The ART of Valuation

Investing Strategies
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I have been meaning to capture the next phase of refinement for our Capital Allocation Framework based on our learnings from 2011 onwards. It’s a tough ask! Several of you have egged me on to try and put together our incremental learnings in a way that is meaningful and useful for the community.

Ever since that fateful discussion and consequent starting of the ValuePickr Public Portfolio and Scorecard, we have been sticking our neck out! We made certain choices consciously on the way dropping some and adding some in our combined (ValuePickr) wisdom of the moment.

Fortunately, most of the calls seem to have worked out. Valuations have got much stronger over the years where we continued to advise BUY/HOLD. Fortunately again, most of the EXIT decisions also seemed to be right (Suprajit Engineering being the notable exception, as it has continued to grow reasonably), in hindsight.

So there is some method to the madness after all - to the ART side of Valuation/Allocation. However getting a real HANG of this sometimes takes a full investing lifetime. We all know some guys who are pretty good at this, and we realise some of us are not so good at this. Some guys are good at getting-in early and equally good at jumping-out early :-). And then there are some who after taking the call, are very very good at sitting-tight!!

Remarkably, all of us have had access to almost the complete information-set (on individual businesses) in good time, and direct and/or email access to the best of the lot at ValuePickr, yet actions taken have been different (even by the veterans).

It is indeed difficult to imbibe the ART of Valuation!! That does not mean we can’t speed up the process for everyone! We believe we can! This thread is about trying to capture some of the essentials from our experience of the last 3 years…so newbies/learners can make a reasonably good headstart, and us practitioners can attempt becoming more refined at the ART form.

Making bold to start this new thread on the ART of Valuation (provokingly titled) :slight_smile: - setting high expectations and inviting the risk of falling flat in delivery - but hey, we have always liked to stick our necks out - challenge and be challenged - in our bid to become more refined investors.

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VALUATION ART #1

Mr D: All your stock picks are good but I can’t help observing almost all of them are processor-type stocks.

Processor-types? What do you mean? Most of these are strongly differentiated businesses with management having a good track-record at the helm - Mayur Uniquoters, Astral Poly Technik, Suprajit Engineering, Gujarat Reclaim, Vinati Organics, Balaji Amines. They have been doing well too.

Mr D: Ya. But all seem to be taking in some input, processing that and selling the output. Not much value-addition don’t you think?

This time I am stumped. Even though I was always looking out for strongly differentiated businesses, I had to admit I hadn’t thought about things deeply enough. I countered, as long as these are growing strongly and are obviously under-valued why shouldn’t I be allocating more capital there?

Mr D: Maybe you should examine what is the valuation range accorded to processor-type businesses

Frankly till that moment I had invested zero time on finding out for myself -practically )- what kind of valuations Mr Market awards different kind of businesses. Let alone spend time thinking about it and the why’s? And I was already completing 3 active years in the market (`close of 2011, I think), had read all the Must-Have-Investing-Books , and been turning dozens of stocks!

Please tell me what’s the range for my processor-type companies. I pleaded.

Mr D: Just check. It’s rare to find Processors crossing 1-1.5x Sales in their lifetimes. And do we have examples of businesses that add-value. Haven’t you noticed Piramal Health being acquired at 9x Sales. There’s a clue there!

What a clue that was, Sir! We got hooked to the next refinement in our -Separating the Wheat from the Chaff. We graduated from trying to identify “strongly-differentiated businesses” to identifying those with “High Business Quality”.

)-----

We started thinking differently about businesses. Even with most things being equal, we realised there ARE a few things that mark out businesses as significantly more value-added, if you like. We graduated to slotting businesses according to business Quality.

B Category - Balkrishna industries, Gujarat Reclaim, Suprajit Engineering

A category - Mayur Uniquoters, Astral Poly Technik

A+ category - Ajanta Pharma, Poly Medicure, Kaveri Seed, PI Industries

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I can’t think of any other input that has had as dramatic an impact on our Capital Allocations, and subsequently Portfolio Performance, as this one single input.

It all seems deceptively SIMPLE, right. We all seem to logically, inherently know and understand this. But probably it’s not an ingrained mental-model for most of us. Once you have that ingrained (hard-coded into your decision-making that is) though, there will be no looking back! Our experience suggests so :-).

Perhaps some folks can take the lead to illustrate the learnings from slotting our picks into Category A+, A, and B kind of businesses by exemplifying these from ValuePickr forum discussions.

That will give us some time to develop the flow for Valuation ART #2.

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At this time I was pretty obsessed with oligopolies - only 2-3 players in the world! Vinati Organics (ATBS #2 in the world and growing share), Balaji Amines (NMP, PAP - among top 5 successfully challenging the dominance of the BASFs of the world) !! and the like.

In my naivety - I was ignoring 2 crucial things:

a) The size of the opportunity - pretty small, and that is why the oligopoly exists. It’s just not worth the while for big chemical giants to pursue that kind of a market opportunity

b) Critical Dependence on crude RM - No matter how excellent a Management, they are vulnerable to crude (petrochem) volatility

The above Business Quality insight led us to prune first Vinati Organics and Balaji Amines off the VP Portfolio in a bid to concentrate more on A and A+ category businesses. Next was the turn of businesses showing clear signs of cyclicality like BKT, GRP and Suprajit. B category businesses - we decided we will ride opportunistically - when valuations were really cheap and additionally there is evidence of cycle turning, etc.

There is another oligopoly -Oriental Carbon - only the 2nd alternate supplier of Insoluble Sulpher to most Tyre majors world-wide, that we reluctantly had to prune off the Opportunistic Portfolio list. This didn’t have the RM volatility as above, but had Auto cyclicality as the other problem and slotted as B category - as were BKT, GRP and Suprajit Engineering.

Oriental Carbon is getting HOT now as an Opportunistic Portfolio candidate, by the way. And we should get to reviewing GRP which looks pretty warm too, maybe even re-look at BKT too.

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Poly medicure A+ — High quality business with entry barriers, almost a lone player, sustainability, scalability and potential to leapfrog into more value-added products…

Most of the pharma formulation companies and FMCG A+

Avanti feeds A- — Variables like weather, disease can affect the business…We must always be on our guard if invested…Unless valuations catch up it may remain so as A- or else B i guess…And need temperament to ride the volatility which most of us lack…Unpredictability but an opportunity to veterans…

B — Some cyclicals like Indag etc…

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There are businesses which may seem to be in a cyclical industry - as we are apt to paint with the same broad brush - but are able to handle the cyclicality much better.

Evidence from VP Portfolio - Atul Auto and Indag Rubber . They continue to remain in VP Portfolio as the business continues to do reasonably well, and we could see that happening based on our understanding.

Another example is Suprajit Engineering which has surprised many of us. Clearly we hadn’t paid much attention/followed the business closely to read the signs of their ability to keep growing reasonably.

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Thanku donald… May be caused a barrier to free flowing and in depth discussion which you were contemplating… Sorry…

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Everyone please feel free to participate, make your observations, supply data and cross-question our findings or submissions - and make this a vibrant discussion - not a monologue. I am also clarifying my thoughts as I try to pen down the essentials - to influence essential discussion pieces.

@ Mallikarjun - your comments/thoughts are welcome just as anyone else’s. Just thought to clarify that Indag shouldn’t probably be clubbed as a pure cyclical - it does well with the CV industry in recession - so your comment was very timely to illustrate a point.

Only if we have free-flowing uninhibited comments coming in, will points and counter-points be raised - and that is essential while trying to refine our thoughts - challenge and get challenged - with the aim to get better at what we do.

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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 question BEFORE 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 of HIGH-CONVICTION vs HIGH-UNDERVALUATION in a business under scrutiny, in our Capital Allocation terms! This important distinction 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.

)-----

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

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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?

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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!!

:))

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@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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I had sent out a query to some senior investors. Here’s the query and a brilliant throught-provoking response received from a very respected senior and VP well-wisher.

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Sir,

Need guidance - to take our ART of Valuation discussion forward. [Link]

How do the best investors think about the right valuation for an emerging business (and therefore the gap) before consensus emerges about that business in the market?

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Interesting thoughts, with very good insight.

I have no idea how good investors make their decisions because Iâm not yet there but I can say for myself. I have never penned my thoughts on this but when looking at emerging stocks, two things I mentally get a hang of are:

1.How does this company make money

2). What can go wrong for this business.

I will not discuss (2).

On (1), I sort of mentally slot where the stock belongs to - what I call as (A) Laborious stocks (B) Average stocks and © Smart stocks. The origin of doing so has something to do with school or hostel days where all of us have classmates of different types.

You have very studious and extremely hard-working guys who generally do well in a class directly proportional to their study hours, night-out effort and time. Rank toppers & gold medalists generally come from this segment. Most disciplined & regimented guys also come from here. Some of the dumbest guys are also placed here because of family & peer pressure etc. they keep slogging with poor results. All these areLaborious stocksâ Type A. They typically constitute 20-25% of the universe.

Then you have guys who are average studying types, will make same mistakes whenever faced with a googly question in the exam or viva. General tastes, fashion, fads etc. You wonât find any Sachin Tendulkars here. These areAverage stocksâ Type B that typically constitute 60% of the universe.

Then you have few who study little but are actually much sharp, fast grasping power, excellent subject understanding of fundas and output they deliver_in relation to the inputs gone in_. Iâm referring to only fair study means, no shortcuts or hanky panky stuff. These areSmart stocksâ Type C. They may not be rank toppers and sometimes they can even be laid back but my experience shows they have done fairly well in life (not always in conventional sense of the word). May be when you think back, youâll find some real life examples.

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It is this Type C â Smart stocks that I always look for when scanning emerging stocks that are yet to arrive (in terms of marketâs institutional discovery and consistency of results) but have some advantage. Scale up, Network effect and expanding of Moats are easier to achieve with this Type C stocks.

Pardon my saying but most of your ValuePickr stocks are the Laborious types including Manjushree, Vinati, Mayur, Balkrishna, GRP, Indag, Astral etc and even Kaveri that you are putting in A+ category. There is nothing wrong in being with laborious stocks and with right traits they make very good money so long as they preserve their traits just like gold medalists and most disciplined guys display. Mayur is a case in point. HDFC bank is a very laborious stock and very disciplined at that, so they can be really rewarding if you find them early and they themselves donât goof it up.

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Ajanta Iâll not comment as I donât understand it well.

I can slot PI in Type C where results can be disproportionate.

Last year, Alembic was a very easy Type C and we made an easy kill there, doesnât always happen. Two Type C that Iâm betting on at the moment are JB Chemicals and Accelya Kale, though from much lower levels. One Type C where Iâve_probably_gone wrong is IL&FS Investment Managers.

While dealing with Type C Stocks, one important caveat is that management quality & integrity should not be suspect. Second is when analyzing such a stock, we should be looking at the outcome of big would-be picture. Third is we should have a handle on the right metric to value such a business, not necessarily the PE or PB.

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The term âProcessor stocksâ never occurred to me thus far, but itâs a nice way of looking at it and they are a subset of Laborious stocks.

Discl: I have no position in any of the stocks mentioned above,except for the last 4 named stocks.On Laborious stocks, to take the cricket analogy forward, I’m reminded of Australian fast bowler - Glen McGrath who can keep bowling the same outside the off stump nagging line to the batsmen the whole day - so disciplined and so immaculate. If VP stocks are those Glen McGrath,I don’t want to give an impression that these stocks will not be good vehicles to ride, as historic CAGR shows they have given superlative returns, and may continue to do so by all means.

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Great thought provoking discussion on the Art of Valuation. Thanks Donald for starting this new dimension to the journey of investing.

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Donald and Abhishek,

Excellent flow and great constructs indeed! This is turning out to be one of the most thought provoking discussions we have had on Valuepickr. Donald, kudos for your ability to put complex things succinctly and clearly. It can not happen without clarity of thoughts!

On your point of “UNDER PAYING”, I am all with you and strongly feel that in spite of varying style and preferences of various value investors, one thing that should be sacrosanct is “margin of safety”. That is the reason, I am not comfortable making investment at a price which has lot of “built in” expectations and margin for error is limited (Ref. discussion on Page valuation).

The idea of a new entry into portfolio should find a place one notch above the least ranked stock in portfolio is immensely powerful especially from capital allocation efficiency perspective. To further imbibe into your thought process and to make it process oriented and keep the discipline, we must resort to checklists. I came across fairly exhaustive check list shared by value investor Rohit Chauhan on Safal Niveshak. One can tweak it to one’s comfort depending upon parameters one wants to capture and detailing one wants to do. However, I am increasingly realizing that such checklist/scoring matrix is a must to ensure that decision making is least prone to “biases” and subjectivity. Thiswill also ensure (only if carried out with full integrity and honesty as you very rightly mentioned) that capital allocation happens to stocks which are better than existing portfolio of stocks and not based on heuristics ( I am tempted to recommend reading Thinking fast Thinking slow By Daniel Kanhman to understand how in so many instances we resort to heuristics to replace a structured decision making process to proxy complex situation with “simplistic” variables!).

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Kudos for the knowledge.

Hitesh & Ayush seems to me in Type C category.

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Thanks Donald for starting the best thread of vp so far.

Till now, all I was looking in a business is is a consistent ROE, ROCE >20, low debt, good management, good sales/ebit/np growth each qtr yoy, and a fair valuation, and a reasonable logic for such performance to continue in medium term future. Just now started to incorporate high dividend payout to my stock selection.

What you started is a discussion a notch or two higher than the way I was selecting stocks. Here you are not just looking at the number and leaving the sustainability part for “lazy evaluation”, but rather by looking at the moat/intellectual property/stickiness of business, you are trying to divide them into buckets>

I can clearly see why PI Industry should be in “Type C” category, especially because of its CSM business, which we all know has a huge order book (for next 3-4 yrs), is sticky nature as its customer dont change CRAMS partner unless in extreme situations, is based on high trust environment. Plus the cashflow generating out of CSM business can be used for building new plants in CSM segment, and boosting agrichem business, which we know has huge potential in future.

What I dont get is why Alembic was a “Type C” stock (I am invested in it from 100 level, and it was a pure undervaluation play for me), and why JB Chem/Accelya are “Type C” stocks. May be you can get reasoning for these 3, so that we can get the framework for identifying “Type C” stock.

Also why “ILFS Inv Management” was a “Type C” stocks and why it failed. As per my knowledge it was the only listed PE firm (and hence a concept stock), and it failed because of its investment in Real Estate cos.

Regards,

-Subash

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A very interesting discussion. It is also very interesting the analogy of various kinds of students being compared to various kinds of companies.

My takeaway from this analogy is that we should look for companies which have laid the building blocks for disproportionate future growth. Laborious stocks will produce a rupee worth of incremental growth for the extra rupee of incremental input. It is not a one to one relationship but an extra rupee wouldn’t produce two rupees of incremental growth in this category.

Smart companies will produce disproportionate growth. This is a moat type company which will be able to rapidly expand because of its brand, IP or network.This is not very different to smart( moat as one is usually born this way) students who have a great grasp of the fundamentals and can combine diverse disciplines to answer complex problems. PI and Polymedicure clearly are in this group. Having built the base e.g Poly medicure can have a disproportionate growth if some large OEM order comes in. Another stock to be included in this category is Amararaja. It has done the hard work of building a dealer network and brand building. It is in the process of expanding capacities.It will capture a larger part of the market share with lesser incremental effort as in a two cornered fight, the spoils to the winner are disproportionate.

A great beginning to a very enriching discussion.

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Thanku Donald… The threads under Capital Allocation are addictive…

Most of the compounders are Type A and Can we say some of our Opportunistic bets are Type C…

Regarding margin of safety; Can we associate quality of business, growth with Margin of Safety…

Since valuepickr or any large player can influence a stock valuation, how does Mr D and other veterans remain rational/objective… Steps they take to remain balanced…

Is it due to vast experience or do they just know what works/will work on the street…(Sometimes we can’t point the exact reason)…Will be grateful to hear from them…

Regards

mallikarjun

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This thread will take the award for best thread in VP - this looks like a type-C thread :slight_smile:

Feels like we are in some mythical land searching for the secret treasure of knowledge.

Type-C may not be exactly related only to Moat/IP. It looks like a high conviction+high undervaluation concoction. The larger picture may be just hiding out there like the example of Warren Buffet’s investment in American Express.

Shilpa looks like a Type-C. I had placed JB under opportunistic bet, but looks like it can turn out to be more than that especially if the company can keep building brands like Rantac.

Symphony was surely a Type-C at 270 levels and maybe even now.

Hooked to this discussion.

Vinod

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** especially market. **

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.

Most of the new technology stocks(intangible assets holding cos) are highly valued like eagle sailing on sky. Do you remember Technology Bubble 2000 ? That will give you answer.

Some creations in this world is far from our understanding. So we better not predict it. For eg. Women’s mind, Universe and its boundary, Technology stocks (not all but most).

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Some common traits which I can perceive for category C type of businesses-

1). Scalable Business having unique Intellectual Property.

2). Requires very little or no capital to grow, as a result most of the cash generated is free.

3). Deeply Integrates with the businesses of its clients such that it becomes indispensable part of its business.

4). Company’s revenue forms very small percentage of the cost for its clients, but adds much value to its clients business.

5). Repeat businesses from the same clients.

6). Enjoys huge operating leverage. Once a certain size is reached costs does not increase in the same proportion as revenue growth.

Businesses referred- Accelya Kale, DRG, IKYA

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The whole idea of Type C stock and comparison with “smart” student is very interesting and conveys the central idea so effectively! It is pleasure to learn the diversity of metaphors and mental models successful investors use! My hunch is that many of the Type C stocks will be clouded by uncertainties. It is important to distinguish between uncertainty and risk. Uncertainty does not ALWAYS mean risk! However, market more often than not ALWAYS considers uncertainty as risk. For example, JB Chem which decided to keep large chunk of cash on the books created an uncertain environment where investors and market were not sure how and when the cash will be deployed in the business. But management made it clear that cash will be deployed for the growth of pharma business. However market was still looking for “proof” and in absence of proof it discounted the value of the business heavily. As management started walking the talk, and slowly but steadily started deploying cash in business, market has started to realize that “perceived risk” no longer exist or the odds of risk materializing is low. Eventually, it will give “due respect” to hard cash…! Same is the case with Piramal. At current price of PEL, one can get exposed to number of positive black swans and a share in high quality businesses on extremely favourable terms . Having said this, senior investor is so right in saying that management integrity is absolutely must in some of these situations. Market is full of value traps where “uncertainty” has materialized into risk due to lack of management integrity.

The whole idea of investing in Type C stock can be very very rewarding! So, again great concept.

In the wake of recent actions taken by FMC of

-marginalizing FT representation on board

-clear indication of no financial liability for MCX on account of NSEL

-Today’s FMC order asking FT to reduce its stake from 26% to 2%

Can we consider investment in MCX Type C opportunity? MCX (or for that matter any DOMINANT exchange" in general) is a very high quality business with expanding moat (network effect as “winner takes all”) which is still scratching surface in India. Can we systematically understand the current uncertainty and its repercussions to evaluate whether there exist significant risk or not. But I will take that up separately on MCX thread.

