anyone serious about investing. However in my experience that is only about 20-30% of the job. And it is mostly about helping you AVOID making mistakes. The Science part helps you avoid traps. The Science part (may give some lead indicators) but mostly does not lead you to the best-performing businesses in your portfolio - THINK about this!

My favourite quote on Valuation is from my Guru Buffet who says you do not need complicated spreadsheets and/or complicated models to tell you a business is undervalued. It should simply scream UNDERVALUED!

The ART part of Valuation is more difficult to put across. And normally it takes years and years and churning of businesses by the 100’s before some clear patterns emerge in your head and then become aids in quick decision-making - rejecting stocks/businesses by the dozen before landing up with a few high-quality ones.

The ART of Valuation is about being able to decide for ourselves the ODDS of high-quality performance delivery by the business in questionBEFORE there is consensus/conviction in the market. Useful to keep this important premise in our minds.

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@Dhwanil

Thanks for the data, and glad you brought this up. Helps to illustrate my next point and just to steer you gently towards the right sort of data collation for this thread.

Some FMCG businesses inherently possess many desirable characteristics as branding (mind-share),repeat purchase, pricing power (probably this holds really true though only for Horlicks, Maggi kind of iconic brands and not for Soap/Shampoo brands per se), and so on. Many of them are high-quality businesses, but they are not the ONLY ones :slight_smile: and there lies the OPPORTUNITY!

Also everyone knows about them, it’s apparent to any serious investor. There is no ART in getting steady 20-25% compounders out of well-known high-quality FMCG-like mature businesses - you normally do not get exceptional out-performance from these.

This is because the expectation of the high-quality business performance is already built-in into the price. Everyone knows about them - there is consensus in the market about the conviction about these companies delivering high-quality performance.

The ART of Valuation is in someway, therefore - about being a little prescient!. A little ahead of the average investor in the market, about being able to decide for ourselves the ODDS of high-quality business performance delivery in question BEFORE there is consensus/conviction in the market about it. Which means there exists a big gap between expectation (current P/E) and actual business performance!

Which in effect means a power-packed combo ofHIGH-CONVICTION vs HIGH-UNDERVALUATIONin a business under scrutiny, in our Capital Allocation terms! This important premise perhaps forms the CORE of the ART of Valuation.

So on to Valuation ART #2 then.

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Interesting- very interesting topic Donald. Hope to learn a lot from this.

Thought a bit on this. Here is how my thinking is going-

There are essentially four kind of Moats-

1) Intangible Assets/ Brands

2) Customer Switching cost

3) Network Effects

4) Low cost advantage

Let me give a few example for the benefit of those, who don’t know this.

  1. Intangible Assets/ Brands-- Nestle, Sun, Ajanta, PI, Kaveri, Page, Cera, Astral, Hawkins, Prestige.

  2. Customer Switching cost-- Mayur, Eclerx, IT comps like Infosys, Accelya etc.

  3. Network Effects-- Winner gets all here. NSE, Google, Facebook, MCX.

  4. Low cost advantage-- Kewal kiran, GRP, Indag (can be due to absolute low costs or due to economies of scale).

So, this thread indirectly asks to rate the Moats.

IMHO**Network >> Intangible Assets >> Switching cost >> Low cost advantage **

because in Network effect… winner takes all. So, he can charge anything.

Intangible assets/ brands… you are a lot better than your competitor. So, you have pricing power.

Switching cost… You are better than your competitor. So you have pricing power but not very high in bad times.

Low cost advantage… You can charge an amount so that you still remain low cost for your customer but can’t ask for infinite amount here.

So, Network Effect will have A+ business.

Intangible Assets will have A+, A.

Switching cost will have A, B.

Cost Advantage will have B. (going as per Donald’s classification)

Views invited.

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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.

Getting an investment call right has two aspects to it, betting on a good business vs betting on a good price (severe undervaluation). When we talk about FMCG or Pharma, typically the good businesses leap to mind. The ones which have a “brand”.

