Valuation: Measuring & Managing the Value of Companies

Started reading this book this week to clear my thinking on the importance of Discounted Cash Flow as a Concept, but the demonstrated futility of using the DCF tool (predominantly) to determine Value.

This Valuation tome by Tom Copeland and Tim Koller is a costly $56 book. However for slightly adventurous ValuePickrs like me, there are very good “Used” alternatives available for as low as $5 including shipping. My first experience with “used” books (2010) was so exceptional, that I have always been ordering “Used” when I can. A friend who visits India once/twice a year, drops them by!

I got this very useful book (hardcover) almost new, for just $5! Sometimes on a beginners journey we get put off by the cost involved, so here’s a little tip for acquiring wisdom, at low cost!

What drives Value?

The DCF approach is based on the simple concept that an investment adds value if it generates a return on investment greater than that can be earned on investments of similar risk (the opportunity cost of Capital). In other words, for a given level of profits, a company with higher returns on investment will need to invest less capital in the business and will, in turn generate higher cash flows and higher value.

We would therefore expect that companies that earn higher returns on capital relative to their cost of capital, to have higher Value. Unfortunately, return on invested capital by itself cannot explain company valuations for the same reason that growth alone does not determine Value.

Other factors matter! Consider two companies starting at the same time with identical expected return on capital over their cost of capital. However one company plans to invest twice as much as the other. As a result, the company with** higher investment** and faster growth should have a** higher value**, despite identical returns on capital. It becomes clear that both growth and return on invested capital should drive “Value”.


While Buffett discourages us from using big spreadsheets (DCF) to calculate a company’s value, he surely acknowledges that true determinants of a company’s value are the free cash flows it earns.

Source: Berkshire Hathaway Annual Meeting 2009 Notes. You can find more from this extensive compilation of Buffet Q&A at

What valuation metrics do you use?

“The appropriate multiple for a business compared to the S&P 500 depends on its return on equity and return on incremental invested capital. I wouldn’t look at a single valuation metric like relative P/E ratio. I don’t think price-to-earnings, price-to-book or price-to-sales ratios tell you very much. People want a formula, but it’s not that easy. To value something, you simply have to take its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate. All cash is equal. You just need to evaluate a business’s economic characteristics.”

So if value is based on discounted free cash flow, we should reason that the underlying value drivers of the business must also be drivers of free cash flow.

There are twin drivers of free cash flow; the rate at which the company is growing its revenues, profits, and capital base; and the return on invested capital over and above the cost of capital.

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What are the components of Return on Invested Capital


Since Return on Capital is a core value driver for a company, it makes sense to break down ROIC into its main components. That will help us to evaluate a company’s economic characteristics, more easily.


Return on Invested Capital is defined as follows:

ROIC = NOPAT/Invested Capital, where

NOPAT = Net Operating Profit less adjusted taxes = EBIT x (1-Tax rate)

Invested Capital = Amount invested in the operations of the business. Invested Capital is the sum of Working Capital and net fixed assets, and net other assets (net of noncurrent, non-interest-bearing liabilities).

So, ROIC = (EBIT/Invested Capital) x (1-Tax rate),

Now, EBIT/Invested Capital =(EBIT/Revenues) x( Revenues/Invested Capital), or

EBIT/Invested Capital = Operating Margin x Capital Turnover

Assuming the Tax rate remains the same, we now know that a company is likely to have higher Return on its Invested Capital, when it has high Operating Margins or high Capital Turnover, or both.

Thus, there are only two drivers for Return on Invested Capital.

1). Operating Margin)- measures how effectively the company converts Revenues to Profits

2). Capital Turnover )- measures how effectively the company employs its invested capital


Question of the week

In ValuePickr Portfolio we have several companies doing extremely well over the last year and more like Mayur Uniquoters, Balkrishna Industries, Gujarat Reclaim, Ajanta Pharma, even PI Industries.