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Beautiful Discussion. Loving every part of it. And yes, one of the Best threads here. Threads on Business Quality and Capital allocation are equally powerful. One point that stuck me the most is “for every new entry in the porfolio, an existing one has to go.” Very Powerful. Needs a lot of hardwork and a structured framework & approach to accomplish this.

Things are very dynamic. On one side are type C and type B stocks (well, I love B types, they have been working wonderful so far, And we all know seniors who compensate smartness with hardwork:), which can be kept for(ever) long-long time and then there are PSU bets based on political environment and sugar cycle plays. I understand we need “to experiment”, but I am struggling with it and not very clear how this fits with the idea “for every new entry in the portfolio, an existing one has to go”. Any thoughts here…?

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Mr D meant, if you have 5 businesses in the portfolio you can add a 6th for sure. But the minimum ranking for the 6th business has to be at least #5. Don’t add a 6th or 7th or 8th business at the bottom of the pile lazily, or mechanically.

Any new entrant should challenge you to think through very clearly why it belongs to the top rungs. It must have enough in it to be able to seriously challenge the incumbents and move up by moving at least one down :slight_smile:

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**

Regarding

)–If there is reasonable/big Margin of Safety - it would mean that the market is undervaluing the business, unable to see the high quality A+ category (sustained performance ability and say intellectual property) that we could clearly see - e.g. in PI Industries or Poly Medicure till recently (refer the Mgmt Q&As).

)–Even an Astral’s or Mayur’s A category business quality (sustained and improving performance ability) wasn’t acknowledged by Mr Market for almost 2 years - while we kept finding the Margin of Safety and kept buying post every result/Mgmt Q&A

**

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Thanks for driving the point home Donald. got it.

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Hi Mallikarjun,

There are some very smart folks at ValuePickr.P Sharma has exemplified it beautifully for us, already. Please pay attention to what he has said.

My takeaway from this analogy is that we should look for companies which have laid the building blocks for disproportionate future growth.

Laborious stocks will produce a rupee worth of incremental growth for the extra rupee of incremental input. It is not a one to one relationship but an extra rupee wouldn’t produce two rupees of incremental growth in this category.

“Disproportionate future growth” is a super new concept or mental model Mr M has given us (sorry Mr M I felt compelled to acknowledge, for posterity’s sake :-)). It deserves special attention and its own thread :slight_smile:

Type C Businesses: building blocks laid for disproportionate future growth Link: …/…/…/forum/valuepickr-scorecard-aug-2011/721990029

Everyone - Let us continue exploring Type C now onwards, in its dedicated thread.

I am sure there will be many interesting practical examples thrown about and much more enriching debate/discussions - and reach logical conclusions, soon hopefully :slight_smile:

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Re: Opportunistic bets

None of our opportunistic bets are/can be Type C.

Our Opportunistic bets are huge UNDERVALUATION plays (less emphasis on high business quality) like we had in Atul Auto, Indag Rubber, Manjushree Technopack, Avanti Feeds. The premise is one should be able to make very good money in these in much quicker time, than long term portfolio picks.

My take is the huge undervaluation exists till there is information asymmetry - Market doesn’t know or is slow to understand the real business dynamics.

Fortunately, most of our opportunistic bets (except Oriental Carbon) have demonstrated that investment premise of ours :). We are very fortunate to have some very astute investing practitioners :-).

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Let's take forward the 3 main constructs so far. To me it seems our "Business Quality" Value Chain has a hierarchy of sorts. Each level is important and great "differentiator" planks to pit one strong emerging business with another.

To reach the higher levels the business may normally need to to build/invest through from the lower levels. Unless the business shows performance consistency, aspiring for or investing in building process/system/product IP may not be possible? Higher levels may not even be reachable my most strong businesses.

Level 1 Level 2 Level 3
Disproportionate Growth
Intellectual Property
Performance Consistency


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Mr M:If you observe,there are no real numbers or ratios to analysein all this process - looks too laborious to do. If understanding of an investment can simplify to this level, then it's our take on the business that has to go wrong to challenge the Conviction.UNDERSTANDING is the real margin of safety.

It's perhaps time to start pitting our favorite businesses against each other - for a "doodh ka dooth, pani ka pani" exercise.

I am filling in for the first few businesses I am pretty familiar with to ignite the debate. Should there be major dissent against, I am willing to defend these in the way I best can.

Business Performance
Consistency		 Intellectual
Property in
Processes/Systems/Products		 Building Blocks for
Disproportionate Future Growth
Mayur Uniquoter Yes - -
Astral Polytechnik Yes Yes (derived) -
Poly Medicure Yes Yes Yes
PI Industries Yes Yes Yes
Ajanta Pharma Yes Yes (limited) ?
Kaveri Seed Yes Yes Yes
Amara Raja
Shriram Transport
Accelya Kale
JB Chemicals
Il&FS Investmart -

All those pretty familiar with the other listed businesses, feel free to speak up and rate these by posting a similar table. Elaborate as needed in the text following the table. Only caveat - you must be willing to defend/debate your ratings with concrete reasoning.
We aren't keen on an opinion poll! (not yet, at least).
But everyone feel free to critique and ask pointed questions of raters ;-)
Welcome comments/suggestions on refinements for this above exercise.
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A really interesting discussion. Nothing much left to be said when so many good investors have put across very thought provoking points. If i may, i would like to add the dimension of ‘time frame of investing’ vis-a-vis valuation, to the discussion

We buy a company (or tiny parts of it) simply because we expect the market cap to go up (preferably, not because of dilution :slight_smile: ) I think there are three factors which drives market cap (leaving aside the khabri, satta and punting stuff)

1). Earnings

2). Cashflow

3). Dividend

The market cap (and valuation) of a company keeps on moving up/down on the overall market’s perception of these three factors.

Now in my opinion, over the short term (for me, thats 3-4 quarters), the most dominant factor affecting market cap and valuation is earnings. Over a longer term, cashflow and dividend also kick in. Hence, if one is investing for a shorter term, one should look more at earnings for determining valuation. As one’s time frame changes, the basis for valuation also should change. So, over the short term (maybe even for a few years), companies which show huge earnings growth will also show a good rise in market cap and valuation. But over longer term, when earnings growth is not accompanied by cashflow (a must) and dividend (maybe optional), the increase in market cap does not sustain. Hence, longer term investors would be better off giving greater emphasis to these factors while valuing a company.

(Till about 4-5 quarters ago, i was in the long term compounding stories camp. These days, i am more in the shorter term/earnings growth/reversion to mean camp. As such, methodology as well as factors for valuation also have changed)

Hope I did not talk much non-sense and was in line with the discussion…

Cheers!

RP

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Valuepickr is a platform with power characteristic of a great mentor who nourishes and empowers his mentee constantly! More important as the mentee keeps up the hard work and keeps getting better at things he raises the bar higher!! This evolution has been phenomenal :)The only problem I have with this mentor right now is he keeps raising the bar faster than I can cope with - but that’s the beauty in it…Determined to keep with the pace set here :slight_smile:

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Thanku Donald for your’s/veterans patience … Will need some time off, to gain more clarity about their Art… Believe more mental models are on the cards…

Regards

mallikarjun

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Amazing discussions in perhaps one of the best threads at Valuepickr. Kudos to Donald and all other contributors. Makes for fascinating reading.

In summary we have seen how market values sustained earnings growth coupled with a moat (of some sort) way higher than only consistent earnings growth. Lesser number of variables to track, strong visibility of future earnings and some visible differentiator (IP/Network/Entry barriers) leading the path for disruptive future growth are key to potential multibaggers.

It is key to note as Donald pointed out, the undervaluation exists for a considerable time even after signs of future potential starts showing up. Whats probably missing during this period is strong UNDERSTANDING of the business and the conviction coming from it. It is essential to pick up new potential multibaggers at this juncture, and not afterwords.

Let us look at two picks which have created humongous wealth in the recent past. One from the Valuepickr portfolio and one outside. It is important, as Dhwanil elaborated to understand the key aspects/traits fromexistinghigh quality businesses .

Both would be Type C businesses, the first TTK Prestige operating at a Oligopolistic market( rather duopolistic at that time with clear boundaries - Hawkins(North) and Prestige(South)) took a clear distinctstrategyof rapid expansion and brand extension across product categories.

Narration 31-Mar-04 31-Mar-05 31-Mar-06 31-Mar-07 31-Mar-08 31-Mar-09 31-Mar-10 31-Mar-11 31-Mar-12 31-Mar-13 Last 5 Yrs Growth
Sales 140 181 222 281 326 402 509 764 1,105 1,358 4.2x
Net Profits 0.2 4 7 12 21 22 52 84 113 133 6.4x
Working Capital 76 68 61 75 59 45 63 80 65 202
Wcap as %age of Sales 55% 38% 27% 26% 18% 11% 12% 10% 6% 15%
Networth 39 40 44 52 67 83 122 189 283 395 5.9x
Market Cap 15 52 172 134 132 103 650 2536 3187 3633 27.5x
P/E (Trailing TTM) 72x 14x 24x 11x 6x 5x 12x 30x 28x 27x 4.3x
Return on Equity 1% 1% 2% 1% 5% 16% 24% 23% 22% 25%
Return on Capital Emp 9% 13% 18% 19% 30% 37% 52% 74% 58% 40%
Increment in Networth 1 4 8 15 16 40 67 94 113
Increment in Mcap 37 120 -37 -2 -29 547 1886 651 446

From FY04 - FY08, while there were clear signs of improving working capital, incremental ROCE what market perhaps ignored was the potential product expansion and size of opportunity with wider distribution reach riding on the brand moat.

The stage was set for disruptive future growth. So while from FY08 - FY13 the market cap improved 27x it was brought about by disruptive earnings growth (6.4x profits in 5 years) and expectatios. (4.3x jump in P/E). Once this was fairly discovered, the returns were nowhere close (FY11-13).


Looking at the second pick from the Valuepickr pf, Ajanta Pharma. Here the somewhat weaker moat derives out of a differentiated strategy of niche offerings and targeting specific low competition niche markets. As in this case the visibility was much weaker in common parlance because of lack of UNDERSTANDING more than anything else. In other words, the moat was not readily discernible.

The company was doing all the right things. Trends like increasing R&D spend, increased no of filings across emerging markets, improved financials - trends that were not very difficult to track, yet mostly ignored due to lack of better understanding. Refer this beautiful summary from Ayush (http://dalal-street.in/ajanta-pharma-and-mps-ltd/#more-1512) last Dec.

Narration 31-Mar-04 31-Mar-05 31-Mar-06 31-Mar-07 31-Mar-08 31-Mar-09 31-Mar-10 31-Mar-11 31-Mar-12 31-Mar-13 Last 5 Yrs Growth
Sales 118 175 206 239 285 319 382 457 604 839 2.9x
Net Profits 0.4 7 10 14 18 21 29 46 66 101 5.7x
Working Capital 100 120 128 143 165 190 154 133 178 186
Wcap as %age of Sales 85% 68% 62% 60% 58% 59% 40% 29% 29% 22%
Networth 173 101 110 121 134 152 176 216 272 356 2.7x
Market Cap 48 68 81 86 94 60 214 237 530 1521 16.1x
P/E (Trailing TTM) 134x 9x 8x 6x 5x 3x 8x 5x 8x 15x 2.8x
Return on Equity 0% 7% 9% 11% 13% 14% 16% 22% 24% 28%
Return on Capital Emp 9% -5% 12% 13% 13% 14% 16% 18% 22% 30%
Increment in Networth -71 8 11 14 18 24 40 56 84
Increment in Mcap 20 13 5 8 -34 154 22 293 992

Thus small incremental and ongoing changes leading to an acquired moat ( differentiated strategy/stronger distribution/increased R&D spend etc. as opposed to Brand moats like a Nestle, GSK) are inevitable much earlier on the ground and reflects in financials if someone is looking to identify the same.
More often than not, this is the ideal time to load up and ride it completely as the (disruptive) profit growth pans out and the market gives the stock true recognition in terms of P/E re-rating.
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Hi Donald,

Shilpa is missing from the list and I am sure you have a view on that.

Looks like building blocks are in place for disproportionate growth.

IP value also is strong.

Consistency in performance is yet to be proven…but that is what is giving the opportunity.

Agree on PI, Poly and Kaveri. Kaveri might have a lean period before the next round of disproportionate growth.

Astral - by getting early approvals for Blazemaster, brand building effort and distribution setup can all be looked at as building blocks for disproportionate growth. But yes the number of years of such growth may not be as large as PI or Poly.

Should we score each com on the three parameters?

Cheers

Vinod

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:)) khabri, satta

1). Earnings

2). Cashflow

3).

** Niraj, Good insight for investment.

Does the factor of putting money back into the growth engines affect the valuation of the company?

Does a company which regularly generates the profits and distributes to the shareholders is to be valued higher or a company which also generates the profits but puts a significant amount of earnings back into the business expansion and generates compounding profits?

**

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Does Biocon fall under category C? The company is known for the disproportionate growth(though on either side)? If available at reasonable valuations and sighting the tailwinds, it has potential to give significant returns over short to mid term time horizon.

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Intellectual Property:

Disclosure: I am invested in Kaveri alone from the above set of scripts.

As everybody else have already said, this is the most enriching discussion that I have gone through on ValuePickr.

Big thanks to Donald and others. To me intellectual property is a double edged sword which could bring great returns in short term but in longer run will almost certainly be replaced. Being from the technology world I have regularly seen companies with great IP faltering whenever a new or disruptive technologies emerge and this happens very regularly. I would value efficiency ingrained in processes and systems in due course of time much more than the product IP in longer run. Another problem with IP based companies is how easily all their moats become penetrable when you have a better technology coming up. Further most IP based companies are almost always faced with the innovatorâs dilemma forcing them to ignore newer trends at the cost of serving current customers.

@Donald: The other thing which I think which is missing from the table is risk of moats being penetrated. Kaveri to me looks the most risky of all stocks in the list mainly due to the following:

a) As explained above IP to me is inherently risky. If say Mahyco or Nuziveedu comes up with a better variety of hybrid seeds it would not take more than two to three years for Kaveriâs bt cotton hybrid Jadoo to be replaced.

b) Any reports of farmer suicide or bad seeds (due to storage, incorrect usage etc.) could involve government and ban of seeds.

c) The acreage size of bt cotton is ~90% of total agricultural area. I do not see the opportunity size to grow. It can only grow at its competitorâs expense. On the other hand I see reduction in crop are for the next year.

d) The R&D expenditure as a percent of sales is low and has come down.

Why I am invested in Kaveri. I think it is underpriced and it does have sufficient catalysts to go for nearly two to three years. I also think in the next few years more bt crops will come up mainly the oil producing cash crops (current imports of cooking oil are generally bt based) and Kaveri might have an edge there in developing hybrid seeds.

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Hi Donald/All,

Intellectual property gives a feel about a limited scope on what can be in Column #2. What it encompasses is what IP component that is present in current business.

But I feel it is intangibles which make it broader.

For example, brand building like Astral/Cera are doing, (and Pidilite/Asian paint/Page have done), which change the processor type of stocks into a different kind of moat-based company, and create opportunity for disproportionate growth in future. Even Nestle making maggi, or GSK making Horlics can be thought as processor type business, if one does not understand, what it means to an average indian consumer. All FMCG super-performer are of this type.

Secondly, most of good Pharma cos, which have build phenomenon experties of making drugs, handling FDA, marketing in both domestic/foreign land, ANDA filling can also be thought of as highly IP based business model.
For example the expertise of Ajanta is the speciality segment in making drugs, and Emerging market cant be copied by any one, and hence constitutes IP. IP doesn’t necessarily mean developing novel drugs, or being 1st to file ANDA in US.

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Few more examples of #2

Eicher motors - Harley Davidson brand

PVR - Virtual monopoly with 70% share (after buying cinemax) in where it operates, in a segment, which is bound to grow higher and higher

On column #3

It does not need to have clear position in #2 to be in column #3 (Building block for huge growth). Even if a company is undervalued, and slowly moving up in IP chain, like Shilpa/Aurobindo’s API to Formulation transformation, it can create huge growth. Same is true with Cera/Astral trying to build brand around their products, and Ajanta trying its hand in entering US market

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Many thanks Anant, Subash for raising important points. Hope many more will perk up soon.

At this point we are taking in all/especially divergent viewpoints. The time for converging will come once we have plenty more comments come in - once more guys have had a go at digesting and pondering a bit over this. We will evolve better/refined terminology too - to drive home the essence.

I will leave few comments - only for the sake of influencing/broad-basing the discussion - hopefully inviting more comments.

@Anant - Yes, we are talking about intellectual property in a broader sense. Highly complex systems/processes behind products are also considered IP - difficult for others to replicate. And if you have processes/systems that drive the innovation psyche in the company - the business continues to produce more innovative products after the first breakthrough. In as ense the job gets much easier.

For Kaveri too - that holds true. the germaplasm bank and the processes behind delivery of first successful hybrid has ensured better hybrids. ATM is reportedly better than Jadoo in both yield and climatic condition tolerance as per the company - not being bandied about - not to cannibalise the Jadoo magic of the moment.

@ Subash - Distribution strength is important, but perhaps not in the same leagues as above. It takes 30-40 years of consistent performance and consistent growth before distribution alone can become one of your most formidable armoury. Like the FMCG giants ITC or HLL today or the Coke and Pepsis of the world. wherever you go they are there.

Iconic branding like Pidilite/Asian Paints - For sure that is in the disproportionate category. While the intention to follow in these illustrious footsteps is laudable, how seriously would one take that intention today. if you are to rank it as a building block today, perhaps one will give it a rating nearer the bottom.

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If we go back and look at our big winners then I feel under-paying has been one of the key factor in generating big returns. Most of the times these were no-brainer propositions.

Usually these cos come to notice whenever they post good quarterly performance etc…but as the past few years or perception is not great, re-rating takes time. People have their doubts etc. But in VP, the good thing was that we were keen on questioning and seeking answers to the reasons behind the change and see if the same is sustainable going forward. The groundworks we have done are not easy and required lot of efforts and focus. The good part was that in most of the cases the change was not only sustainable rather the story just kept getting better with the size :slight_smile:

So one of the ART is questioning right!

Another key thing is looking at the bigger picture - many of the stocks were faced with temporary issues like forex loss etc. (Astral, Poly) from time to time yet they did well. Its important to think beyond it and see what can happen over next 3-5 years.

Regards,

Ayush

VALUATION ART #3

:)).

Repeating the process having the discipline full honesty and integrity

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It is heartening to see so many high quality ideas being generated in such a short time on not so simple topic. It speaks for the quality of participants and forum!

As we are discussing so many diverse ideas/concepts of how “high quality business” should look like, I feel we should simultaneously focus on how do we identify such businesses? As an investor, It may not be enough to have understood that PI/ Poly Medicure/ Amara Raja/Ajanta are high quality businesses. It’s great that we have come across such businesses. But, I somewhere feel that it is equally worthwhile to discuss

)- Going forward how do we identify such high quality businesses on consistent basis? When we identified PI/Poly Medicure/Ajanta did we follow any thought process/screening which we can replicate or was it just a combination of “undervaluation” and “performance consistency”?