The interesting aspect though is to look for those businesses where the brand is not yet fully established, there is potentially a large scale of opportunity and where the price is cheap (due to ignorance or small size of the company where it has not yet drawn institutional observers). Here the potential risk-reward is very high.

For example, Astral, a stock which has been very well discussed at ValuePickr. It is a wannabe brand, large scale of opportunity, was available cheap a few years back when most of us bought.

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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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Very little experience in the capital market, so trying to learn as much by vicarious experience.

W.Buffet in his 1984 letter to shareholders expresses his views on A+ businesses. " My own thinking has changed drastically from 35 years ago when I was taught to favor tangible assets and to shun businesses whose value depended largely upon economic Goodwill. This bias caused me to make many important business mistakes of omission, although relatively few of commission…

Ultimately, business experience, direct and vicarious, produced my present strong preference for businesses that possess large amounts of enduring Goodwill and that utilize a minimum of tangible assets."

I suppose businesses like ILFS Investment Managers, Accelya Kale, DRG acqured by PEL requires very minimum tangible assets and have enduring Goodwill.

Regards

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Thanks Donald for this wonderful community.

My 2 cents.

3 parameters that affect valuation are

1). ROE/ROCE

2). Growth

3). CAP - Competitive Advantage Period.

Lot has been discussed in this community about first 2 and even all valuepickr stocks share first 2 and did exceedingly well but may not necessarily have a very long CAP (upwards of 10 years). Now that most of the valuepickr stocks have run up a lot it may not give similar return as in the past (although I missed out of most of the multibaggers Luntil recently) and hence need for the quest for the next multibagger.

This seems to be the best moment for applying another strategy to the portfolio, stocks with sustainable higher CAP (upwards of 10 years).

Advantages if stocks with higher CAP

1). Current valuation does not matter to some extent since even if you buy at an expensive price over the long term (10/20 year), you will earn returns similar to the business.

2). Even though these may look expensive based on P/E, P/BV valuation but market consistently undervalues these stocks (check some recent posts from prof. Sanjay Bakshi).

3). Generally these stocks command similar valuations even after 5-10 years due to CAP expansion.

4). Minimum reinvestment risk. We donât need to keep searching for next big thing.

5). Good candidate for SIP investors.

6). During crisis, these stocks are least impacted.

7). Large diversification may not be required.

8). Easier to get conviction on these stories.

eg; Nestle, Page, HDFC twins, Gruh, etc.

These consistent growers can complement valuepickr portfolio and add lot of stability to the portfolio during crisis time.

Happy Investing!!

Regards,

Dinesh

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VALUATION ART #2

)— Spot on… Few months back guess most of us were in two minds…i was… Almost all the A+ picks were richly valued… It was getting tricky to allocate fresh capital…

Donald if Ajanta Pharma, Pi Industries and Polymedicure are valued at more than 25 pe then which stock among these will Mr D allocate fresh capital and why…Will love to hear from veterans…

( Or do we need to constantly monitor/think in terms of ‘what can go wrong’ in the underlying business and then increase allocation )

Regards
mallikarjun

Abhishek correct me if I am wrong-

Nokia, Apple were technologically driven moats which are more risky & unpredictable. Better to stay away from these as Buffett does.

But look at multiples Network effect driven moats get especially when currently captured market is very less than future perceived market.

Look at Facebook, Twitter or Just-dial valuations.

Donald, am I on the right track OR you are talking some very different point here?

There is an interesting checklist on how to think about sustainable moats (based mostly on Porter 5 forces) from a Mauboussin paper that I have cut and kept. While not all elements on the checklist are equally important, this has started to serve as a nice guiding tool for me. Hopefully the VP folks may find it useful as well:

**Value Creation Checklist **

**Economic returns **

  • What stage of the competitive life cycle is the company in?

  • Is the company currently earning a return above its cost of capital?

  • Are returns on capital increasing, decreasing, or stable? Why?

  • What is the trend in the companyâs investment spending?

**Lay of the Land **

  • What percentage of the industry does each player represent?

  • What is each playerâs level of profitability?