1). Can we identify which businesses in ValuePickr Portfolio enjoy superior economic characteristics?

We should be easily able to say, Hey company X is a better quality business than company Y, any day! Separating the wheat from the chaff, again :slight_smile:

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I am not sure of real value of DCF in real life. My concern is how do you estimate some of the parameters like growth rate, discount rate etc accurately going many years into future. The other issue is small variation in assumed values can cause large change in outcome. Some say you try to get a value range by using the range of values - min and max kind. Not sure of value it offers in real life investing. Would like to learn from experienced investors.

DCF may be useless for fast growing or cyclical or small/mid size companies. But can it be used to get value range for stable companies like Pharma, FMCG, utilities?

Would be interested to know members view on which is more valuable firm from the list given by Donald. I have personally made decent profit in Balkrishna Industries. Very satisfied with that investment. Learned many things from that investment for future.

This seems interesting!

Donald, are you/the authors saying that we can use a nice benchmark like Capital Turnover for differentiating between companies.

Those with sustained high operating margins with high capital turnover are companies that inherently have a better quality business! better economic characteristics, a la the Bufett quote, above.

If this is correct, it adds another dimension to the Capital Allocation discussion, isn’t it? Somehow I had never thought of companies this way - which are these companies with high Capital Turnover.


I think we are essentially talking about basic Du Pont’s analysis.

High Margin, High Capital Turnover - Great business (eg. Mayur Uniquoters)

Low Margin, High Capital Turnover - Any retail chain (Big Bazaar)

and so on and so forth.

So, high capital turnover only cannot necessarily be used as a benchmark to differentiate between companies.


I agree with Kiran that there would beexcellent cos doing great in either parameters. But cos doing great on both cap t/o and margin falls in the very best category - you cannot ask for more :slight_smile:

Should we just check past data on this or think about who can sustain higher cap t/o together with higher margins in the forseeable future?



I wanted to be clear about the economic characteristics of Mayur Uniquoters, and compiled this view! And what a view, no wonder many have their highest allocations to Mayur!!

Mayur Uniquoter 2007 2008 2009 2010 2011 2012E
Revenues 66.26 90.24 115.05 164.73 248.56 310.70
EBIDT 6.67 10.57 11.78 27.92 40.87 49.71
Depreciation 1.52 1.39 1.59 2.08 2.67 3.44
EBIT 5.15 9.18 10.19 25.84 38.19 46.28
Operating Margin 7.77% 10.17% 8.86% 15.68% 15.37% 14.89%
Working Capital 13.42 11.88 12.07 22.21 33.01 32.94
Net Fixed Assets 15.95 21.32 22.65 23.15 31.3 45.83
Net Other Assets

Invested Capital 29.37 33.20 34.72 45.36 64.31 78.76
Capital Turnover 2.26 2.72 3.31 3.63 3.87 3.94
EBIT/Invested Capital 17.53% 27.65% 29.36% 56.96% 59.39% 58.75%
ROIC 11.75% 18.53% 19.67% 38.16% 39.79% 39.36%

Interesting to look at the real progress this company has made in both Operating Margins and Capital Turnover.

I have 2 requests:

1. I could not really understand how to compute Net Other Assets (net of noncurrent, non-interest-bearing liabilities). If Ayush, other CAs can explain how to that will be great

2. Can someone do the same exercise for Balkrishna Industries (Pls use the attached file, it will take just 5-10 mins to fill in the data)


Mayur-Economic-Characteristics.xls (9.5 KB)
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hey arindam,

thx, I will take this up for Balkrishna and revert. will be good to do for a few other companies too.


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Some Notes on the terms above:

1). Working Capital : We should include all current assets used in or necessary for the operations of the business, including some cash balances, trade accounts receivables, and inventories.

We should specifically exclude excess cash and marketable securities. These generally represent temporary imbalances in the company’s cash flow. For example, in Balkrishna Industries Q2 BS, there was some excess 650 Crs+ held in Cash Investments if I remember correctly. The money had just been drawn from ECB for deploying for capex in Q3 and Q4. Usual cash balance for the company is normally 5-10 Crs.