)- When we spotted Ajanta, Kaveri, Poly Medicure and partly PI also, apparently we spotted them due to undervaluation and not because of quality (it’s my understanding from the threads, and please correct me if it’s wrong). On further digging we discovered the high quality business and disproportionate growth potential. However, largely we all agree that Poly Medicure/PI at current level, post re-rating also are attractive. But, probably we would have not discovered these high quality businesses in the first place if they were trading at PE of 15-20, in 2011 and would have excluded large and attractive opportunity set of high quality business. Does it imply that Art of valuation is skewed towards identifying high quality business only if they are undervalued on some conventional parameters (and some times to an extent that they are no-brainer, as Ayush so rightly pointed out. Though,personally my vote unequivocally go for such approach)? If not, how do we bridge this asymmetry?

As a corollary to this, another point that Ayush has made on “under paying”, seems so very central, which we have so far not discussed. We are currently discussing A+ businesses and which businesses may qualify. After our views converge on that, we should discuss with same vigour “how much” to pay for the quality? How do we ensure margin of safety and not get carried away by “paying up for quality”? As Donald mentioned earlier, this whole ART is about remaining ahead of the curve and UNDERPAYING!

Frankly, I do not have answers to many of these questions. But hey, this thread is not about everyone knowing everything anyways! It’s more about stimulating a discussion to further refine our thought process and mental models. I have immense faith in collective wisdom of this forum and unbridled enthusiasm of senior valuepickrs to guide us.

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Good debates being generated on the forum.

I think while exploring Type C companies (including our A+ businesses), many of us are are still mixing up aUndervaluationa with aQuality of business (or improvement therein)a. These can very often be 2 distinct dimensions.

A business available cheap (say Alembic or PI Industries) can attain a moderately higher multiple, and we feel happy that it has caught up. On the other hand, an already expensive company (Page or Just dial) becomes even more expensive, and we donat know what to say.

But what weare referring to in Type C stocks is disruptive opportunity in creation of market value. Sometimes businesses show a quantum leap in financial indicators over say last 2-3 years backed by something right they are doing in their business positioning, revenue model, and management drive. Usually multiples accorded by Mr Market take time to factor these in?

As I sleep over this, I can easily see examples of building blocks being laid for a disproportionate growth in future mostly by companies who have expertise in productising services/products in niches that they are already laying claim to as their own. Though as Anant mentions before, nothing is (really) sustainable in high-technology sectors (not only IT btw) and is prone to obsolescence but still relatively speaking - given their strong presence in a sector, how often are these factored in the PE multiples of the business (in its nascent stages)?

In that sense, we are not at all talking about the undervaluation catch-up while discussing the Art of Valuation. Undervaluation can add to our “level of comfort” in making an investment entry/exit decision; it has nothing to do with business quality which is an independent variable.

This is essentially different from science of valuation part.That said, beyond a point it’s difficult to convey in words, and Markets are supreme.

I think there are some good examples already, good food for thought and some actions.

Will revert on specifics as I get a good grip on this myself, first:)).

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As hinted at before, getting better at this is process-driven.We have become better at the game in quantum jumps form 2011, every year!! Because We took to Capital Allocation passionately.

Step 1: Take Capital Allocation seriously. Repeat,seriously. That is pit every business against the other and start grading them. Your FOCUS will perforce shift away towards High Conviction, as apart from High Undervaluation.

Step 2: Study/Think about why Mr Market is giving different multiples to different businesses, first in different sectors for a broad understanding or slotting of business types. Commodity, Commodity processors, lowest cost plays, cyclicals, brand plays, intellectual property plays, and the like. And tehn study with in a sector too there are players with varying business quality. Take Pharma for instance and you have all types of players! Study, why Mr Market values them differently.

Step 3A: Start thinking as the “Owner/Acquirer of the business”. This is a simple construct but probably the most valuable construct to think really hard about Valuation. The Copeland Valuation book is a great help in getting “Business Quality” thinking ingrained.

Step 3B: So a useful question to ask is what is the value of a business to a 100% owner-acquirer? Look at the open offers, delistings, takeovers, reverse mergers, amalgamations, special dividends etc with this question in mind to figure out the answers from the aquirer’s point of view.( I am yet to seriously act on this: we do have a specialist in us though, T Anilkumar who used to devote as much as 80% of his energies to this aspect :-).

Step 4: Get smarter about businesses laying/have laid building blocks for disproportionate future growth ;-).

Of course, needless to say minority shareholder like us, have to apply appropriate MoS to determine his/her entry and exit price, holding periods, other opportunities that may arise (to be compared with each other on a risk-reward scale). There is no ‘right’ answer to this exercise and the answers may as well change as the variables change!

Speaking for ourselves: I can easily say 2011 went in absorbing and assimilating Capital allocation basics. But by mid 2012, we had firmly shifted focus first on business quality and only then undervaluation, not the other way around. That is why we had no hesitation in re-recommending Ajanta Pharma at 2x of our first entry levels, Kaveri Seed at 1.5-2x first entry levels, Poly Medicure at 12x was a steal and a PI industries also at 2x earlier entry levels.

Don’t forget Capital allocation is all about the product of conviction and under-valuation. If you have high conviction and high undervaluation then you can bet real heavy. We believed we had that high conviction and high undervaluation combo in each of the businesses cited above, and thus there were unanimous reccos on these in 2012 and 2013!

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In essence, I think like what Hitesh mentions, we need to have a list of top ideas, if fully laden with Type C companies - the better, at all times and need to follow them vigorously.

Allocation on these names however will depend a lot on valuation and MoS. The relative undervaluation score combined with the quality of business score might see them move up or down in the ranking of opportunites. But the first cut to the list should be on merit of business quality and that alone.

This is with regards to the long term portfolio.

The scope of pure “undervaluation” plays might come up for the short term opportunistic portfolio with regards to no-brainer investment choices provided to us by Mr. Market. Here of course, conviction would be low and hence would be allocation.

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Note: 1) I am using certain stocks as example to convey my thoughts. I have used these stocks because of my familiarity with these stocks. Request everyone, not to give too much emphasis to selection of stocks and letas not digress from main topic by starting debate on individual stocks, rather than thought process. 2) This thought process in mainly for Type C stocks, stocks with disproportionate growth.

I have not yet invested in any company following this process, but am trying to study various stocks with possibility of disproportionate growth in market cap over next 5-10 years.

  1. One of the most important points to remember and understand that everystock CANNOT BE VALUED. Infact I would go one step ahead and say, valuation should be the last thing one should look into [By this I am not suggesting valuation are not important, but by initiating our thought process with valuation, we block our mind to see tremendous opportunity which lies ahead of the company or get too focussed on quantitative cheapness that we failed to see risks in the business model. Many investors ignore the risk of black swan events. I think black swan events in the last 10-20 years and occurring with frequent intervals and one just cannot ignore it completely]

  2. **Ignore excel sheets, historical returns including ROE and ROCE and focus solely on BUSINESS MODEL AND SCALE OF OPPORTUNITY.**Again by no means I am suggesting historical ROE and ROCE are not important. But for many of such business when they are in their initial stage of high superlative growth, these ratios might be meaningless due to high expenses compared to current scale of operations, high investments in R&D etc. Read success story of Parag Milks here_http://forbesindia.com//article/big-bet/how-parag-milk-foods-got-it-right-with-cheese/35431/1_aIf he had gone about analysing this opportunity in a conventional wayalooking at the amount that would have to be invested, the return on that investment and so onahe would probably have decided it wasnat worth the risk. But he did what a classic entrepreneur wouldahe deleted the Excel sheets and took a gut call. aI realised it was now or never,a he says. He decided that there was an untapped opportunity in processed cheese and that Parag Milk Foods would ride the coming wavea

  3. **Think like a venture capitalist:Have an investment horizon of 8-10 years and act as if you are investing in unlisted company and you will get exit opportunity only if company is ableto scale up its business model profitably.****If you think you will be comfortable in investing such business even if itas an unlisted company, then only invest else not.**Thinking in terms of decade will ensure that you eliminate companies where you suspect technological obsolesce, product obsolesce, regulatory changes or suspect management etc.

  4. **Position size:**Again I think, mortality rate will be higher in such companies in initial stages when then is high possibility of superlative growth. Obviously superlative growth companies will be operating in innovative or untested field and there is very possibility that company may fail. So itas important to invest in such companies as a basket of 3-4 companies restricting position limit for each company to around 5%.

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Cont…

Let me take an example of Muthoot Capital vs Intec Capital:

Now if one starts their analysis with focus on valuation and historical growth and ratios, definitely Muthoot Capital is better than Intec Capital. But for me Muthoot Capital is not type C stock but Intec Capital is. Main reasons 1) Size of opportunity for SME business vs size of opportunity for 2W finance over next 10-15 years 2) Existing competition in SME finance vs 2W 3) Future competition in SME business vs 2w [Machine Finance is not like simple lending to 2W. 4) Yes ROE and ROCE of Intec are not respectable at present, but compare their employee expenses and other expenses as % of assets under management with other companies. 5) Look at the growth achieved by Shriram Transport Finance and Shriram City Union by operating in a niche field. Both these companies show possibility for creation of tremendous wealth by companies operating in niche field and huge opportunity size. 6) Lastly past actions of Muthoot Capital [which I highlighted in Muthoot thread] does not give me comfort on management.

Secondly lets take example of Shriram City Union. Again this is a company which is operating in a filed with tremendous growth and highly underpenetrated [SME lending]. Now this company and Intec Capital both are in SME business, but Shriram City Union restricts maximum loan at 20 lakhs and does not lend amount higher than 10 lakhs without immovable and other tangible assets security whereas Intec Capital lends money without any tangible assets security. One can think of a joint bet on Intec Capital plus Shriram City Union to gain from possibility of tremendous growth in SME lending.

**Disc:**No investment for Intec Capital/Muthoot capital/ Shriram City Union from Type C stock perspective as of now. My current investment in Intec Capital is more from a special situation in open offer.

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It may be worthwhile to start putting the points discussed so far into some framework to create a base for further orient our discussion to tie up three major focus areas of this discussion i.e. Capital Allocation, Business Quality and Valuation and further refine Based on the discussions in this thread. A quick personal view on broad principles of each of the focus areas.

- Quality of business: Based on discussion so far, and as Donald has so beautifully categorized the hierarchy of businesses based on business quality, we can define broadly four category of business

- Businesses having strong quantitative matrix and consistent business performances

(Mayur/Cera/Atul)

- Businesses having consistent business performance and some intellectual property

(Kaveri/Shriram Transport)

- Businesses having consistent business performance, intellectual property and high

visibility of decent compounded growth for next 5-10 years (Astral/Amara Raja)

- Businesses having consistent performance, IP and high probability of

disproportionate growth (PI/Poly Medicure/MCX)

- Valuation: In my opinion we should have rough idea of what is "cheap" and "fair" valuation for each category of businesses based on previous trading multiples for type of businesses, as Donald mentioned earlier, acquisitions, delisting, take overs, mergers etc. This differentiation is critical, as we have observed. For a business whose sole ISP is consistent performance record, PE of 12 may be fair but for a company having strong IP and high probability of disproportionate growth P/E of 12 may be cheap.

- Capital Allocation: We should allocate capital to each combination of business quality/valuation range to keep the balance. However, obviously, the proportion of capital allocation should be "disproportionate" based on expected returns! I would also like to add that in addition to each category of business, we should also make some allocation for "opportunistic bets for special situations, turnarounds, short term re-rating etc.

So, for better visualization I am creating a table here

Obviously, this is just a framework and numbers on valuation as of now are my hunch and needs to be further honed (based on actual data as discussed earlier). Capital allocation also is my personal take and we can debate it. However, the underlying principle is that one should allocate disproportionate capital to high quality businesses (60% in this case), and even within that, disproportionate capital to high quality businesses available cheap (35%). Secondly, P/E is not the only parameter to assess cheapness.

Even though, there are some suggestions that we should ignore paying attention to parameters like ROCE/ROE/Free cash flow/ leverage, and focus on scalability and growth I personally feel that all these parameters having in place on consistent basis is an inherent part of ensuring a strong and sustainable business model in place. Until, a business passes such test, as "passive owners" who are not driving the business like an entrepreneur, we may be exposed to disproportionate risk (which venture capitalist can take with access to large funds and deep pockets, ability to drive business decisions and directions).

I will be glad to hear more views and take this discussion forward.

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It shall provide us some guidance if we study the thought process of some of the greatest entrepreneur/investors in search of A+ Businesses

Ajay Piramal after the Abbot deal as he says in one of the analyst meet- We want to reallyinvest in new types of businesses and a new portfolio which we thought will be the portfolio for the future where we have

(1) High Long Term growth which is driven by

(2) Increasing market demand with

(3) High Long term margin potential due to some IP or some other proprietary advantage.

(4) In the businesses that could grow with M&A AND

(5) Where we know we could add value.

Vinod Khosla- We invest in companies across lots of industries where innovation is designed to create a new product/service or to completely disrupt the economics of the existing products.

Warren Buffett- Invests only in Co’s with proven track records with ever expanding moats at reasonable price.

It is really interesting that the most successful ones think with the time frame in mind for decades before investing in any enterprise.

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Most successful investors need to invest such a large sum of money that they can not exit any investment on a short notice. That is the reason for thinking in terms of decades. We small investors have an edge over them as far as exit problem is concerned. We can exit any investment on a short notice without damaging the price. Their thinking is driven by their concerns. We should not be approaching our investment decisions based on some other investors problem just because they are big. As long as investment is good for next 2-3 years with huge potential upside, we should go and pick that.

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A brief one - couldn’t help posting - finding some space in vacation.

As I slept over what we have discussed and put on the table so far. the hierarchy for me is getting pretty clear.

Strongly differentiated Finance/NBFC businesses with a unique business model belong pretty close to the top of the rung - This is a pure “Feel” (strong gut) thing at the moment, but I will try to articulate this better conceptually, at a later stage:).

Pursuing that vein, I am studying Intec, SCUF and STF in that order :slight_smile:

Views welcome.

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Hi Everyone

Suven Life Sciences fit the criteria for disproportionate output i guess…

Going through their site… Its too heavy and all over the place…

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Hi Donald,

Very interesting hypothesis.

One curiosity I have is whether there is any specific reasons for studying Intec, SCUF and STF in particular order? Though, being an investor in STFC, I am bound to have bias, personally the comfort level (promoter/track record/business model) is exactly in the reverse order!The reasoning that I have is that NBFC and banking are areas where one is exposed to negative black swans which can completely wipe out the companies, if things go wrong! Hence track record of managing risks, promoter’s integrity and competence are of great importance. Moreover, valuation wise, STF and Intec are in the same range. STFC has virtually no competition in used CV financing business from organized players (I am not sure whether Intec also enjoys such luxury) has excellent track record for last so many years and value driven promoters. Wouldn’t it make more sense to analyse them in reverse order?

stage:)).

:))

Views welcome.

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One of Charlie Munger’s pearls of wisdom fit apt with recent discussion :

Disney is an amazingexampleof autocatalysis. They had all those movies in the can. They owned the copyright. And just as Coke could prosper while refrigeration came, When the videocassette was invented, Disney didn’t have to invent anything or do anything except take the thing out of the can and stick it on the cassette. And every parent and grandparent wanted hisdescendantsto sit around and watch that stuff at home on videocassette. So Disney got this enormous tail wind from life. And it was billions of dollars worth of tail wind.

Obviously, that’s a marvelous model if you can find it. You don’t have to inventanything. All you have to do is to sit there while the world carriesyouforward.

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Dhwanil,

I had to respond to that:) although the order shouldn’t really matter.

For me the promising unknown is far more enticing than the known sure-fire thing!

As I have mentioned before, one good reason we have done exceedingly well in unknowns (that performed well) is we had an EDGE over the average investor in the market. We cannot have much of an edge over the market in the knowns. The knowns can give you 4-5x in 3-5 years but surely can’t match the 8x-15x-20x in the unknowns in the same period (my personal experience).

So the attractiveness will never be the same - provided of course the unknown has something going for it; in this case there is something Shriram guys have themselves acknowledged - that Intec guys have slowly assiduously built a niche - extremely difficult top replicate. check Intec thread for more.

Having said that, there is a time for extremely good bets in the Knowns - in a secular market crash, when everything is beaten down, when panic has set in, but business fundamentals are still good to strong.

I am studying STF too, and I know how well respected it is, the pedigree of having created its unique unmatachable footprint; however the business fundamentals aren’t good - it’s at best a turnaround bet; Some STF veterans I know have actually booked most of the profits in STF recently!

Studying Intec, SCUF and STF together - order really does not matter much :slight_smile: will give me a better handle on NBFC industry, and will allow me to construct management Q&A discussion flow better around issues common to the industry first, and then I can go onto specifics.

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Another Great Discussion, something that is becoming a moat at Valuepickr ;-)!

I was re-reading a book and one of lines stuck me as very relevant to this discussion, to paraphrase:

The valuations will determined by amount, riskiness and timing of the future cash flows.

Hence I think as an investor the question is whats the edge one has in predicting the above better than anyone else ?

In my experience after a while a good investor develops an instinct ofwhether a business is interesting enough [often a function of individual’s investment style/strategy] and after thatthere is no shortcut to hard work!

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Also I think ( and as many have indicated) I think its the “market opportunity size” and trust in the ability of management to scale are the most important parameters for these disproportionate returns.

;))! amount, riskiness and timing of the future ofwhether thatthere

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Hi Donald,

I am just responding to the comparison of IP of a NBFC with others like PI, Poly,Kaveri etc. Just get a feeling that the niche segment we are talking about in case of NBFCs is not due to IP - yes evaluating the credit worthiness and repayment capacity of a street vendor or an earth moving equipment is more complex than evaluating a salaried person, but to give it same ranking as that of R&D based companies might be stretching it a bit too far. This business can be done by any bank if they want to without breaking their head. Micro finance, gold loan companies are all getting into this if not already in it.

The untapped sectors or niche sectors tapped by Gruh, Repco, Intec etc are untapped because major banks are not interested in it. They dont want to work hard for extra NIM as the headache of NPAs if some employee or the other falters is too much for them. Also to assess these niche customers they have to go to the customer’s place, understand the business and also send their person to collect EMIs, delayed payments etc. In that sense the Niche NBFCs are type A (in the parlance of the Sr investor) as they are laborious and hard working. To keep the NPAs off they need to be on their toes 24/7 tracking each and every loan. Gruh is doing an excellent job at this.

I am not at all saying that Intec, Repco etc are not good investments, but their IP may not be as strong as we think. Opportunity size is big, entry barriers may not be big.

stage:)).

:))

Views welcome.

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The very fact that I am emboldened to post at this thread again - after a big gap of 4 months - can only mean two things:

  1. We had reached the end - in illustrating our ART of Valuation incremental learnings at VP (from 2011-2013); needed time off to take things forward and imbibe new stuff

  2. there wasn’t anything original that we could come up with that DROVE HOME another (may not be new) exciting & insightful ART of Valuation Tenet - something very simple and powerful - that everyone could look to implement :slight_smile:

I am excited, again. Think we got hold of something simple - something powerful - something that you and me can immediately put to use with (I think) telling effect. Really??