  • What have the historical trends in market share been?

  • How stable is the industry?

  • How stable is market share?

  • What do pricing trends look like?

  • What class does the industry fall intoâfragmented, emerging, mature, declining, international, network, or hypercompetitive?

The First Three of the Five Forces (Suppliers, Buyers, Subsitution)

  • How much leverage do suppliers have?

  • Can companies pass supplier increases to customers?

  • Are there substitute products available?

  • Are there switching costs?

  • How much leverage do buyers have?

  • How informed are the buyers?

**Barriers to Entry **

  • What are the entry and exit rates like in the industry?

  • What are the anticipated reactions of incumbents to new entrants?

  • What is the reputation of incumbents?

  • What is the level of asset specificity?

  • What is the minimum efficient production scale?

  • Is there excess capacity in the industry?

  • Is there a way to differentiate the product?

  • What is the anticipated payoff for a new entrant?

  • Do incumbents have pre-commitment contracts?

  • Do incumbents have licenses or patents?

  • Are there learning curve benefits in the industry?

**Rivalry **

  • Is there pricing coordination?

  • What is the industry concentration?

  • What is the size distribution of firms?

  • How similar are the firms in incentives, corporate philosophy, and ownership structure?

  • Is there demand variability?

  • Are there high fixed costs?

  • Is the industry growing?

**Disruption and Disintegration **

  • Is the industry vulnerable to disruptive innovation?

  • Do new innovations foster product improvements?

  • Is the innovation progressing faster than the marketâs needs?

o Have established players passed the performance threshold?

o Is the industry organized vertically, or has there been a shift to horizontal markets?

**Firm Specific **

  • Does analysis of the value chain reveal what activities a company does differently than its rivals?

  • Does the firm have production advantages?

o Is there instability in the business structure?

o Is there complexity requiring know-how or coordination capabilities?

o How quickly are the process costs changing?

  • Does the firm have any patents, copyrights, trademarks, etc.?

  • Are there economies of scale?

o What does the firmâs distribution scale look like?

o Are assets and revenue clustered geographically?

o Are there purchasing advantages with size?

o Are there economies of scope?

o Are there diverse research profiles?

  • Are there consumer advantages?

o Is there habit or horizontal differentiation?

o Do people prefer the product to competing products?

o Are there lots of product attributes that customers weigh?

o Can customers only assess the product through trial?

o Is there customer lock-in? Are there high switching costs?

  • Is the network radial or interactive?

  • What is the source and longevity of added value?

  • Are there external sources of added value (subsidies, tariffs, quotas, and competitive or environmental regulations)?

**Firm InteractionâCompetition and Coordination **

  • Does the industry include complementors?

  • Is the value of the pie growing because of companies that are not competitors? Or, are new companies taking share from a pie with fixed value?

**Brands **

  • Do customers want to âhireâ the brand for the job to be done?

  • Does the brand increase willingness to pay?

  • Do customers have an emotional connection to the brand?

  • Do customers trust the product because of the name?

  • Does the brand imply social status?

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Jatin, so Facebook, Twitter & Just Dial are not technology companies? :wink: Remember Orkut, MySpace, Yahoo - companies which flattered to deceive? In response to your question on whether to invest fresh capital at 25PE, my personal take would be that I would not (would look at valuation metrics other than PE but if all/most metrices show its overvalued, I would pass).

Sir John Templeton had a few rules for investment success. Two of them which are relevant in this discussion are as follows:

  • When buying stocks, search for bargains among quality stocks
  • Buy value, not market trends or the economic outlook
    So, I would continue to keep looking till I get “bargains among good quality stocks”. That is why its important to track a reasonably good number of stocks which are not in one’s current portfolio.

Dinesh, I get very uncomfortable whenever anyone talks of ignoring current valuations.We should be very very careful of creating an investment thesis based on short term trends (5-10 years). We have to look at history of atleast 2-3 complete business cycles to get some level of comfort that what we are talking about is correct and works. Please go back to the US Nifty Fifty boom. Your points are exactly what people used to make back then. And we all now how that ended. So, be careful of what others say (including such eminent people like Prof Bakshi, whom I have a lot of respect for). Over the last 100 years, the ONLY trend that has worked over the largest duration of time, is value investing. And it continues to work simply because it is psychologically very very difficult to implement.