Excess Cash and marketable securities are the short-term cash and investments a company holds over and above its target cash balances to support operations. Target cash balances are usually less than 3% of Sales, depending on the industry.

2). Non-interest bearing current liabilities: These are Accounts Payable and accrued expenses, and other non-interest bearing liabilities; Usually subtracted from Current Assets to calculate net current Assets or Working Capital; so we need not really worry about the workings here

3). Net Other Assets - ??

Ayush and other CAs in the forum. Kindly comment on the above notes. Any other things to be careful about for the calculations. And please elaborate what should we consider for Net other Assets.


This is turning out to be an wonderful exercise - and I am getting new insights!

Check out BKT economic characteristics! File attached, I changed the order of the years in the file recd - so we can copy data easily from someplace like Moneycontrol!

Balkrishna Industries 2012E 2011 2010 2009 2008 2007
Revenues 2800 1997.16 1386.74 1252.43 991.47 877.35
EBIDT 477 371.58 397.16 201.64 233.6 182.62
Depreciation 97 74.44 66.22 56.52 43.83 36
EBIT 380.00 297.14 330.94 145.12 189.77 146.62
Operating Margin 13.57% 14.88% 23.86% 11.59% 19.14% 16.71%
Working Capital 772 572.75 370.61 299.14 359.94 268.75
Net Fixed Assets 1069 687.44 614.89 534.55 424.47 399.37
Net Other Assets

Invested Capital 1841.00 1260.19 985.50 833.69 784.41 668.12
Capital Turnover 1.52 1.58 1.41 1.50 1.26 1.31
EBIT/Invested Capital 20.64% 23.58% 33.58% 17.41% 24.19% 21.95%
ROIC 13.83% 15.80% 22.50% 11.66% 16.21% 14.70%

I took Q2 figures of BS for BKT 2012 data, so removed about 670 Cr of excess cash. is that right?

Balkrishna-Economic-Characteristics.xls (9 KB)


Thx evryone for the inputs! nice discussion. I would like to see how Gujarat Reclaim fares in this whole thing…I think its a great company…going by what I have read from Ayush and others.

one question - how do we project for 2012 in this sheet. How to estimate WorkinG capital or fixed Assets,etc.

Re: 2012 projections

I took the BS figures from Q2 results from Balkrishna. Donald had asked to adjust for excess temporary cash so I had done that adjustment to working Capital. You can do the same for Gujarat Reclaim…may be add a 10-15 Cr more on the fixed assets side,etc.

Revenue and EBITDA should be easier. 9 months results are out, we can just extrapolate I think. maybe add a little more on the depreciation side than earlier quarters as there has been big additions to capex.


Firstly, thanks to Donald for initiating this thread and secondly, nudging me to look at this. Didn’t get a chance to read it before today.

My two cents worth:-

  1. DCF is one method of analysis and by no means the definitive method. As I think Girish has mentioned, the number of parameters out there are too large to reduce/eliminate assumption errors.

  2. Return on capital - instead of splitting hairs on difficult formulae, I think it is important to understand that at the end of the day, return is net profit or net cashflow divided by either total shareholders equity (if you are looking for equity capital returns) or toal capital employed (if you are looking for overall returns including debt taken). All other return calculations, to my mind, are academic. The reason is taxes and depreciation are as much a part of individual businesses as their operating characteristics.

For net equity returns: Net Profit / Networth

For total returns: Net Profit / All assets

  1. Business are primarily of 2 types - I call them the “Fine Italian restaurant” and the “local Chinese”. Italian restaurants have a high margin, low turnover business andChineseones typically (except places like mainland china) are low margin, high turnover businesses. Neither is a preferable model as there can be great businesses in both categories. The problem arises when management confuse one for the other or try to be everything to everyone (you cannot sell Nano and Jaguar from the same showroom or make them in the same factory, that is why Toyota has a premium brand like Lexus completely separate).