It all depends on my ability to reproduce my conversation with Mr S exactly as it went ;). So pardon me if I can’t get you equally excited immediately - but eventually we will get there.

VALUATION ART #4

Mr S: (A Senior Fund Manager & Friend) How would you incorporate (assess) Future Value creation in a Business and assign a Valuation multiple - with sound economic reasoning?

I must say I didn’t provide a satisfactory answer - how could I - we are still grappling with these things. I told him we toiled hard in trying to decode Business Value Drivers with the very promising Economic Profit = Invested Capital *(RoIC - Cost of Capital); We also played around with lots of lots of examples (Nestle, Colgate, ITC, HUL, Page and scores of others in the FMCG pack) but clarity eluded us.

Mr S: How about breaking the Business Value into 2 components: a steady state value & a future value creation? [Merton Miller and Franco Modigliani - Foundational paper on Valuation
A much simpler read Mauboussin: What does a P/E Multiple mean

)-----

Business Value = steady-state value + future value creation

Steady-State Value = (Net Operating Profit after Tax (Normalised))/(Cost of Capital ) + Excess Cash

Future Value Creation = [Investment *(RoIIC - Cost of Capital)*competitive advantage period]/[Cost of Capital * (1+ Cost of Capital)]

)-----

Seen another way

Value of Firm = Debt + Equity, then

Equity Value = Steady-State Value + Future Value Creation + Excess Cash - Debt

)-----

Steady state Value: calculated using teh perpetuity method assumes that current NOPAT is sustainable indefinitely and that incremental investments will neither add nor substract value

Future Value creation boils down to how much money a company invests, what spread that investment earns relative to the cost of capital, and for how long a company can find value-creating opportunities

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Let’s ignore the heavy stuff (formulas :-)) for a bit and focus on a few things the equations seem to be telling us:

1). We can break up Valuation for a firm (say PE or Market Cap) into a Commodity component (the first part) and a franchise component (the second part). This lets you & me quickly understand how much we are paying (today) for future value creation

2). The huge significance (impact) of Return of Incremental Invested Capital becomes very clear. If that Return is equal to the Cost of Capital, the value of equations second term becomes zero!

3). The equation also shows us very clearly the impact of Growth. For companies that have a large spread between the RoIIC and Cost of Capital, rapid growth adds a lot of Value. For large negative spreads, growth subtracts (destroys) a lot of value. So whether the growth for a business is good or bad - depends on its ROIIC.

4). The essence of value creation thus lies in existence of opportunities to invest significant funds at higher than normal rates. The “normal rate” is the Cost of Capital

5.The equation gives you and me a quick sense of the Expectations built into a Stock (which may belie the Economics of the Business)

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5.The equation gives you and me a quick sense of the Expectations built into a Stock (which may belie the Economics of the Business)

Now this is the part that got me excited at the possibilities. The above comes from the efficient market theory precepts - however we all know how often the market is found grossly inefficient.

So here is my reasoning:

1). Consider 2 businesses - both available at teh same multiple say 25x. They have had more or less similar number of years in business, but are in very different industries. So obviously they will have different steady state value and future value creation.

2). We could easily calculate for ourselves the Future Value Creation part - Invested Capital, RoIIC, Cost of Capital are all known, assume similar Competitiuve Advantage Period (CAP)

3). It may well turn out that for Business B, Future Value creation is something like 30-40% of current Market Cap, whereas in Business A, the future Value creation component is insignificant or value-destroying!!

4). To me, this gives me a quantifiable objective framework to decide clearly that I should pay up for Business B and not Business A

Don’t you agree? ???

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If you do, then why can’t we apply this to

a) all VP Portfolio candidates - check where there is the best future value creation, and where there is probably too much of froth?

b) apply to what seems always frothy - perennially expensive stocks like Page, Nestle and decide hey this and this is where it makes sense to pay up and not here

It gets me excited to think this is again a pretty tangible, simple mechanism to really understand Mr Market’s Valuation anomalies (when they exist) and take good advantage of him!!

Its a pity …I haven’t been able to play around with data, and I am going to go complete incommunicado (Silence) for 6 days starting 24th night - doing an Advanced meditation program at AOL International Center at Bangalore - while Kids are enjoying their rollicking boisterous Summer Camp at the same place :slight_smile:

Can folks like Utkarsh, Dhwanil, Vinod MS, Ankit, Om and other young turks take the lead in dissecting this quickly? Will Ayush and Abhishek and Hitesh guide them in getting to the bottom of this exciting puzzle?

Cheers

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I think the best example of returns on incremental investments is Astral. It should be seen a case study in this theory and once we dissect it, we can go ahead and try to find out similar situations. Even the market cap versus opportunity size applies perfectly to Astral.

I guess putting numbers in case of Mayur also might be very very interesting.

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Value = steady state + future value

Very similar and excellent discussion is also there in “Accounting for Value” in which author suggest value = Book value + speculative value. Further speculative value was broken down into steady state value and value for future growth.

Go through the presentation here http://www.forumtools.biz/oiv/upload/OIVLecturePenman.pdf. In the book author made it little complicated by using some extra formulas but even then for me its one of the ten must read books.

Prof Bakshi made it more simple for us to understand the valuation concept in the lecture presentation [Download lecture 14-15 from here http://www.sanjaybakshi.net/bfbv/] and no need to put link for relaxo final lecture. Forgot about the stock, focus only on the methodology…

But before applying the above methodology one should REMEMBER that its WRONG to apply the above SYSTEM to EVERY STOCK. Personally [at risk of being COMPLETELY WRONG] I will not apply above system to stocks like Avanti feeds, Muthoot Capital & Kaveri seeds for various reasons. I will be happy to apply above system to stocks like Symphony, Page Industries &Astral.

80

2). The huge significance (impact) of Return of Incremental Invested Capital becomes very clear. If that Return is equal to the Cost of Capital, the value of equations second term becomes zero!

I failed to bring out clearlythe key takeway that I derived from this .

Basically we have another good incremental handle on Capital Allocation - while assessing a business for increased capital allocation - Consider incremental returns on capital first, and growth next. Growth creates Value only if incremental investments generate a return much in excess of the cost of capital.

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81

A good discussion again.

If there is one person who has spoken the most on this topic it is Warren Buffet. The concept of incremental return on equity is one of his favourite topics. He defines his earnings in partially owned businesses not only by the dividend payments he receives but also by his proportionate share of the retained earnings. His annual reports have the usual GAAP earnings that he is expected by the law to report but also economic earnings which is his share of the retained earnings in the listed companies. He is happy to let the companies retain the earnings as in his mind the capital is growing at a faster rate than what he could have achieved in his wholly owned companies.

On the issue of incremental rate of return on capital and growth, the former is more important without a shadow of doubt. However, high returns accompanied with high growth is the icing on the cake.

Let us take the example of Hawkins. It has very high return on capital and a decent return on incremental capital,though it is dipping. The issue with Hawkins is that the growth is very anaemic.

There are only two ways that you can invest capital to run any business. Either the money goes to fund the fixed assets or to fund the working capital.

It doesn’t take a lot of capital to erect machinery or buildings to bend aluminium sheets or rivet handles to them. This is not to advocate that we should invest in asset heavy businesses. The superior returns on capital is on account of this asset light business.

Therefore, the only recourse Hawkins has to suck in enormous capital is to grow very rapidly and deploy incremental capital as working capital. This is clearly not happening. Therefore one vital ingredient in the equation is missing and we have seen the results. I as an investor would have been happier if Hawkins had retained all the earnings and deployed it in the business with the ROCE that it has.

A better business still to own is something like HLL. It takes large amount of dealer capital and deploys it at very high rates of returns. However, such businesses with negative working capital are few and far between and quickly priced by the market.

The last 15 years has seen a radical change in Warren Buffet’s portfolio. Starting in 1999 he started investing in the utilities business. Utilities are a regulated business and the regulator determines the return that an investor can earn on his investment. For obvious reasons, there is a positive spread of a few percentage points the cost of capital and the allowed returns.

I don’t think that Warren Buffet had a choice. He was dealing in ever bigger numbers and his insurance businesses were churning out a lot of positive float every year. He had to invest large amounts of money every year and the US utilities with a sensible regulatory framework was the perfect avenue for him to deploy this capital and earn the spread. Given that the US power grids needed upgradation after years added to the allure of this sector which demanded large capital.

If we look at the VP portfolio, Astral, Kaveri, Atul Auto etc have managed to achieve both of the above and were probably rewarded by the market in terms of higher valuations.

Another case in point is JB chemicals. The incremental ROE is almost double the headline ROE for the last two years, a point not being appreciated by many in the market today. This coupled with the growth could probablylead toan appreciation in the stock price ( I am invested in JB Chemicals and this is for illustrative purposes only and not a recommendation to buy the stock). Spotting these trends early could be a rewarding exercise for investors.

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82

Excellent food for thought, P Sharma.

At a slight risk of digression, how does one find/calculate the return on incremental capital?

Am I right to equate this to the variable cost for manufacturing the (n+1)st item, where n is the current turnover?

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@ P.Sharma.

Great comments. You have mentioned that incremental ROE is double of headline ROE for JB. From where can we get such data for JB and other potential companies?

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There are various ways and terms used to calculate incremental returns. The way I look at it is to calculate the change in the net fixed assets+ WC between two time periods of a balance sheet. Adjust this for cash if the cash is high. Look at the incremental EBIT/PAT for the same time period and calculate the incremental capital return.

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85

I might be totally wrong on this one. Can anyone please say where I’m wrong on my rationale/thought process below.

To calculate this incremental capital return easily, what I do is to look in Cash Return on Invested Capital (CROIC). CROIC tells the business ability to generate cash per invested capital. Now the management can either distribute this cash to shareholder or reinvest the cash into the business. If ROIC (with the cash that was generated as explained before) is higher for the business, then shareholders are better off with the company retaining the earnings. The way how I check is like this: (Eg: Astral; taken from Screener.in)

1). ROCE: 36%

2). CROIC: 43% (with the capital, they generate 36% then cash returns on ROCE is 43%)

3). ROIC: 44% (then the cash generated returns 44%)

4). Dividend Payout ratio: 3.5% (Wow! Prima facie the business employs more incremental capital at the high return so much so that profits are retained to generate more cash and maybe to retire debt)

5). ROA: 12% (not very capital intensive that earnings has to be retained to service next year earnings).

6). PE: 39 times TTM. (Of course, Mr Market is not a fool. Incidentally Mayur and Astral have identical M Cap/sales ratio.)

P I Industries and Mayur also seem to have high ROIIC. Mayur’s ROA is 23% which seems to suggest that it is not Capital Intensive and ability to employ more and more incremental capital is at question. We should see Mayur’s increasing market share and this business market value if Mayur can do more capex to have sustaining high ROIIC. It would be interesting to see ROIIC over the years for various business and observe if the ROIIC is sustainable for a long period of time.

I’m screener.in challenged but going to try and see if I can get this ROIIC ratio thingy on Screener with the calculations illustrated by P Sharma.

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Another important matrix for valuation of company /stock is EVA (Economics Value Add) which is simply can be defined asthe profit earned by the firm less thecost of financing the firm’s capital. Equity is considered more costly than debt in this calculation and considering indian conditions assuming average cost of capital to be 15 % a simplified formula can be calculated as(Net profit + Interest - Total Capital Employed * .15 ). Most of the companies tried to give EVA for measuring performance of senior management and company and few companies like Pidilite, Godrej etc also follow this to calculate performance of the company. This is established through various research in last 15-20 years that companies with positive EVA usually has better stock market return in long term assustainablelevel and a good indicator for future stock price performance.

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Again, very relevant discussion on a very important aspect of valuation and investment. This is one of the more important but less discussed topic. Typically, as an investor, we look at historical (5 year/10 year) return ratios (ROIC) while analysing business but fail to notice the return generated on incremental capital deployed. However, as Donald so aptly pointed out, the future value of business depends on how much return is generated on incremental capital deployed in the business and the growth. I did a small exercise for some of my portfolio stocks/VP portfolio stocks for last 5 years to further understand whether high return ratios that I see for each year actually translates into the high returns on the additional capital deployed. Sometimes, high return ratio is just an optical illusion and absolute returns are high just because, historically, business has yielded very high ROIC hence, though the return on incremental capital is mediocre, the resultant overall return still looks attractive. Here is the summary table of the exercise


 09-10 RoIIC 10-11 RoIIC 11-12 RoIIC 12-13 RoIIC 5 yr avg. RoIIC 5 yr avg. top line growth (CAGR) 5 yr avg. bottom line growth (CAGR)
Mayur Infinite 67% 73% 26% 61% 28.5% 48.5%
Atul Auto 40% Infinite 147% Infinite 832% 27% 54%*
Astral 129% 43% 12% 32% 33% 33% 34%
Cera Infinite 27% 12% 29% 29% 25% 28.5%
Ajanta 44% 46% 34% Infinite 78% 21% 35%
Kaveri 13% 87% Infinite 90% 107% 45% 41.5%
Shilpa 239% 124% -88% 26% 84% 18% 2.4%*
Swaraj Infinite 77% 115% 6% 71% 18% 21%
ARBL 139% -16% 267% Infinite 112% 16.5% 29%







* As the difference in bottom line numbers was very large due to extraordinary circumstances in 2008-09 resulting in very low numbers and hence quantum jump in 2009-10), we have calculated CAGR on 4 year basis starting 2009-10.

Link to the detailed analysis is here https://www.dropbox.com/s/73iq3osnkdcewbm/ROIIC_Calculation.xlsx

Following are some of the observations/caveats in my opinion

- I have only considered capital invested in the business to calculate the RoIIC and excluded cash + Investments (unless it's in subsidiary/associates for which the numbers are consolidated)

- I have used number from Edelweiss and there may be marginal difference in numbers from some other source

- Wherever, the difference in total capital deployed between two successive years is negative and NP has increased, in mathematical terms the returns are infinite. However, one must understand that for most of this business this may be an aberration for specific period/s.

- As companies deploy capital to put up fixed assets to meet with forthcoming growth, it takes time to ramp up the production/sales from these new assets and to stabilize the operations at new assets. Hence in years where such large capex becomes part of gross block/net block, the returns from such incremental capital may be very low for initial years. Hence it is prudent to look at moving 3 year/5 year average to smooth out such aberrations.

- However, it is very important to understand the limitation that the analysis is based on historical numbers and future may look very different than the past. Few of the companies have old and depreciated assets and are sweating those assets to keep up with the growth. However,these companies need to create new assets to cater to the forthcoming growth in future. Hence what is the likely return generated on the capital deployed to create these new assets?

Let's take example of Swaraj Engines: It plans to add capacity of 30,000 with total capex of 38 crores. Average realization for SEL is around 85,000 for each engine. Hence at 80% capacity utilization, estimated topline is 204 crores. Average NPM has hovered from 10.5% to 13%. So let's take average NPM of 11%. Thus, expected NP is 22.4 crores. Normally, as the production increases, Wcap requirement too increases, however, SEL has bucked the trend and has operated on negative/negligible Wcap since last few years. Thus no additional capital required for WCap. Thus 22.4crore on yearly basis for Capital addition of 38 crores means, payback period of 1.7 years and ROCE is 60%. This is superlative by all means.

Similar calculation one can make for Atul Auto for upcoming plant of 50,000 capacity at 100 crore capex.

I personally feel, that at this juncture it is also important to draw inference from this analysis in sync with analysis of two critical aspects

1) Is company able to deploy large capital in the business and still able to generate high return on that?

2) If the additional capital requirement is not large, even to keep pace with further growth, then whether the management is returning the excess capital to shareholders or not (through dividend/buybacks)?

Valuation assigned to the business by the market may depend a lot on answer to the above two questions in addition to the RoIIC.

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hi dhwanil,

just looking at the swaraj engine case,what happens the next year,he made 22.4 cr,say he distributed 20% as dividends as is the norm in most companies and the rest adds on to the networth assuming all the 38cr was equity,so what would he do with the 15cr he has added to his networth,iam sure he cant start another plant as there may not be a market for it or in crease prices/margins.So the returns in the next year would be 22.4/38+15.We can look at Balkrishna industries as an example,they set up capacities and then found themselves in the midst of a recession.Maybe i made an error. Iam invested in atul,howevr iam not confident that all the volumes that they churn out from the new plant can be consumed by the market.

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Dhwanil,

Totally agree with the last point of yours. Will the management be able to deploy incremental capital and earn high returns on it or at least a significant positive delta on it as compared to the market rates to make it worthwhile for the shareholders to let the management retain their earnings? If the management is able to do it, then this is the best case scenario for the shareholders.

The most prudent course for the management if it is unable to do this is to return the money to the shareholders and not fritter it in deworsifications. The downside here is that with the management returning the money to the shareholders means that the increase in networth/book value is lower and consequently the market value.This can have a big impact on the long term valuations.

We can always argue that the shareholders have some other avenue to invest this money at higher returns and will still be rewarded. This is a big ‘if’ but a better situation than the existing management squandering the money.

Biju,

The market opportunity for SEL is limited and hence even if it is the market leader, there is only so much it can grow and hence a limitation to the capital it can deploy to earn higher returns. This is why the opportunity size coupled with the incremental return on capital is investors ultimate dream.

This very situation is faced by Warren Buffet and it would be interesting to know what happens on the May 3rd AGM. This was a statement made by Warren Buffet a few years ago which was revised subsequently;

We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely.

We continue to pass the test, but the challenges of doing so have grown more difficult. If we reach the point that we canât create extra value by retaining earnings, we will pay them out and let our shareholders deploy the funds.

Berkshire Hathaway will most likely miss this target this year. The increase in book value would be lower than the increase in the S&P. Warren Buffet’s test is that if Berkshire Hathaway is not able to achieve this, then the shareholders are better off investing in a S&P index fund( There have been some minor repurchases of Berkshire Hathaway stock).Let us wait and watch what his response would be. Just a caveat ,that the reported book value for wholly owned businesses doesn’t reflect the market value and some of the underperformance is owing to that.

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Excellent discussion here.

I just want to point out an observation I have had. Most of the companies we have in ValuePickr have had significant margin expansion over the course of past few years. In a sense, I feel this inflates the ROIIC tremendously, there is nothing wrong in it.

A company in flux in past, due to change in product mix, and favorable product portfolio at the end of margin expansion cycle (which is of major interest to us now) may not be able to generate high ROIIC generated during margin expansion cycle.

In order to get a steady state picture at current juncture of already higher margins in some of the stocks like Ajanta Pharma, won’t it be more prudent to consider incremental sales/incremental capital ( Sort of Capital Turnover for incremental capital) of past few years as it neglects the increase in profits happening due to margin expansion.

Views Invited

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Hi,

We had a similar enlightenment in the Quality of Business thread discussion where it was said

Economic Value Added = (ROIC-WACC)* Capital employed

We also concluded that growth only adds value if ROIC > cost of capital.