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Hi Donald,

May be I was not able to put across my point clearly. The reason for putting up data was to illustrate the characteristics that a high quality business should possess eventually and not to suggest those businesses mentioned in the list are good investments in the context of our discussions. As you rightly mentioned, all these stories are well known and priced in! However, when we come across a business which demonstrates gradual movement towards such qualities such as negative working capital/float and pricing power, we should acknowledge them as potential high quality business “in the making”. Only then, we can be ahead of the curve.

I think at this juncture, I have observed bias for slow contrast effect come into play. Many a times we ignore small incremental changes that, eventually result into large impact. Take for example, Amara Raja, in last 10 years, W.Cap as % of sales have decreased from 30% to 9%, gradually. This is equivalent to what industry leader Exide used to achieve in 2000 when it operated in almost monopolistic environment(and continues to do so even today).Slowly but steadily, company has more bargaining power with dealers and customers, indicating expanding moat. Same is the case with pricing power. Lead prices, increased by 3 times (i.e. CAGR 12%) in last 10 years and ARBL not only maintained but improved its margins even surpassing market leader Exide’s margins. And now ARBL has decided to decouple its pricing policy from that of competitors! So, ARBL is charging premium to Exide in replacement market and still gaining market share. So is ARBL inching towards “high quality business”? If so, isn’t it attractive at current price, trading at 15 P/E?

So,as an investor when we aspire to be ahead of the curve in identifying high quality business, I feel as an investor we may have two separate approaches at their disposal

  1. We identify clear and visible trends towards “predictability” and “intellectual property” or other such high quality business attributes and invest when every one else in the market is still waiting for “proof” (like many of the members would have done in case of Page or TTK prestige few years ago). Here the conviction level may be subjective to each individual. But hey it doesn’t matter, we are talking about the “Art” part anyways :-).

  2. Invest when high quality businesses are facing headwinds due to macro factors slows the momentum down. Be contrarian. So may be companies like Triveni Turbines and Shriram Transport Finance can be good bet. Economic down turn has resulted into below average results for these companies but both of them demonstrate all the attributes of high quality business. Both of them are leaders in their segment by virtue of intellectual capital.GE, which is one of the most technologically advanced company especially in Turbine technology, has formed JV with Triveni to market 30-100 MW range steam turbines world over. It is a vote of confidence for Triveni’s intellectual capital, technological prowess and process orientation in <100 MW steam turbine market. Triveni is undisputed leader is <30 MW segment in India with close to 60% market share. Having been associated with energy sector, I have experienced its phenomenal reputation which puts its product comparable to world’s best offerings from Siemens/Alstom/Nippon. Triveni’s growth has slowed down due to challenging economic environment in Indian and globally. But, once the economy turns around, there is high predictability of Triveni doing very well.

Same goes for Shriram Transport. It has got a vote of confidence from one of the best capital allocators in India, Mr. Piramal. It’s offering is unique and it will be very difficult to replicate the unique systems/processes for risk and cash management that STFC has evolved over last many years. It is competing largely with private moneylenders and hence in spite of charging hefty margin for “perceived” risk, it still lends at competitive rates as compared to rates charged by private moneylenders. And look at its new offerings such as “Auto malls” and “new look” which not only compliments its core business but also can “de-risk” it by infusing fee based income. So, again, attributes of high quality businesses.

But the moot question here is, how much one should pay up for “high quality businesses” considering the additional risk one is taking either by jumping in early or taking the risk of being wrong? How should we still ensure that we do not lose capital by overpaying?

Best Regards

Dhwanil

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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:

Regards,

Ayush

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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.

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:-).

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!!

:))

@Dhwanil

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.

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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]

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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]

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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]

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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.

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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.

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VALUATION ART #3

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.

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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.

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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.

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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!

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