  2. Valuation to me is not a numbers game. I need to have a good “feel” about the company, its ability to scale in the future, market position, market share, the way the management answers questions in analyst calls and other such intangibles which are not directly available in the numbers.

  3. Dupont analysis tells us how the RoE is being achieved. And is a good tool for understanding the various levers the business has.

Also, if you could all add your inferences that you are drawing from the data tables that you are putting up here, it would help the others.

Here are the details for Gujarat Reclaim. So it looks like the company is making a comeback of sorts...into better times...after 2 or 3 stagnant years.
There just does not seem to be another like Mayur Uniquoters - in terms of business quality. any names??
Gujarat Reclaim 2012E 2011 2010 2009 2008 2007
Revenues 250 187.35 144.82 132.19 110.74 86.49
EBIDT 56 33.18 27.57 26.54 19.01 19.31
Depreciation 7 5.11 4.35 3.96 3.45 2.42
EBIT 49.00 28.07 23.22 22.58 15.56 16.89
Operating Margin 19.60% 14.98% 16.03% 17.08% 14.05% 19.53%
Working Capital 50 26.96 21.28 16.86 16.41 9.87
Net Fixed Assets 100 68.72 48.56 38.09 37.21 32.55
Net Other Assets

Invested Capital 150.00 95.68 69.84 54.95 53.62 42.42
Capital Turnover 1.67 1.96 2.07 2.41 2.07 2.04
EBIT/Invested Capital 32.67% 29.34% 33.25% 41.09% 29.02% 39.82%
ROIC 21.89% 19.66% 22.28% 27.53% 19.44% 26.68%
Somewhere in the thread above, there was mention of Growth. Gujarat reclaim had relatively high RoIC in 2009 and 2010, but Growth was stagnant as was Invested Capital in the business.
Now that Growth is returning and margins and returns are improving, it may make for a good investment?
Perhaps it is better to go with someone who has the ability to keep investing higher amounts of Capital at higher RoIC, and is growing better/faster?

Hi Abhishek,

Thanks for writing at length, and wonderful insights!

You are right, we get more a “feel” for the company from how the Management answers queries and the insights we receive from studies on the size of the opportunity, ability of the company to scale up, fund itself, etc. Ratios/Numbers become less important, once you have seen the basics are good.

I think the point Donald and others are trying to work at here is - In the normal way of doing things, we are really not clear which business has the** best economic characteristics** in Warren Buffets words. We do not have the mental models ready to think about businesses clearly in those terms.

If we look at the valuable data that is being thrown up by members, there is a wealth of additional insights - just form a few simple numbers - about the quality of these excellent businesses - apart from what we already know about the Management, opportunity size, etc. Actually the data tells us much about the scalability of the business too!

Assume all of these businesses are available ~7x 2013E earnings. Where will I put in my money - given all of these are some of our prized companies - all have done pretty well too -** I think these numbers are a great way to start thinking more clearly on how much Capital to allocate** )- in addition to the other not-so-objective ways of determining Business Quality.

Invite your views.

Thanks all for useful data and good discussion that is happening here.

Should we also include freecash-flowin the companyfinancialspreadshit? Free cash flow as percentage of sales is useful indicator of company’s earning prowess.

Hi Arindam,

Very interesting points. Let me try and add my thouhgts more to clarify my muddled thought process though penning it down.

“…not clear which business has the best economic characteristics” - how do you define what is the best economic characteristics, that I think is the question… Is it return ratios, asset turnover, margins, market share etc? Or does it inlcude possible market size and market share in the, say, next 10 years? If yes, then how do you measure that?

“…data that is being thrown up by members…about the quality of these excellent businesses…” - So, let us look at the numbers from one of these companies, say Mayur. (Let me pick Mayur as I have it has the highest capital investment and the second highest weigtage in my portfolio).