So what additional insight does RoIIC provide ?

I understand that RoIIC gives us incremental return on invested capital but I am still at loss at the utility of ROIIC as an additional tool that can help us seperate wheat from the chaff over ROIC. What are the the situation where RoIIC can help us but not RoIC.

Appreciate if seniors can demysitfy through an example where RoIIC helped over RoIC.

Thanks,

Atul

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Great discussion. Thanks Donald for starting it and Dhwanil and others for their views. The incremental capital can result into increase in capex or increase in working capital as Dhwanil pointed out. While evaluating this increase there are a lot of questions that need to be probed:

  • Increase in capex

o Capacity addition: Important thing to understand here is at what capacity utilization is the company currently working at? Is the capex really required? Is there a market for the increased capacity? Are there any supply side constraints that the company is looking to address with the capex?

o Inorganic buyouts: Does the new buyout add to companyâs strengths? What is being paid for the buyout? Is the buyout happening from the same promoterâs company? Lookout for possible red flags. There are plenty of bad examples around this. I have seen this as one of the major source of value destruction.

o New product launch/diversification: Does the newer product add to companyâs core portfolio? Will new marketing/advertising expenditure be required for newer products? Is it a case of di(worsification).

  • Increase in working capital

o Increase in inventory:

Is the increase in inventory due to capex/new product launches? What is the inventory position of newer introduced products and the older one?

On a cursory glance of the companies that Dhwanil has put out I think Ajanta has been very successful in deploying incremental capital and at the same time taking a minimum load on the inventory. The incremental capital has also resulted in increased OPM for Ajanta.

There is another set of companies (generally FMCG) which outsource manufacturing and have almost zero increase in their working capital and capex and an ROIIC analysis does not suit them. Symphony is an example that comes to my mind. Another interesting question that comes to my mind (due to these companies) is about the advertising expenses. Advertising helps in building brands an intangible asset generally not reflected in balance sheet (if it is I will be wary of). But as an investor should I think of it as some kind of capex (which builds a lasting brand) or as some kind of operating expense (you cannot live without advertising in FMCG sector)?

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Hi Biju,

For the point pertaining to SEL, it all depends on how company deals with the extra capital that it has. Precisely for this situation, I suggest that it is important to consider whether management returns excess capital to shareholders or not. However, this is not such a uncommon situation especially for businesses having asset light models with high return ratios. However, a key monitorable parameter in such companies is how effectively company/management returns excess capital.

As to the setting up new capacities, it is always that demand is built up slowly and that is precisely the reason one should consider the 3/5 year average RoIIC which truly reflects the economics of the underlying business.

prices/margins.S

94

Excellent discussions and examples taken.

One thing which I’ll like to discuss is - that I feel its not easy or its many often risky to extrapolate the past ROEs onto new bigger investments being made by the cos. And this is where individuals judgement comes into play and thats what makes a huge difference in the future value and premium valuations.

For eg: Case in point is GRP - The co has had excellent ROE, ROICE of above 30% consistently for last 10 years till 2012 or 2013. However, one new plant in a new state got them into trouble. (Though i feel the co will come out of the problem)

So extrapolation is ok when the new investment is happening at the same location in the same product line. The moment some new variables come into play, one should be very cautious in extrapolating the past nos.

Regards,

Ayush

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Hi Guys,

Thanks for carrying forward the discussions - excellent inputs from P Sharma, Utkarsh, Dhwanil & others.I have been thinking of how to capture the essence of my excitement :slight_smile: very simply, very practically - and I think I might just have found a way!

1). Let’s just think of 3 our biggest wealth-creators in VP Portfolio - Ajanta Pharma, Astral Poly Technik and Mayur Uniquoters - all 10-15x baggers over last 4 years.

2). It was very difficult to completely stay put in Ajanta Pharma - not understanding the business that well, but it was pretty easy to stay completely put in Mayur and Astral over last 3-4 years of major value/wealth creation

3). As mentioned before in VALUATION ART #4,MarketCap capturing a Steady-State Valuation )+ a Future Value creation is a very powerful construct for me - in separating the Wheat from the Chaff again - this time among Mayur, Astral & Ajanta!!

4). These 3 are in very different industries with different business models and very different competitive positions. It is safe to say that they are all creating different Future Value for themselves at this juncture - and going to create in the next 2-3 years - right?

5). Now I am sticking my neck out and saying that hey - Ajanta Pharma is creating much higher Future Value than Astral & Mayur today. Let’s assume all 3 keep growing business performance at 25%+ CAGR for next 2-3 years - it will create far higher Future Value in the next 2-3 years. Let’s additionally assume that main business/investment characteristics haven’t changed for any of the 3 (it has for Mayur because of PU, but let’s try and keep things simple. Let’s also assume, they keep doing more or less the same thing that they have been doing so far - keep executing as meticulously as they have been so far.

6). It’s pretty easy to demonstrate who (among the three) is creating superior future value - through the Economic Profit Added (EPA) model that we captured in the Business Value Drivers discussion thread - without much heavy weight-lifting by way of formula/calculations!

7). However, this is not the exciting part. The exciting part is when we can easily see (only when we ourselves have a pretty intimate knowledge of the business/industry & issues) how Mr Market may be getting it wrong - i.e. Market Cap (PE) clearly not reflecting the “superior” future value creation!!

As you ponder over this, let me try & present the tables/data to drive this home, in my next post.

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FY2013 Ajanta Mayur Astral
Sales (Cr) 839.20 380.54 821.09
EBITDA Margin 25.58% 18.87% 13.84%
Invested Capital (Cr) 460.88 125.81 302.98
Capital Turnover 1.82 3.02 2.71
EBIT/Invested Capital 39.49% 52.95% 31.68%
Tax Rate 28.51% 32.13% 22.28%
RoIC 28.23% 35.94% 24.62%
RoIIC 72.46% 125.56% 24.28%
WACC 13% 13% 13%
EPA 70.19 28.86 35.21
EPA/Sales 8.36% 7.58% 4.29%

* Those interested in the Calculations can find detailed workings in attached Ajanta Excel. Best part is you can upload this excel at Screener.in/excel and download the same calculations (automated) in a jiffy - for any business of your choice. Eternally grateful to Pratyush & Ayush Mittal for this wonderful service/tool

Ajanta Pharma Excel below [Ajanta Pharma.xlsx|attachment](upload://i0IRhUbwT88pV7eQqVXIVchfSKy.xlsx) (122.9 KB)
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Some observations from my side:

1). Data used is for FY2013. It will be very interesting to do these calculations on FY14 data and see. (Mayur results yet to be out)

2). One must note the huge difference in Margins between Ajanta, Mayur & Astral. Esp with FY14 Margins for Ajanta at 32%

3). From the EPA model discussion, we know there are only 2 drivers of RoIC - Operating Margin & Capital Turnover

4). While Mayur can never catch up on Op Margins with Ajanta, it more than makes up for it by way of Capital Turnover currently ( I stick out my neck again and maintain that this is going to change in greenfield installation for PU; existing PVC plant is 17 yr old fully depreciated plant, uncannily they added another line at half-cost again, but this will change)

5). Again there are only 2 drivers of EPA - Size of Invested Capital & ROIC. Ajanta - Capital Invested is 1.5x Astral (for same size Sales) and ~4x Mayur (for 2x Sales). The above argument can be turned on the flip side saying Ajanta Invested Capital will go higher up once both plants are commissioned, but Capital Turnover will probably slide further down.(FY14 BS is out and it shows a 75 Cr Gross Block addition without additional debt Capital)

6). Mayur shows the best Return on Invested Capital (RoIC)with Ajanta coming 2nd and Astral slightly behind. But the Return on Incremental Invested Capital (RoIIC) figure should really wake us up as to where and how rapidly is future value being created. Astral lags behind by some margin here.

7). We can see that Ajanta is adding more than double Economic Profit Added of both Astral & Mayur.

8). Given the size of the business - Mayur being half the size of Astal or Ajanta - EPA/Sales provides a better correlation - and that shows Mayur is running Ajanta Pharma pretty close (Does not mean it will have the opportunities to invest higher Capital in the business than Ajanta in future)

9.The kicker - now just compare Mr Market’s (current) valuation of the 3 businesses!! Where do the ODDS lie?

10). Caveat/Disclaimer - there are many things different in the 3 businesses. Investment characteristics will/may change in the short term for these businesses; Business Segments/Profile may also change. The above does not take into account a very important valuation criteria - the value of the business to a 100% buyer of the business; but that’s another very very interesting discussion coming up!

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Donald, In this model, how do we fit the companies which are paying huge dividends like Accelya ?

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@Atul - Yes Dividends play a big role. You can just look at Dividend Payout ratio and check how far ahead it is of the norm. For folks more into Capital Preservation, big dividend payouts are a huge turn-on; Future Value Creation while important may not be of primary importance. But for those into Capital Building phase Future Value Creation may be of primary importance.

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I have had a few calls since morning on the above Topic. Let me reproduce the 1 hour plus conversations - and I had 4 of them including one last night :). There was a common pattern of objections.

Q. This concept of Future Value creation - is it really new? We use it all the time in evaluating start-ups or PE investment.

A. Of course it is not new. But how many apply it diligently, or are very clear about how to use it Sir?. I started looking at it in 2011 - in the Business Value Drivers discussion. Only in this past week I can say with honesty - that I think I know how to use this well as another refinement in my toolset.

Q. So what is the new insight ;)??

A. If you asked me 2 weeks before about relative merits about investing in either of Ajanta, Mayur or Astral now - I would have 5-6-10 points in each business about the pros and cons of the next 2-3 years. However none would have been as compelling or insightful an answer as the EPA table I shared. I know that’s true because without the EPA Metric sitting firmly in my head I did not have this clarity. Obviously without this small refinement I would have failed to transfer my conviction.

Q. Okay. But isn’t this making too many assumptions? That the businesses will retain similar or better RoIC or RoIIC patterns in next 2-3 years?

A. Yes. But we are forgetting to note that the businesses in question - Mayur, Ajanta, Astral - we have been tracking and invested in now for 3-4 years. We have good knowledge of the industry and respective competitive positions. It may not be off-the-mark to say we know/understand what is possible and what is not possible in the industry. It may even be correct to say we have an edge over the market in understanding the business closely. On top of that, we understand the Management - their depth, their bandwidth, their hunger in upping the ante. Every year of association we have got a little better at that - is that a reasonable assumption.

Then all we are saying is that the ODDS are high that the businesses in question will continue to execute and continue to record normalised RoIC levels.

Q. Hm! But is it incorrect to say that this still does not factor in the Risks in the business or in the environment?

A. :). Now its my turn to smile. Sir - Risks can be nailed down to the number of variables in the business. For us Astral was a ZERO RISK investment 2 years back - on 2 counts Mr Market thought were the biggest risks. Forex fears and on CPVC competition (every Tom Dick and Anupam was advertising CPVC manufacturing on the back of Autos - and there were biggies like Supreme adding capacities. With our closer understanding and 360 degree interaction with stakeholders in the business- we thought these are Ignorable Risks.

Other than that if there are environment or other new variables that suddenly crop up - that may well be true for any business. No Valuation modeling or ART can capture that.

Q. Final question. It seems that you are mixing up Science of Valuation while talking about ART of Valuation!

A. Yes. We are doing that. We still maintain the Science part is only 30% of the job. All our hard work, industry scuttlebutts and understanding of the business and continuous refinement in Business Quality thinking and Investment thinking - that is the rest 70% - and they go hand in hand; one without the other can fall flat!

But I wasn’t even doing justice to the 30% Science job so far - I didn’t have a EPA metric to cite between Ajanta, Astral and Mayur!!

VP Q. So now do you agree this is indeed a valuable addition/refinement to an average investor’s toolkit? Something a learning investor should be excited about??

Yes. and Yes. I could finally get my point across.Communicating effectively is an ART :), we have miles to go there… I think all will readily agree to that.

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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.

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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.

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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.

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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.

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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 screener.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:

Regards,

-Muthu

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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 ?

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Hi,

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

varadaraju

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@ 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.


 RoIC
 Growth Rate
 Market Size Opportunity
 Market Share
 Dividend Payout
 EPA/Sales
Accelya Kale
 119%
 12%
 Not Sure
 Decreasing? 123%
 25.1%
Swaraj Engines
 69%
 27% High Flat 74%
 8.3%
VST Tillers
 45%
 21%
 High
 Increasing
 16%
 3.8%
Ajanta Pharma
 67%
 30% High Increasing? (Rank 39 from 40)
 18%
 8.3%
Mayur Uni
 74%
 18% Medium high?/Monopoly?
 21%
 7.6%
Astral Poly
 43%
 30% High/Monopoly?
 5%
 4.3%
Amara Raja
 46%
 18%
 Medium/Duopoly
Increasing
 15%
 5%
* 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.

Ajanta

- 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.

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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:

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@ 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 business.Screener.in 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.

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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?

Cheers

Vinod

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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. :))

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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?

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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.

Kunal

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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.

Cheers.

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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.

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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

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

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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.

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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!

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121

Dear all,

I am a new comer to vp and had found this thread extremely interesting. I was wondering if we apply the same logic - EPA, ROIIC etc. would you have identified Asian paints, Pidilite, Dabur, Marico etc.? Has any one done the math for proving the hypothesis?

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As the title of the thread suggests, we are looking at the art of valuation and not the science of it. It is easier to get attracted to hard numbers as they tend to convey a picture of what is happening in the business. However, numbers without a narrative convey only half of the story.

Donald Rumsfeld ( erstwhile US Defence Secretary) had made this quote in the thick of the second Gulf War. He was ridiculed for saying this but what he said has a lot of import for all investors as investing in stocks holds the same kind of uncertainty as war.

“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.”

Known Knowns )- This ispubliclyavailable data. These are things like revenue, PAT and with a little bit of effort data points ROE, ROIC etc. This is level one thinking and it doesn’t provide any edge to an investor.

Known Unknowns â These are the gaps that one is aware of and can be conquered by diligent research. These are things like industry knowledge, companyvisitsand Q&A. This provides an edge over 90% of the investors who don’t think it is necessary to do the requisite research and draw inference of where the odds lie. This is more like level 2 thinking and provide adiscernibleedge in the markets.

However, the harder aspect of the known unknowns is what this thread is trying to achieve in terms of trying to narrow down some of the factors we think impact valuation of companies in the long term. Liquidity, dividend payout, FII/DII participation etc have been discussed.

Unknown Unknowns â These are the investor blind spots. The size of the box varies from one investor to another. This is the investment journey and comes from experience and a result of the maturation process. The idea should be to keep reducing the size of this box both through self and vicarious learning.

The hardest part is to accept that there are unknown unknowns. However, no matter who you are, this category of unknown unknowns will always exist. Herein comes individual investing characteristics like humility,patienceand discipline. The ability to accept that there are some things about the business or the markets that i don’t even know that i don’t know.

As Donald very rightly puts it,have faith that i have done all that i could have done in terms of my research and now the best thing i can do is to sit tight and wait for the story to unfold. We tend to over analyse every piece of news coming out and every quarterly result. This noise at times drowns out the signals and we end up taking decisions that we shouldn’t.

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[quote="Donald, post:96, topic:286853916"] * Those interested in the Calculations can find detailed workings in attached Ajanta Excel. Best part is you can upload this excel at Screener.in/excel and download the same calculations (automated) in a jiffy - for any business of your choice. Eternally grateful to Pratyush & Ayush Mittal for this wonderful service/tool [/quote]

Very good discussion here!

The ratios ROIC and EPA are calculated based on current year's numbers. However I would think that the EPA would accrue based on investment that happened earlier which may, or may not be within the same financial year under consideration. In essence, there is a lag between the time investment happens and the time it generates EPA. When the calculation does not capture this fact, is it to not complicate more than necessary, or is there refinement possible to capture this fact? For example, one might consider calculating the EPA based on average of this year and previous year investment. This would certainly vary across industries, for instance between Pharma and consumables, or steel.

Thanks

Arun

FY2013 Ajanta Mayur Astral
Sales (Cr) 839.20 380.54 821.09
EBITDA Margin 25.58% 18.87% 13.84%
Invested Capital (Cr) 460.88 125.81 302.98
Capital Turnover 1.82 3.02 2.71
EBIT/Invested Capital 39.49% 52.95% 31.68%
Tax Rate 28.51% 32.13% 22.28%
RoIC 28.23% 35.94% 24.62%
RoIIC 72.46% 125.56% 24.28%
WACC 13% 13% 13%
EPA 70.19 28.86 35.21
EPA/Sales 8.36% 7.58% 4.29%
124

Thanks Arun for your query. Your comments are valued inputs into the EPA discussion.

However this is not the EPA discussion thread. This is the ART of Valuation thread, It was made very clear that all EPA specific discussions need to be carried out on the Business Value Drivers thread.

We will start enforcing this more strictly from here on - in a bid to keep important discussions clutter-free

Kindly repost your query in the appropriate thread. Pls take the trouble of finding the right thread and do the needful. Everyone please pay attention to a simple tenet : Are you adding value to the ongoing discussion? Is this the right place for your query?

Thanks.

125

Sorry for bumping this, but just had a query regarding this.

Was reading this concept a few days back and loved the paper - the concept of breaking value down into two parts. Just a query, from the comments and follow ups, since there is no effect of inflation accounted in calculating the steady state value,shouldn’tthe cost of capital also be inflation adjusted? So lets say, for a company having 50% equity and 50% debt as its capital structure: WACC = 16% (assumped CoE) + 11% (1-33%) (assumed CoD and tax rate) = 12%. However, IMHO, weshould notbe using this WACC in the equation for steady state value; rather we should be usinginflationadjusted WACC which should be much lower.

Any thoughts on this? Please correct me if I am wrong.

:)) ;)).

_

VALUATION ART #4

Mr reasoning? _

Business Value Drivers Link: …/…/…/forum/valuepickr-scorecard-aug-2011/184497495 lots of lots of examples Link: …/…/…/forum/top-down-sectoral-dissections/531558273 Foundational paper on Valuation Link: http://student.bus.olemiss.edu/files/fuller/div/Miller%20and%20Modigliani%201961.pdf ]

)-----

)-----

)-----

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126

@karanmaroo Another similar approach to this is to calculate the Fair P/E of the company using the formula:

And to calculate this Fair P/E in several small components and add them up: From the retained earnings in the first 5 years, from dividends in the first 5 years, From the retained earnings in the next n years and from the dividends in the next n years and the terminal value effect on the P/E.

I have described this in detail at: http://www.igvalue.com/2015/03/how-to-get-started-with-value-investing_16.html

Hope that helps.

127

Dear Sir, Why is this post not opening?

128

Very interesting thread. Many important concepts like

  1. Think like an acquirer
  2. A new entry into the portfolio must not rank the last
  3. Market values different businesses differently (Average, Laborious, Smart etc.)
  4. Understanding the business is the only margin of safety
  5. Undervaluation can not be a basis for extra long-term (>10 years) investments as valuation will catch up sooner than later.

Now to put these to use is a big task and effort.