What does it tell us? That it has increased sales about 6 times over the last 5 yrs. Margins have doubled but has been in the same range for the last 3 years, not enough to conclusively prove that it has moved into a higher margin business or if its a cyclical upturn. ROIC has again gone up significantly in the last 3 years, but not enough to be sure if its a secular upmove or cyclical one.

All this tells you what happened over the last 5 years, with no real indication of how it happened and most importantly why it happened. The numbers tell you that it might end 2012 with a revenue of 300 odd crores. How do I know whether revenues can go up to 3,000 cr or 30,000 cr in the future? Can someone me what the net margins are likely to be in 2020? Will they be 15% as it has been for the last 3 years or will it be 8% like the 3 yrs previous to that, or any other number for that matter. I rest my case on this point.

“Assume all of these businesses are available ~7x 2013E earnings. Where will I put in my money - I think these numbers are a great way to start thinking more clearly on how much capital to allocate” - Great question. What I would do if I got say Mayur, BKT & Guj Reclaim all at the same valuation is I would have a 50:30:20 spread amongst them. The logic has nothing to do with numbers here but everything to do with “feel” and circle of competence and understanding of business risk. Mayur has a much higher potential market size and not too may competitors. Management seems sensible. Company is growing. BKT has a niche market which is difficult to replicate easily. Gujarat Reclaim is also a niche business but scalability is somewhat limited to my mind. It cannot increase its sales 10 times in the next 10 years even if it tried to. However, stock prices have a nasty way of misbehaving and making us look like fools. So, you might see Guj Rclm doing the best in the next few years! :slight_smile:

Aonther way I have learnt to think (borrowed from Charlie Munger from his Art of Stock Picking) is if I have to start a business and have access to unlimited capital, what business would it be? And if I have to harm any business what could I do? Again, taking an example, would I buy Mayur as a whole company today (assuming they are willing to sell and I have unlimited capital)? If yes, why? If no, why not? Also, if I have to start a competitor for Mayur, what would I need to hurt Mayur? Can I take it out of business?

Net net, my thought process is more based on critical thinking and subjective analysis aided by core fundamentals, rather than the fundamentals itself.

P.S 1 : I take all published numbers with a pinch of salt. I am not sure if all the numbers that are published are 100% accurate. Not saying management is not 100% honest in all cases (which is certainly true in most cases). But other than actual cash numbers most are back calculated to a certain degree. So, use the numbers as a guide and not a roadmap.

P.S 2: Girish, free cashflow is an approximation in most financial statements as it is not directly reported. But to my mind it is one of the most important numbers that we should look at. Cash is king, you cannot dispute with it , unless of course you are holding Satyamshares:-)

Whew!! That ends my lengthy discourse, and now back into hibernation!!!


Thanks Abhishek,

Very valuable directions. Much of this will allow me to think more clearly. I agree with your philosophy of 50:30:20 roughly between Mayur:BKT: Guj Reclaim - for the reasons you mention.

I have 2 things to point out in the data interpretation.

1). Economic Characteristics - At the simplest level, by this Buffet perhaps meant - does this business inherently have superior economic characteristics - Will my Invested Capital earn more returns for me in this business than say business x - more likely to, because it is incredibly more capital efficient. Not the whole sizing up size and prospects 20 years down the line …which is a much bigger exercise, no doubt

2). You were looking more at trends of last 3 years. more or less at the same level is the verdict.But If I look at just Capital Turnover - this is a truly 'classy" aspect of the business for Mayur. This has been a steady upclimb to almost 4x. They can put less capital in the business and take out more Sales -every year.

3). This is what amazes me - and sets Mayur apart from any other business we are looking at currently. It is a better business to put my money in -compared to others - as long as it is also growing decently in comparison to others.

4). Free Cash flows - Mayur has a phenomenal record there - and this is ultimately linked to Capital Turnover, I guess. The more capital efficient you are, the less you will need to put in the business ( Working Capital and Capex).