So here is my question regarding KRBL:
Most of the company’s revenue comes from branded rice sales. They are market leaders in Basmati rice. Their prices are 10-20% higher than rest of the market and they have very integrated operations.

My question is - at what point Mr. Market value it as an FMCG business? Will it ever value it as an FMCG business? OR What does KRBL will have to do so that markets see it as FMCG business?

I’m skeptical that KRBL will have pricing power in the long term (rice is rice!!), but that needs to be tracked.

If this is the wrong question for this thread, then please help it move to the correct thread.

Thanks,
Rupesh

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129

@rupeshtatiya

If you are otherwise convinced about KRBL, can you keep aside Valuation, and learn/assimilate all about the Business.
Trying to put together a BQ Sheet (on the lines of the 6 shared) with complete integrity - will make it clear to you how much you really know/understand about that business.

Ask anyone who has an attempted a BQ sheet - Anant, Dhwanil etc - the real insights are revelaed when you do an honest job there.

My suggestion for you will be no different :smile:

130

Sure Donald, I’ll work on BQ sheet for KRBL and try to present in this forum (In KRBL thread) in 1-2 weeks.

But my intention behind asking question is not particularly regarding KRBL but to eke out a particular aspect of ART of valuation. When does Mr. market decide that business has transformed itself from category B business to category A business? Is there any mental model for it? Does this phenomenon happens often?

Thanks,
Rupesh

131

We don’t usually see a Category B business making the transition to a Category A business. The industry dynamics, the business model it follows - startegic assets and business architecture - are evidence enough to slot the businesss. Sure the competitive position can and do get strengthened (or deteriorate) over time.

Mayur and Astral were always A category business for us - it didn’t transition from B to A when Market recognised it. All the characteristics that determined the category slot were in evidence from 2010 when we saw them - or for that matter an Ajanta Pharma or a PI Industries.

Its about Business Quality. Its about our mind being trained to Value the Intangibles in the Business. Mr Market may take 2 years or 5 years to wake up - to sustained., predictable performance. When they wake up is not in our hands.

Its futile to try and predict that. Its far more profitable to focus on correctly slotting your business - gain those crucial insights in the business - that is your edge over Mr Market.

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132

Hello Donald / All,

I have been reading this thread to learn more on the Art of Valuation. I am amazed at the kind of knowledge shared on this forum - thanks o you and all vetrans of investing. I have got stuck on this post where u have calculated the EPA - the thread contains an excel link - but am unable to open. Would anybody be able to send me the excel pls.

133

Hello All,

It seems people have missed my querry - so repeating it. Kindly mail me a copy of the excel calculating EPA of Ajanta Vs Mayur Vs Astral. I am not sure whether we can openly share the email id on this forum - but since this is not for soliciting anything - here’s mine.

134

Sorry about the late response.
Takes time…Digging out old files :slight_smile:
last worksheet …future value/EPA calculations

Ajanta-Pharma-Future-Value.xlsx (79.0 KB)

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136

Thanks Donald,

This means a lot. I am obliged and vow to give back to the forum everything that I learnt. I have made a small note of my leanings from the forum - still work in process but will share the same once it is complete. But the journey has just begun - Me destination being my Financial Freedom - I will need your and all the members support to achieve it. Kindly bear with me through this wonderfully challenging journey - am sure it will have it’s ups and downs.

137

Sir,

From my limited knowledge I think I can summarise that theoretically a portfolio return can be expressed as

Return = Uv x Pfd

In this equation

Return = return that may be realized.

Uv = undervaluation return

Pfd = probability of failure of the business.

For example

In case of a company in which we estimate the Pfd to be 0.7 which assumes that there is only 70% chance that business will survive.

We need a undervaluation return of 200%.

So 200 x 0.7 = 140

That is our return.

Now in this Ev = undervaluation return that can be calculated by dcf, net net etc.

Pfd can be calculated theoretically by examining each event that may affect the company, thier probability of occurance, their magnitude of affecting the compnay. However it will be beyond the scope of an individual investor. Hence this will be the art side of investing considering management quality, business model, moat , etc all this are the risk and survival factors that may be considered to assign a probability of failure factor.

Theoretically this concept is used in calculating failure rates of safety systems in nuclear plants, oil and gas industry. Aeronautical industry etc.

In these Pfd is also assigned considering the previous data of failure of components.

138

As an example I would assume a Pfd of 0.99 for Coca Cola and would consider buying at faire value.

But in case of Welspun right now I may assume a Pfd of 0.4.

139

Hello Donald & All

As promised - I am through with my reading of the threads on

  1. ART of Valuation
  2. Business Quality: Calculating the Value Drivers of the business
  3. Business Quality: Refining our thinking on “Great Businesses”
  4. Assessing Value: To a 100% acquirer of the business! (This is my personal favorite so far - highly intellectual though abstract).

Attached is my summary of learning from the threads. It is excellent - seems like taking the 1st baby step towards the learning. Please note that these are inferences which I have drawn from the reading and hence they are MY OWN - given that I am a novice - I may not have done justice to the wisdom and hence is not a substitute to reading the threads.

I have the following request -

  1. You refer to a revised version of the Business Quality Insight - post review / suggestions by some members. Again, the excel does not seem to open. Kindly upload the latest version for the benefit of readers.

  2. The business quality presentation PDF refers to the VP Management Quality Insights presentation (Which I have read) and
    Valuation Insights presentation - which I am unable to locate. Kindly also upload the same.

  3. Having read this - I think the next logical step would be to undertake the case study of the stocks - just wanted to confirm - am I missing something - Do I need to read any other thread before undertaking the stock study threads.

  4. I request Donald / Seniors to read it once atleast - to see if it is useful - suggest ways where we can improve it’s usability on this forum. Hope this helps

Thanks for everything…
Ronak
Identifying Multibaggers - Q&A.xlsx (42.2 KB)

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@hitesh2710

Mr D: Just check. It’s rare to find Processors crossing 1-1.5x Sales in their lifetimes. And do we have examples of businesses that add-value. Haven’t you noticed Piramal Health being acquired at 9x Sales. There’s a clue there!

Is this Market cap/ Sales ?
Thank you

141

Yes…it is market cap to sales…

Finrahul9
September 24

Mr D: Just check. It’s rare to find Processors crossing 1-1.5x Sales in
their lifetimes. And do we have examples of businesses that add-value.
Haven’t you noticed Piramal Health being acquired at 9x Sales. There’s a
clue there!

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142

hi guys

Thank you very much for explaining in a simple & crisp language.

regards

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Hi @ronak

I am sorry that I didn’t get around to check out your compilation before. Just didn’t have the space due to my various interests :slight_smile:

I spent a quick 20 mins going through your excel. This is indeed a wonderful compilation of incremental learnings at VP over last 6 years.

Some immediate observations/comments
1.Shift the Aspiration - from identifying Multibaggers to just identifying Quality Emerging Businesses
Staying with Quality Emerging businesses that continue to perform - has no option but to take you through market-beating superiror returns - if you can sustain the intensity of the quest. That will be a happy byproduct of your search for excellence

Have seen some very good folks taking not so rational decisions - when the driving quest is Multifold returns - somehow the mind plays its tricks!

2.Its wonderful to see you start off with a compounding sheet over 25 years.
I have seen very few investors extend their horizon over a few decades to “appreciate” the real impact of slow-n-steady miracle of compounding. Some suggestions
a) extend horizon to 4 decades - 25 years starting age to 65 years say
b) use a 26% compounding rate - thats 10x in 10 years
Most folks again blink some before they can answer when quizzed - how many folds do you stand to make if you can find an investment that grows 26% on an average for next 40 years. A whopping 10000x …forget 100x. In a country like India, at the growth stage it is, we can do much much better than 100x!!
Check out Motilal Oswal Wealth Creation studies …may be a good starting point…

At a portfolio level the VP experience has shown us (over 6.5 years now) that sustaining a 26% cagr over 10 years certainly looks doable - when we remain consistent in upping the learning curve, learn to not be in “Love” with our portfolio businesses, always be OPEN and HUMBLE to “appreciate” different styles that work in market, be open to Market cycles to appreciate why Market works the way it works - are some of the prerequisites.
Sustaining it over another 3 decades will be a tough ask - but certainly something that should be aspired for!!

3.Your compilation is excellent, but can be improved
Its still pretty high level - try and bring it down to more practical levels by asking
a) how do you spot a promising opportunity - must have patterns
b) what makes you sit up & notice - success patterns
c) what to avoid at all costs - failure patterns
Look at these threads …there is GOLD in many threads at VP for an aspiring learner. Also see the 2015 and 2016 Chintan Baithak presentations - someone like you will again pick up loads and loads of actionable/practical dos n donts

4.Understanding Yourself

  • what kind of an investor are you - strategic/opprtunistic mindset
  • what are you more excited by - Superior Quality or High Undervaluation
    In my expereince the investing word is neatly divided in the middle. Either you are excited by Undervaluation or you are excited by superior quality. If you belong to one camp, its very very very difficult for you to cross over. Continuus Learners at VP -try to bridge that part through exposure to other successful styles.
  • what kind of a risk taker are you - Calculated risk taker or a risk mitigator
    this aligns with above quaity vs undervauation personality pattern

These are my top-of-mind reactions to your excellent effort. and thanks for sharing this back with the Community. Young Learners take Note - This kind of sustained, systematic approach is needed initially - to drill home things in an untrained mind - then you will see some mental models taking root - which as we all know - are key to our decision-making ability (in the face of incomplete information…it will always be incomplete)

Sorry again for not reverting earlier.
Lets talk sometime next week post 9th …busy with children’s exams now.

Cheers

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144

A quick question. What will be the starting valuation (If it raises funds through New IPO or Preferential Issue) one will be comfortable for a greenfield new venture from a top pharma company? I know everyone can have a different number. But, wanted to know at least a range.

Thanks in advance.

145

Hey Donald… Many thanks… Really appreciate your advise and looking forward to meeting you / talking to you. Do let me know a convenient time and your email / contact no. . Alternately - my email id is ronak.raichura@amsecglobal.com . Am looking forward to it. All the best to your kids and a very caring dad for the exams.

146

it took me some time to go through this entire thread and some of the companies ( not all ) mentioned. The three most cited ones are Astral, Mayur and Ajanta. Not that i need to point out however warren buffet also describes the three types of business ( akin but not exactly to the cat a, b and c student analogy ) http://basehitinvesting.com/buffetts-three-categories-of-returns-on-capital/

the art of valuation is to identify such businesses as their story is developing and one of the important components is (i am aware it has been repeatedly referenced & discussed ad nauseam on this forum!) - is how much extra sales / profits is the extra reinvested capital fetching you ( i can see the eyes rolling :slight_smile: )

The evidence thrown up by Astral, Mayur and Ajanta does support this and this is BEFORE they became hallowed. So it IS possible to identify these types of businesses and then deep dive into them to understand their business models. The stock prices of these three companies took off vertically from 2012-2013 onwards.

In all these companies , you can clearly see that the Sales/Profits were growing at a rate which is significantly higher than the Asset base ( Assets are excluding of cash, investments and CWIP), as on 2013 i.e before mr market recognized them fully. These companies were doing a great job at accumulating productive assets. As Arnold schwarzenegger says about body building - the difference between lifting 70 kilos and 140 kilos of iron is just an addition of a couple of pounds of muscle in your body. a bit of muscle in your productive assets allows you to produce outstanding results!

Which brings me to the art part of it - After reading through all the posts here , I could extract 5 generic factors that contribute to making valuation an art ~

  1. Is the company doing something that is unique? ( processors vs IP )

  2. Is the company doing something that is valued by customers?

  3. Can it be replicated by others?

  4. Can it be scaled up OR down?

  5. Are its customers price insensitive or better still do the customers value the product more as its price goes UP ( of course this factor becomes redundant when low price is what makes the company unique)

The ideal company of course would be doing something unique that is highly valued by customers which cannot be replicated by others, the production of which can be scaled up and customers that basically just ignore the price.

With Regards (and i hope this is the right thread to post this)
Bheeshma

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147

Thank you very much donald & all guys

This is one of the best thread in VP i came across. I am trying to grasp every bit of this.

Ajanta Pharma excel sheet is not opening. Please do the needful.

Regards,

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148

Donald

Thanks for explaining with so much detail, recently in an interview have heard similar view from an investor with an analogy of the Chinese Bamboo Tree : the seed of the Chinese bamboo trees when planted doesn’t show any movement till 05 years and in next 01 year it grows to 90 feet.

This thread is not opening

“Valuation Stages for a Quality Emerging Business: We can All learn to Ride Well”

Access denied / Private

Regards,

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149

Every time i re-read this thread i learn something new. I have been thinking about quickly identifying these processor vs non processor type companies. The idea obviously is that non-processor companies are more valuable because there is just more value addition. So i put myself in the shoes of a person who runs these valuable non processor companies and two things occurred to me immediately simply by this mental switch.

Non processors should have substantially less material cost as a percentage of the total expenses. These businesses will spend less on raw material and more on other things. It seemed logical to me.

The second thing is that non processors will have a lot of talented skilled people working for them and talented skilled people generally get paid higher than lesser mortals like me! :slight_smile: ( my wife says that the only measurable talent i possess is eating )

So % of employee cost to total expenses should be high. These two % of material cost & % of employee cost to total expenses - can be combined in various ways. for e.g % of material cost minus % of employee cost. A lower number indicates that the business is a non processor.

To test my theory i went to screener.in ( where else would anyone in his right mind go ? its the iphone of all screeners anywhere)

I looked at some companies mentioned in the above post by @Donald over time and computed the material to employee numbers & found the following.

Pasted image929×1608 72.7 KB

Look at how Ajanta was successfully able to reduce this number ( the portions shaded green are consistent reductions in these numbers). In fact i think it successfully went from being a processor to a non processor! Or look at Page. or Eicher or any company that catches your fancy.

Do comment and critique. The more i know, the more i dont - after all science progresses one funeral at a time!

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150

Hi bheesma,

How did you calc material cost, manufacturing cost,. Employee cost… did you do it in screener.in

151

Yes i used screener to calculate these costs

152

Hi bheesma can you please guide us how to calculate these costs using screener features. I am not seeing these costs directly anywhere

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you dont need to calculate screener does it for you. Here is the screenshot for ajanta. But ensure you crosscheck with the Annual reports just to be sure you are on the right track.

Pasted image1206×593 146 KB

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154

You need to click on Expenses to view these costs.

155

In the above post what this 1-1.5x sales and 9x sales refers.Is it referring to stocks price? Sorry if it sound silly, you are trying to say something very valuable,i want to understand it clearly.

156

Dhwanil unable to find the table (is this restriction for new user?) could you please share the same to email praneshrvikram@gmail.com.Thank you.

157

Double click on Expenses. Even I got to know this today only !

158

Never noticed this before on Screener since there is no indicator that Expenses are expandable. Thank you!

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159

Hello Bheeshma,

This is a good way to assess things. I appreciate the unique thinking process.

But in my humble opinion, the decline in (% of material cost - % of employee cost) may not always necessarily indicate the shift from the business being a processor one to a non-processor type. The 2 main reasons for the shift can be :

  1. Increase in net profit margins. This will contribute to : lesser % of material costs.
  2. Increase in employee cost can again be due to 2 reasons : a) addition of more employees to cater to increasing demand & b) annual appraisals to the existing employee strength.
    The former serves better business prospects in the long term.

A simple and a very common way which I follow to assert the company’s increasing supremacy in the market is : a look at the consistent yearly rise in Total Sales., and increase in % OPM. (sone pe suhaaga).

These two almost sum up the story.

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Hi @mukesh_gt

You are correct. I sometimes look at the employee cost of various companies in the same industry to get a sense of the type of business. Let me share an example from logistics ( data is from screener )

Here are the employee cost%'s & RoCE numbers of some companies in that sector

As you know logistics is a very cutthroat sector and is largely unorganized. If the company invests in employees it must be because the employees are doing some important value addition with their skills. If you look at VRL, Blue Dart, Allcargo & Kesar ( Green shaded) you would see that high employee costs correspond to relatively high ROC’s.

CCI,Sical and Gati ( the orange guys) all dont seem to spend so much on their employees and all seem to have relatively low ROC’s.

A glaring exception is Tiger Logistics which spends a low amount on its employees and is still having high ROC’s which would indicate that it has some differentiated business compared to the rest ( which it has ).

Looking at employee costs and material costs often seems to throw interesting insights into the company businesses. I find it very useful to build a mental picture in my mind.

Best
Bheeshma

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161

Hi,

Not sure if this is the right thread or not, but I wanted to understand how to value a stock which is already in your portfolio and it has reached slightly stretched valuation - I am referring to Kajaria. Most of the content that I found was w.r.t. when we buy the shares and it makes complete sense.

If you want I can share the detailed thesis on KCL. but the gist is : -
It is market leader, the tiles industry will continue to grow at decent rate for next 3-4 years, it has good distribution, it is spending good amount of money on branding (60+ cr consistently for last 3 yrs.) which is more than the PAT of some of its listed peers and branding is kind of reflected in good numbers (improving ROC, NPM etc.). It is launching new designs - but i am not weighing that in.

Everyone knows it - and market has provided a high valuation for it. Although, when i compared to some of its peers ( NITCO, Somany, Bell, orient, Asian granitio) - KCL does stand out in terms of business quality and financial with good able management running it. Unless they do something wrong or any irrational competitor comes into the market, KCL should continue to do better than the average market growth.

Now, my question is how should I value a stock which I already hold in the portfolio, for which I am hopeful that business will continue to do well but I am not sure how much of that is already priced in. Does it make sense for me to continue to own this business? Should my valuation of business for buy and hold not be different? How should I go about doing valuation for this and similar stocks.

I read the entire thread but could’nt find one. Mr Bakshi’s example on Asian paint does provide some insight but for every AP there might be thousands of failures as well, what key things I can look to ensure that whether i am holding a high quality business which still has a upside potential from 5 year perspective at current valuation?

In my mind conflict is - I have a feeling that its a good business but is it the right investment at current valuation to continue to hold for 3-5 years?

Any insights from VP team’s experience, Books , links etc would be of immense help to me and would help me to think currently about it.

If this is not the right thread, please direct me to right link( I could not find it though).

This question has been bugging me since long now and not able to get over it.

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Here is how I think about this:

When the price is increasing on back of fundamentally good results and if the company is CONSISTENTLY growing 20+% YoY and and 6-7% QoQ every quarter then I would not hurry to book profits. In fact I would buy on dips, till I am fully invested. Selling a rising stock too early and not letting it reach the full potential is a mistake that is easy to make. But to do this, I will need conviction.

If the conviction is lacking then I would take of more mathematical approach:

  • When the price is increasing on back of fundamentally good results then I keep an eye on the valuation band.
  • Take for example the simplest valuation parameter of PE. I keep track the lower and higher PE bands.
  • I also keep track how consistent the company is in its result. If the company is consistent then I calculate its 1 year FW PE based on its TTM growth. (NOTE: 1 Year FW calculation is a tricky bit. I do it only for consistent companies).
  • Now if the 1 year FW PE is GREATER THAN the HIGHER PE band then I will consider booking profits.

Most important point to note is that forward estimates should be calculated only if the CONSISTENCY is high and NOT for any company.

This is the basic framework I have. Actual decision will have more inputs and fine tuning.

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Decision to hold (financial)

  1. Alternate investment choice having a better return on investment not available
  2. Dont need cash now
  3. Even if company is not growing today, or in foreseeable future, is the Total Addressable Market itself expected to grow? If yes, is it expected that this company will get its fair share ( & thus past growth), or even grow faster than the overall market by taking share away from competitors?

Decision to hold ( emotional).

  1. If this stock were to delist for next 5 years, would I be unhappy?

Decision to Sell ( Financial)

  1. If I convert this stock into cash and sit on it for next 3 years, I lose about 25% ( -7% cost of cash per year). I am confident I will be able to, and I will buy this stock back at at least 25% down from here in next 3 years.
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@deep86 You are not alone in pondering/wondering on this aspect :slight_smile:.
The SELL decision is certainly one of the most tricky. We keep learning with every experience. I find it also has much to do with temperament. We have seen in the Capital Allocation thread the typical sell decision for us is A. Is the business capable of growing at 20-25% CAGR for next 2-3 years? If not, the case is decided there itself (assuming there are many others who can; so far that has never been the problem in our markets). B. If the business can keep growing at 20-25% cagr for next 2-3 years or double, then can the stock price also double in the same timeframes?

So here, we are addressing mostly B - the overvaluation situation.

The first extreme over-valuation situation I faced was Astral Poly (quoting at 70x plus - or almost 3-year forward earnings) 3-4 years back. The most usual advise I got was “don’t try to fix what ain’t broken”; dont try to second guess markets; we don’t know how high Mr Market can take Astral. I coudn’t be satisfied with that as I kept asking so where would you draw the line? what if the Valuations reach 100x, will you still not book any profits?? I started booking profits in Astral in chunks as earnings failed to keep pace with the expectations built-in.

Although each individual sell decision merits its own specific industry/business cross-examination, let me share some generic comments/insights from our collective experience base - perhaps some of these may resonate with you.

The comments below should mostly be taken in the context of small to mid-size emerging businesses only (my experience base).

  1. Markets are inherently forward looking - even in bear markets. So 1-year forward is the base rate. In bull markets like current, 2-year forwards become the optimistic norm - such as what we are experiencing now for most businesses. I have seen I don’t get too worried when valuations are within 2-year forwards. When valuations exceed 2-year forwards and start approaching 3-year forwards, I find myself uncomfortable and start selling in chunks.

  2. For me it became important to SLOT a business in my mind (Art of Valuation) and assign a stable normalised PE for the specific business - depending on past track record, business quality, management quality, and future earnings visibility - (Industry and Competitive position). I found myself doing this in B+, A, A+, A++ slots. Astral was in A category or 20-25x earnings slot and was a sell at 70x earnings 3-4 years back.

  3. I find Industry tailwinds and specific business growths practically swing the needle the most. A business consistently growing at 40-50% when valued at say 40x earnings, can within a year of holding come to more reasonable valuations like 27-30x earnings. It no more appears that expensive. And curiously, when half the financial year is past us (like now) such high-growth consistent businesses may no more be expensive!! (except in businesses with seasonal variation between quarters)

  4. The key to persistent high-valuations is high-growth sustaining in the near to medium term.Therefore, it becomes extremely important for me to be focused on the Industry Tailwinds, Competitive Position of the business remaining stable (NOT deteriorating) - which means high visibility into near-term growth NOT faltering. Sustained high-growth becomes the panacea for most of our mistakes (including staying put in over-valued territory).

  5. It therefore became extremely important for me to learn to become ruthless (get out of love with my money-spinners, imitating Hitesh Patel, at first) in the dissection of the industry and the business - when deciding to stay put in over-valued territory. Learn to be ruthless in distinguishing HOPE vs VISIBILITY. So the first thing I ask in such a over-valuation situation is a) Is the Runway still large enough - for the leading players in the industry to keep running at the same speeds b) What’s the near-term evidence - if there have been speed-bumps, how severe were these c) in case of speed-bumps where I decide to keep faith, what makes me so confident that high-growth would return in the near-term (few quarters, a year)

  6. I have also learnt to respect the fact that reversion-to-the-mean is a rule of nature - especially true for high-growth, high-profitability businesses. 8 out of 10 cases, there is plateauing after 3-4 years of high-growth. Very very few businesses continue to defy this rule consistently beyond 3-4-5 years. So if I make the case for sustained high-profitability growth beyond 3-4 years (Or, high-growth returning quickly, say in less than 1-2 years of what may seem like a blip/pause after 2-3-4 quarters of low growth/de-growth) I want to make sure to double-check the facts; make sure to engage with the skeptics and be able to reasonably rebut all the objections with consistent data-points based defence, not my hope-based opinion.

  7. I find myself holding a different perspective from another popular (and probably financially correct) edict - that if you can’t buy a business at current levels, you have no business holding it, either. So yes, even when I am pretty confident about sustainable high-growth in a specific business (say, Bajaj Finance) Buy and Hold decisions for the same business are different for me in a bull market situation like current from a practical standpoint - when valuations are over-stretched. I find much higher margin of safety (higher risk-adjusted returns decision-making) if I am holding from lower levels, than if I were to buy afresh. I want to ensure I don’t lose capital, rather than bet on only one scenario playing out, however probable. However, when valuations are reasonable (near stable normalised levels for category slots) I often find myself averaging-up with conviction (If I find Industry is stable and growing/ and competitive position is demonstratively getting stronger) in consonance with the edict :). Contradictory behaviour - in higher-risk situation?

  8. Once comfort level on Valuations are breached as above, I find it useful to sell not all in one go, but in meaty chunks. If discomfort is quite high, it’s more like a 20% trim, else 10%ish. Instead of taking a call on how high Mr Market can take the business to, its nice to spread out the selling - giving us a chance to admit that we might have been wrong, and pause - if the trajectory of upward valuation is steep. Witnessed this with Can Fin homes, and paused for a long long time, eventually easing out :slight_smile:

  9. In this recent bull run, I have been compellled to trim/book profits mostly on account of position in portfolio becoming too large for comfort. I have learnt not to let individual position sizes get bigger than 20-25% for any extended periods. With larger portfolios, I find the need to preserve capital has taken center-stage, at the cost of sacrificing some growth for more assured risk-adjusted returns.

Re: your specific business - Kajaria has proven to be a quality business. However, I have not invested/tracked Kajaria ever, so not the best person to comment on the specific case. But if i see that growth has hardly kept pace or faltered, I would be wary of that. And examine if that is the same fate being met by most of industry. If certain competitors are able to grow significantly even in this environment (FY 2017 and 1HFY18) I would like to understand the reasons behind. In such a situation it would be a mistake to assume the over-hyped (in my opinion) notion that post-GST the most organised players are slated to gain the most. We are probably seeing far more the case that the semi-organised are getting better organised faster. One would also examine the housing industry segments that are growing and that are not, and which businesses might be able to take advantage of the growing segment better. One would also like to take into account the fact that Tiles segment probably has relatively low share of replacement demand; that tiles is relatively a late-cycle beneficiary of housing market rebound - while making the case for the industry/business for next 2-3 years.

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The above Mr Donald is pure gold. I have much to learn. Only the second post in recent times that I think I, and anyone, would need to read 10 times over to understand. Thank you.

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Valuation based selling is one approach, like you have mentioned is what I have been using mostly. Another approach I also use is a trailing stop approach. The trailing stop approach works well for me in those companies where valuations are way above my comfort level, but are market favourites. Like Bajaj Finance you mentioned. I don’t want to out-guess the market. So, my sell point would be say a 20-25% below it’s previous high. Most of the time I have seen it allows me to ride the upturn quite nicely without selling out too early.

The 20-25% stop point will vary based on my conviction about the company and the level of under/overvaluation.

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Hi Abhishek,

Thanks for your pointers. Trailing stop approach is novel for me.

Can you explain more. How is this useful in the context of an emerging business that slowly gets discovered and is still in the early growth phase. Did you mention applying trailing stop loss for Bajaj Finance?? In what context?

I am unable to appreciate how to use a “previous high” level for BFL - as the valuation curve has been a one way journey up and up - from about say 9x-13x earnings levels during 2013 and mid 2014, continuing to be valued higher and higher progressively each year to current 40-45x+ levels, with more consistent performances - leaving competition far behind, increasing the distance with peers every year. Current 52w high of ~2000, and a 20-25% stop loss would mean selling a chunk at 1500-1600 levels?? What am I getting wrong :stuck_out_tongue:

Wouldn’t that be akin to second-guessing Mr Market? I find that any trailing stop loss anywhere in this early growth stage - would have generated false signals and been at odds with the growth trajectory of the business, and prove to be sub-optimal?? Same would likely be the case with most quality emerging businesses during the phase Mr Market reaches consensus on consistency of performance and superior competitive positioning/strategy, isn’t it.

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Ok… so let me try to explain a little bit. What I have seen is as long as the growth keeps coming, the stock price does not correct much. We saw this in many many cases, Astral, Mayur, Poly Medicine, Symphony, Cera etc… At most the correction is 10-15% due to extraneous factors. Say I bought Astral and after a few years it’s up 5x. And valuations have moved from 12 PE when I bought to 50 PE. In my opinion it is overvalued. But the business growth is intact. So, the idea then is to not second guess the market. I don’t know if 50PE is high or low. The market may decide to give it 200PE, like it did to Infosys at one time. So, my approach is because I am 5x up, I will put a trailing stop say 30% below the high price I have seen. If my thesis is correct, it will not correct that much from the recent top, but reverse and continue it’s upward journey. And I will keep revisiting my stop upwards to that 30% mark.

The only practical problem with this approach that I have come across is what to do when the stock just flat lines and does nothing. Like PI in the last 2 years or Symphony. Then the SELL decision is based on my understanding of their next 2-3 year growth prospect (your first point).

The major advantage of this approach is I have been able to eliminate in most cases selling too early and capture the momentum in price if there is any.

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Coming to the specific example of say Bajaj Finance. The reason I have a trailing stop is I feel it is overvalued at the current level. And the reason I am holding is exactly as you mentioned, because of the quality of the business, ability of the management to garner growth etc etc. But there is also the possibility that it may time correct at this level for 2-3-4 years till the earnings catch up. Or RBI comes up with some new guideline that is unfavorable to the company.

As I mentioned before, a good company will not price correct significantly, except in demon like situations,when it becomes a call one needs to take whether to keep or sell. So a 30% stop will make sure I lock in the gains. I can always get back later if the business keeps doing well.

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Ah! got it. You mean - in the consistent performance phase, usually the 25-30% trigger doesn’t get breached, so you are good.

Actually in the growth phase I would be greedy - that the 25-30% trigger gets breached - allowing a Buy at 30% cheaper levels :slight_smile:. Like we could actually buy BFL at bulk ~800 levels in Nov/Dec/Jan - think the previous high was 1180 then.

Employing stop loss trigger would have sent me conflicting signals. Wouldn’t have been able to resolve, I think.

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@deep86,

As Donald mentioned, most of us have faced this dilemma in the past and probably will continue face the same in future. Even though it may sound too overarching…indeed there is no one size fits all approach possible. In my opinion this has to be case specific both in terms of the business that one is holding and one’s investment style and/or return expectations.

For me what has worked is, typically, overvaluation is not a good reason to sell a high quality business where I see strong entry barriers and growing strength of business model. However, any change in my underlying assumptions about the quality of business/business model/industry dynamics is DEFINITELY a trigger point for sell decision.

One of the reasons I feel that overvaluation is not a good reason to sell,especially for high quality business, is…if we look at past history of all high quality business franchises, even if they have not traded cheap in the past, they have generated an alpha by a wide margin without taking commensurate risk (of generating alpha by participating in stories where business model is still evolving or competitive advantage is yet to be established/confirmed). I did a small exercise where I looked at some high quality businesses (Asian Paints, Nestle, Pidilite, Dabur, Emami) going back to Circa 2006, I did a 10 year DCF analysis based on 2006 numbers, with some very optimistic assumptions on topline growth, margin expansion and profit to cash flow conversion, 3% terminal growth rate and 12% discounting. In most of the cases,in 2006 market cap was much above/near the DCF number even under very optimistic assumptions. Hence, if one would assume that, odds would be against one to invest in those companies at such high valuation and make high risk adjusted returns. However, contrary to that, in ensuing 10 years, those companies would have generated 20-33% CAGR + dividend.

Here is the excel file:DCF_Undervalues_Good_Businesses.xlsx (16.7 KB)

As I mentioned, most of these five companies in 2006, market was factoring in very optimistic assumptions and hence were richly valued, however, inspite of that, one could have generated significant alpha over market by remaining invested (or even buying!!) at that point of time.

Now the cache here is to figure out…the quality of the business and ability for the business to grow for long period of time. So, if one is confident about high quality of the business, it may make sense to stay put.

Having said that, I feel, the decision above is also a function of what is the hurdle rate for investment that one have in mind. So, for a mircocap investor, who has hurdle rate of 35% CAGR, this approach may not make sense while someone with more modest expectation of 20-25% CAGR over longer period of time, it make make lot of sense. One tool that has been immensely helpful to me, and weeds out this dilemma, is the expected return framework as suggested by Prof.Bakshi. I have been clued into that as it does not look at valuation in isolation. It combines,expected growth rate, entry multiple and exit multiple, to provide a picture that is wholesome. If according to one’s assessment, the expected return is lower than hurdle rate, one can sell otherwise, one may hold.

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Actually you see in this particular case the 30% stip loss did not actually get breached :slight_smile:

My take is currently in BFL, I don’t bring any new perspective to the table. When I first bought it was not a consensus buy. Stock was available at 2x book, people were concerned about possible NPAs in consumer lending and not much institutional coverage. Today it is the darling of institutions and extremely well researched. In this type of a stock, I would also take market view as an input. If price is severely correcting (above 30%), then I want to be open to the idea that the bigger players know more than me.

So, net net, it needs to be taken on a case By case basis. But a trailing stop seems to work well in most situations for me.

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My BUY/SELL decision is mostly based on a reverse DCF approach.

I typically buy when I see a big difference between the growth rate implied by the current price and what I think the base growth rate for the business can be. If the implied growth rate is 6% and I think the business can do 10-12% I BUY. Selling framework is the inverse of the above. I also use some base heuristics like Operating Cash Flow yield vs the 10 year G-Sec and FCF yield (where applicable)

Needless to say this calls for some excel modelling and discipline to make a distinction between the base case, optimistic case and pessimistic case. A pure PE approach does not work for me, nor does the funda that a stock needs to grow earnings at 20% to justify a 25 PE which is a very lazy approach that is too easy to provide insights.

Practical example - When Cera peaked out at 2950 in May 2015, my reverse DCF told me that the company had to do 20% earnings growth over the next 10 years and get an exit multiple of 35 at the end of the period to justify the price. Low probability event and I did sell some though my execution wasn’t ideal, I do keep a tail in such scenarios if I believe the business has a long enough runway ahead.

The type of business also is an important input to the reverse DCF process, if the business serves segments like FMCG where the range of outcomes is not very wide, it is not meaningful to sell out for minor incidents of overvaluation since the Terminal Value is where the juice is, not the earnings visibility for the next 2-3 years.

However if it is a cyclical business, one needs to be more conservative even at the risk of selling out too early. Classic example being Sanghvi Movers which went from 70 to 400 in 1.5 years as the company became profitable again. However the stock price is now back to 150 range since the company did a massive capex and the wind energy segment saw a fall in demand. Such businesses where the end demand is cyclical and can suddenly change has a range of outcomes that are far wider, in such cases I am happy selling out prematurely. It is another story that I could not execute very well here as well but I saved myself a whole lot of trouble by being conservative.

I always ask myself - is my valuation thought process for a business consistent with my evaluation of the quality of the business? If not mistakes will eventually be made that will cost me. If I believe something is a high quality business (irrespective whether the market prices it that way) I will give a longer rope to the business than to a business which may not rank very high in my evaluation.

This thought process is my conclusion from -

  1. reading most of Michael Mauboussin’s papers
  2. The investment checklist I have developed that is optimized for my own thought process and style of investing
  3. Borrowing ideas from Morningstar framework on classifying businesses into wide/narrow/no moat

Unless all of these tie in it is very tough for me to take a conclusive call on selling. Buying I admit is way easier and something that I am more confident about

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when you say valuation exceeds two year forwards, do you mean current valuation in terms i.e., share price x no. outstanding shares?

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There is something magical in this thread…such valuable posts coming in thick and fast - @Donald, @basumallick, @desaidhwanil, @zygo23554 !

If one has to summarize,
@Donald approach to selling is based on Analysis Edge, or…behaving as an owner of the business
@basumallick approach is based on market edge, assuming that the information and analysis edges are already taken care of, and thus acknowledging the psychology of the market /buyer in addition to, or over-riding the behavior of owning the business
@zygo23554 approach is more classical reverse DCF.
@desaidhwanil on the contrary provides the dis-confirming evidence about selling on overvaluation! :money_mouth_face:

When I check my notes on Cera in March 2015, I find the note that t ~2500, the stock is a screaming sell, with a upside-downside of 80%. The valuation model I used was for buying, i.e. what is the margin of safety IF I buy at 2500. So a downside of 80% is clearly very high ( obviously, i used very strict constraints!), but then the stock did go down to 1470 in Feb 2016, i.e. about 43%. But now in November 2017, its roared back to 3500. From 2500 to 3500, I still have a 40% return over 2.5 years - not great, but I will take it. Now if I had another business to buy in 2015 which would have exceeded this return as per the three edges, I would have allocated capital to that business , at the cost of Cera, assuming no additional capital allocation. Using @basumallick’s 30% trailing approach, I would have sold out at 0.7*2950 = ~2000…and thereafter either bought back Cera itself at 1470 a year later, or another business. So the unknown factor here is, would I have allocated the capital to Cera again in Feb 2016, or another stock anytime during March 2015 to Feb 2016? Given that its not easy ( for me !) to identify good businesses and good managements and the industry tailwinds being supportive, would I have still stuck to Cera ?

Some more thinking certainly on the cards for me here - thanks to the very insightful posts !

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Which is the first one ?

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This.

Best Regards

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VP is full of insights. Problem for me is that I discovered it late. Used to read only printed underlined materials. Is there any way to get some of these immortal threads in Word format or PDF. Tried to copy paste but found it difficult. Some of the people here are very knowledgeable & I request them to write a Book, alone or in collaboration of various members of VP. Thanks

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If you do a simple Ctrl + P it gives a readable PDF for the whole thread. Like for this one it gives an 83 page PDF.

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I tried. It shows variable pages from 10 to 98 but does not get downloaded. Once it showed first 15 pages and I was able to download it. Later on I tried to copy only Summary (37 pages) it was downloaded easily (but without replies, even if you keep open all the replies manually). Thx

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Dear Abhishek,

Interesting approach on the stop loss.How would you take (for example Canfin which has corrected almost 30% and now bounced back sharply). Simply selling out again is like timing the market.In a bull market correction of 20-30% is a given depending upon situations. It clearly boils down to individual styles and comfort and also what has worked in the past. I am wondering how do people keep stocks for 5-10 years without selling to capture compounding benefits if we keep selling.

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I have held stocks for 10 years or more. Many of them. The main ingredient for holding is conviction in growth, quality of management and quality of business.
Coming to Canfin, I don’t track the company so can’t comment on the specific details. But for Canfin type of company, I (and this would vary from person to person) would have a much smaller stop, maybe 15-20%. Also I did not see any major bounce back after a 33% fall.
My approach is for protecting profits for companies where my conviction is moderate to be held for many years.

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Specific to Can fin homes. I am new to starting understanding process of investing. Holding Canfin so may be biased. As far as I understand Hsg Fin companies are leading this bull run especially Canfin. Temporary problems are there in housing due to rapid Modi govt reforms. But these reforms will give further boost to Housing sector as a whole in the next few quarters. So number one reason for holding HFC of your conviction is that " this Earning decline is temporary". Second reason is that this Bull run has not ended, it is just taking a pause. Come 18th Dec and this bull run may accelerate again & which Sector will lead? Of-course Housing! This decline in Can fin is for accumulation or entering the stock if not already holding it.
Disclosure- Allocated major part of my PF in Can Fin.

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I think as investors one thing we should keep in mind is that there is no one size fits all policy. For me the exits can be due to

a) Growth with High RoCE: Long term compounders, industry tailwinds, the compounding machines. The reason for exit is clearly a deterioration in the industry outlook (like industry headwinds as in pharma), reducing competitive positioning, management’s inability to seize the opportunity.

b) High RoCE with limited growth: These are pure valuation plays for me and a lot of good companies fall into this bracket. For example Mayur, Kitex, Ambika, Accelya etc are all good business with high RoCE and some or other kind of competitive advantage build in but they are not compounding machines. Personally for me these kind of business are good entries at a certain valuation and are an exit at certain higher valuation.

c) Asset plays: Buying a company at a very large discount to its assets and exiting when that discount goes away all the while trusting management to do the right things.

d) New Entrants: If I do find an extremely compelling story I would have to slot that against my current holdings in terms of BQ/MQ, risks and growth and if I see the new entrant to have a significantly better outlook than one of my current holding I would have to exit one of my holdings. There is another style where you trim positions from each of your current holdings, I generally do not follow that.

e) Allocation: If any company’s allocation goes above my comfort zone.

Now coming to what @basumallick said and I think that is an extremely good tool to have. Most of the times when we start looking into a business a smallcap/midcap we do tend to have certain advantages over the market. It could be an information advantage, an analysis advantage or something else. As the story becomes well known the advantage begins to dissipate. It would be unwise for us to fore-judge how market would value the business and it is much better to let it run without worrying about the valuations, at the same time it would be unwise to let the market do the same thing on the downside. Now here too one needs to find different mechanisms/tools depending upon the stock reaction in a secular downtrend, or an event driven movement or a stock specific reason, basically there is no one size fits all.

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Hello @Donald. I have recently joined this wonderful forum and trying to learn as much as i can. While going through this wonderful thread, found that some of the details are restricted like Ajanta Pharma excel of this post of yours. Is it possible to provide access to these pages?

Regards,
Suhag

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Got the Ajanta excel from subsequent posts on the thread.

Regards,
Suhag

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pls check https://blogs.cfainstitute.org/investor/2017/11/16/keep-it-simple-11-rules-for-equity-valuations/?curator=alphaideas&utm_source=alphaideas

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Hello Donald. Thanks for creating such a valuable forum where amatures like us can benefit a lot. I am unable to download excel table uploaded by you and it says page not found. Can you please help me, how can I download it to understand ROIIC better.

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Hi @rambaranwal

Donald has shared his excel sheet on the zenith fibres and screener.in thread. If he doesn’t respond you could visit these threads and download his file. It contains all the metrics.

Best
Bheeshma

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Thanks bheeshma. Downloaded Ajanta Pharma and Zenith fibers files. However,it doesn;t match the Ajanta Pharma excel mentioned at comment 96 of this thread. Was thinking why I am unable to download this file.

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As I went through the thread, I got the excel. Thanks Bheeshma for your help.

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My approach is to sell when you are convinced you want to short the company.

So this is similar to the Margin of Safety approach we use when we go long. We make sure that we don’t buy based on one or two factors only, we take into account all the factors like history, management, growth and so on including price. So now in reverse you can’t base your sell decision solely on price. You have to be convinced that there will be no growth or negative growth, management can’t help the situation etc. The best short sellers in the world don’t go short based on price. The business model should be unsustainable, that’s what makes the best shorts.

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Why I am unable to clink on the links? Fr eg: Here Must have investing books.

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Dear Friends, thank you for all the suggestion and knowledge. i have come across this wonderful site few weeks back and found this amazing.
Can anyone please suggest what is the best source of income statement, balance sheet, and cashflow statement. I usually take it from moneycontrol but the consolidated data is not complete. What do you do in such cases. Moreover, quarterly consolidated data is never available for the last few quarters. How do you handle such issues.

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@LearningToFly

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@LearningToFly u can also check valueresearchonline.com

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Thank you for the prompt reply.

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Thank you. Will take a look.

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Good morning. May I use an illustration of a stock I own in order to understand better the trailing stop approach - I own 200 shares of Hatsun Agro. Average price 302/share. Two years ago. The highest price I have seen is 970/share. If i calculate 30% down from the high - it works out to 679/share. That is the trailing stop approach price, 679 that I ought to consider selling at - if I decide to sell? Also does the recent LTCG tax make any difference to this approach. Newbie. Trying to improve - please excuse silly questions. Thank you so much

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If you decide to use 30% as a trailing stop, then yes, you would sell at 679. Tax would not be a consideration.

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Thank you very much. If set one’s own percentage is it reasonable to set 15 to 20% rather than 30 % - or is there a calculation I ought to learn about? Sincerely IG

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The percentage will depend on the conviction you have on the company. If you are very highly convinced, then have a larger trailing stop. If less conviction, then a lower one. The idea is that you do not want to sell out if you really like the prospects of a company. However, you are using this as a tool to ensure you do not give up your gains if the overall market corrects and brings down your stock along with it.

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Understood! Makes a lot of sense. Have been wondering for a long time how to use one tool to set a “fair” price to sell. I will try and use this as one tool. Appreciate the time and promptness in replying

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A related question but maybe off topic:-

How to do averaging up in this case?
If conviction level is high and stop-loss is triggered(at 30%) do we consider it as buying opportunity ?
If conviction level is low…but business is promising…but near term risk is more…sell and wait for better price or?

Thanks

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As I understand the concept of “stop-loss” is used only in trading scenarios.

For an investor (not a trader) if the fundamentals of the company have not changed then a 30% lower price is an ever better buying opportunity.

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But as an investor I would not want to continuously invest in a single company. There comes a point when my percentage allocation to any particular company has reached the maximum. I would then try to book some profits. As Mr Basu Mallick has pointed out this trailing approach allows me to stay invested in the company and also try not to lose out on gains if the market corrects. My understanding.

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Looking a year back since this post was made, the price of Astral has increased 100% since 2014-15 when this stock was sold.

Narration Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Trailing
EPS 7.02 6.41 8.43 12.08 14.62 15.73
Price to earning 35.71 72.11 50.64 46.30 63.31 60.62
Price 250.74 462.36 426.90 559.32 925.49 953.85

Another example of high PE stock discussed was Cera -

Narration Mar-15 Mar-16 Mar-17 Mar-18 Trailing
Price to earning 47.99 28.00 36.75 42.33 30.26
Price 2,496.60 1,796.85 2,938.09 3,262.79 2,380.70

Cera stock has essentially remained flat from March 2015 till now, although in March, it would have given a 25% gain in 3 years. In other words, Cera has undergone a time correction which is perfectly aligned with its stagnant profit in the same time period.

Astral on the other hand has risen over the same time period maintaining the high P/E, and the reason is not far to see. It has been able to grow its profit during the time 2015-18 over two and half times.

The message from market seems to be, as long as growth in profits is seen, high P/E can be maintained.

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12 posts were merged into an existing topic: Valuation of stock

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My aim of this post is to understand how good we are in understanding business moats. The entire point of this thread was should we hold on to overpriced stocks (by conventional valuation metric) if they are very good businesses.

The team categorized the following:
B Category - Balkrishna industries, Gujarat Reclaim, Suprajit Engineering
A category - Mayur Uniquoters, Astral Poly Technik
A+ category - Ajanta Pharma, Poly Medicure, Kaveri Seed, PI Industries
Cyclicals – Vinati Organics, Balaji amines

B category companies were correctly identified as their margins were mean reverting (implying vulnerability to raw material prices), hence more cyclical in nature.

A category: Mayur uniquoters was incorrectly slotted here as it hasn’t shown any meaningful growth in sales since FY15. Astral on the other hand has managed to grow their sales well (albeit with margins fluctuating b/w 12-17% implying some degree of cyclicality).

A+ category: Ajanta, Poly Medicure and PI have shown business leadership traits with FY20 sales meaningfully higher than FY15. However, Ajanta and Poly Medicure haven’t gave meaningful stock returns because valuations were reflecting a lot of optimism in FY15-16 and growth didn’t pan out to that extent. PI has panned out better in terms of growth and given meaningful returns. Kaveri turned out to be a cyclical, definitely not a A+ category stock (still to attain its FY15 sales number)

Cyclicals: Vinati turned out to be more an A+ category stock with low sales growth but expanding margins. Balaji has been thrown to the wood chipper.

In essence, its clear that if one simply ignored valuations for A or A+ category stocks, returns would have been underwhelming (detailed work on valuations here). Out of all A or A+ companies, reasonable stock price growth was witnessed only in PI Industries and Astral Poly. This makes me ask a fundamental question, Is an overvalued high business quality business a better investment than an undervalued business with decent quality but superior growth profile?

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Thank you. This is a good thread. Along with understanding the valuation / quality I think it is equally important to see how long you are willing to hold (only after assessing the quality and once you are sure that the company will weather multiple economic cycles). Post by Vishal (A Simple P/E Valuation Model that Works - Safal Niveshak) made me think deep into the entry price

https://drive.google.com/file/d/1zEq0QGxsWabxpM3lviLo3JxZoJ3xkG3t/view?usp=sharing

Please see the example of Asian paints (The FV based on diff EPS and what price one should pay now to get expected return is what I tried in here) - Based on one’s expectation the return expected etc can be changed and see what should be the entry price.
Disc : I have AP in my portfolio. (Not a recommendation)

Longevity of the business is something one need to assess and tune the return expectation accordingly (Based on the intuition).
Any feedback will be great help… any flaw you think this method of valuation has…
I understand that high PE stocks are high PE for a reason and above examples of Astral etc were really nice (one need to know the phase the company is in to see if they are fairly valued, under valued or over priced!)

This video from RARE might be helpful

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Hi, I have one question on valuation. I dont know if this question should have been asked in this thread or different thread. But I thought of asking.

We have some industry like FMCG where valuations are high like PE of 60-70 etc. But there are other industry like NBFC or companies like Mannapuram/Muthut finance where PE is between 10-15. How do we know what is ideal PE for an industry. e.g. we have Pharma and Chemicals as flavor of the month. But I dont know if current PE of some of the stocks is low or high. Company like Alembic,Granules,Jubilant life are trading between PE of 15-20(approx) while chemical companies are trading between 25-35. So is there any way to check PE at industry level like what is ideal PE of an industry?

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Valuation is a function of ROE, growth, longevity of growth and prevailing interest rates. I found this video from Samit Vartak on the nitty gritties of valuations very helpful, might be useful :slight_smile:

https://indianinvestingconclave.com/recordings/20

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The answer to this is not static
Till 2014-15 FMCG companies weren’t trading at these 65-70 PE kind of valuations
Till 2013 end good small caps were trading at 7-9 PE
There was a period in the early part of the 2010 decade when it was believed that one should not pay more than 15 PE for large IT Services companies
Chemicals did not trade at a PE of more than 20 till some years ago

PE is not valuation, it is at best a short hand for valuation. The only way I can reliably value a business is to ask myself how will the financials change for the business over my investment horizon? This forces me to consider a lot of things -

What is the baseline growth for the industry? How is this changing and to what extent?
What does the unit economics for the particular industry/business look like? How can this change?
Competitive structure and the relative competitive position - market share, products, new product development
Risk of disruption over the medium term if not the long term
Risk of fuzzy accounting
Longevity of the business - directly impacts the terminal value one can assign
and many more perspectives

My experience has been that once you get down to doing structured work on analyzing the past and having a view on what the future might look like (given your understanding of the business) and have these views captured in a financial model that is representative of your investment horizon - 80% of the work is done. Once this is in place it is very easy to make changes to some assumptions and figure out how the financials could change as a result. While the exercise is not intended to be precise or even very accurate, this gives you a good enough framework to be able to make decisions consistently across time. When the corporate tax rate was changed in Sep 2019 all I had to do was change one cell in the model and the impact of this on the specific business could be quantified.

Very few investors (professional investors included) do this structured leg work over a sustained period of time. What we have is people reading some annual reports, checking what the average PE for the company/industry has been and having debates on metrics like growth rates, capital efficiency as if they are static variables that cannot change.

The very exercise of putting pen to paper or building financial models that capture your assumptions about a business brings tremendous clarity to whatever you do. Your decision need not be based purely on this (after all GIGO is a risk) but the exercise by itself is extremely useful in expressing a view on valuation.

Valuation should be a lot of hard work and a tangible exercise that can ensure consistency in decision making over time. After doing the leg work it becomes relatively easier to spot anomalies like a business getting priced for 8-10% growth while 15-18% growth might be the more realistic scenario. It can also become apparent that the particular business is more sensitive to near term earnings rather than what it can do over the next 10 years.

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I think if u can share and explain this model with an example of a company (which you best understand so when learners ask questions you can easily answer and help them), you will do the investing community here a big favour in terms of their learning.

Thanks
RR

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Hi frnd

This Sunday i did some brainstorming to formularize the effect of valuable variables such as ROCE, D/E, P/E on the stock price and how changes amongst these variables may causes change in returns. This exercise is for fun purpose only for fundamental level understanding of the maths behind these variables and to develop a visualization skill on how these inputs actually affect the balance-sheet of a business and how much returns an active investor may expect if he is somehow able to predicts the variables, even approximately right, for the next 5-10 years.
GROWTH ANALYSIS 28.06.2020.xlsx (21.7 KB)

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Hi @rajput_delhi

Yogesh Sane had done some exhaustive work on this front. If you are interested in financial modelling then you can refer to the thread below. Also, members like @dineshssairam are also into using financial models to guide their decisions and he has also shared his sheet on the forum.

Spreadsheet Model for Valuation of a Company

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Not just financial modelling in isolation for that there are many but how he captures his structured work of analysing past, future, biz understanding into the fin model.

Cheers
RR

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@Donald I have been pondering on why stock picking is an art and not science. Thanks to you for covering that aspect in this thread.
Most of the links shared in this thread are taking to a private page including this excel sheet. Could you please give access to these tools ?

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247

Cannot view the table !

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Nice valuation related video

Good Reasons to Ignore Valuation by Brian Feroldi

similar thought process as Saurabh Mukherjea

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249

Sitting in 2022 and reading the blog, I feel that Saregama is on a similar track.

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SaReGaMa is showing growth on profits but sales is almost flat and not so consistent with profits. So bit different from what’s discussed above.

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Amazing observation even though the thread is going to be a decade old soon but I must say I ve never thought this way ( time for repeat buy i.e frequency). A totally new perspective for me.

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In today’s world of abundant information ability, a good assessment of CAP will give long, continuos and peaceful investment opportunities.

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Sir, can you please share tutorial links related to valuation of company?

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Aswath Damodaran has an excellent online curriculum for valuation. It is the same course that he teaches in class.

It is one of the best resources to get a hang of valuation.

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thank you for sharing.

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Great learning experience while reading this thread on the art of valuation here.

I have a question - whether one should have higher allocation in the stocks one is willing to hold for longer duration or should have lower allocation. Does Investment Horizon also factor in as a parameter alongside Undervaluation and Conviction when determining Capital Allocation?

Thanks.

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In investment time duration is a major factor. We should hold companies that will prosper during good and bad times.

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Sir, Thank you very much for the insight.

Sir, Do you mean Astral has less chance to become 10 bagger from hereon

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May I request you to please give any example for each of the valuation checklist (if possible)

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Hi Donald,

Thanks for insightful information. These pointers definitely are sure to look upon while investing. With the dynamic business scenario, was thinking there should also be some points on how fast the companies can adapt. With the advent of SME exchange, the money flows in faster, thereby increasing competition.

Need thoughts on how can we measure flexibility of a company to adapt to industry dynamics.

263

Low debtor days might help.

264

Sir, I couldn’t find the table.
Can you please share it with me
mail id: ajmalmuhammedy10@gmail.com

265

Hi
I recently joined the VP forum and in awe of the knowledge which is being shared here. Ans yes i have read Thinking fast and slow by Daniel Kahneman, It’s one of my favorite books, do read Noise another book by the same author and i have been reading a lot about our cognitive biases. Just a thought i wanted to share.
Thank you

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Welcome to VP.
Good to know that you have read these books.
From my side, I have created few VP posts on behavioral biases.

Interesting Stories of Investing Biases

Screenshot 2024-12-11 105347
Screenshot 2024-12-11 1053471431×861 44.5 KB

Please check the link and the snapshot.

dr.vikas

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267

I am not able to visit the capital allocation and valuation of quality emerging business threads who link are provided in some of the conversations above. It says permission denied/ private group.

Why is that? Does anyone also facing similar issue? How this can be resolved? Am I not having all the credentials to visit those pages?

270

Wonderful thread and lots of learning as recommended by Mr. Donald as a starting point to pour into this forum.

As I have been going through this post, I was curious to look, how all 3 Type C companies have performed over more than 11 years and I struck in an awe to see how exceptionally well these companies have compounded over time.

For this calculation,
I assuming rough price estimation of a stock in month of December,2013 and price of May29,2025 from screener.
I also tried to adjust stock split and bonus shares issued after Decmber,2013 as per data from money control
I might have made a mistake in calculation, but I am open for discussion and any input.

                                ~ Dec 2013               29 May, 2025           ~ CAGR (%)    X times
  1. Poly Medicure Rs 80 Rs 9144 53% 114
  2. PI Industries Rs 225 Rs 3876 29% 17
  3. Kaveri seeds Rs 335 Rs 7465 32% 22

If any of this senior investor tracking these companies throughout these years if can throw some lights as what events took place in the past which created this good and different might be very helpful to improve learning curve of new investors like me.

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A nice reminder that in investing, identifying the key variables often matters more than building complex models.

“When I was a young analyst my Qantas model came to 150 separate Excel tabs. I forecasted every seat, food tray, flight attendant and landing slot for the next 20 years. All that to discover only the fuel price and US dollar mattered.”

FT.pdf (952.7 KB)

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