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Approach To Stock Valuation Oct2018 PDF
Approach To Stock Valuation Oct2018 PDF
APPROACH TO
STOCK
VALUATION
@VenkateshJayar2
@VenkateshJayar2
Disclaimer
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• Any examples, sectors, stocks and cases discussed in this presentation are only for educational
purpose.
@VenkateshJayar2
Only after listening to a few videos of Mr. Raamdeo Agrawal in 2015, I could see a bigger
picture of how different facets of investing are connected. I owe him a lot for the knowledge
that he has shared in many of his interviews.
• This is because price of stock is readily and easily available at click of a button.
• But value of a company can be judged only after a in-depth analysis of stock. This analysis may run
for weeks (or even months) in the case of a individual investor.
• Price is in the screen of your ticker or television, but the value is in the eyes/mind of a Investor.
BEFORE VALUING A COMPANY, THERE ARE MANY OTHER FACTORS AND THOUGHTS THAT MUST BE
PUT UPON TO DECIDE, IF IN THE FIRST PLACE THE BUSINESS SHOULD BE BROUGHT OR NOT. ONLY
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AFTER THIS IMPORTANT DECISION SHOULD ONE GO FOR STOCK VALUATION.
LET US WALK THROUGH THESE STEPS IN SEQUENCE, WHICH HELP TO DECIDE, IF A BUSINESS IS
A BUY, BEFORE FINALLY MOVING TO VALUATION PART.
Analysis before Valuation
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STEP 5 - VALUATION
STEP 4 - DISRUPTION
• Appropriate valuation
models • Can anything disrupt the longevity of growth estimated in Step – 3?
• Margin of Safety
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STEP 2 - GROWTH
• Opportunity Size
STEP 6 - ??? • Size of Business within the opportunity
QUALITY
ANALYSIS OF A There are Two Facets of Quality
• Quality of Business
investment is with a safe person even, if the returns are slightly lower.?
• You are going to buy gold. What do you look for? Even if you pay slightly more, you look for a
Jeweler with impeccable reputation to ensure that the gold you get is pure.
• In another situation, you have to mortgage the gold for a urgent finance need. Would you not look
for a option, who will return your Jewel safely, when you return the borrowed money?
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• This is a very rare virtue. Your driver works for pay cheque they receive.
• Instead imagine, if the driver is passionate to drive & pay cheque comes next.
• Enjoys driving...If stuck in a traffic, even without being told chooses a alternative route and
reaches destination on-time safely.
• Never been late to report to duty and you were always on time for your appointments.
Your schedules was always driver’s priority.
Traits of a Good Management (Contd.)
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PASSION is very important. So dedicating one full slide with a wonderful quote emphasizing the importance
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Traits of a Good Management (Contd.)
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Now relate these qualities to Business Managements:
The person running the show must be competent enough not only to run the day-to-
day business, but also to navigate the business in all conditions i.e. Economy slow
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The management must treat the minority shareholders in par with promoters/
majority share holders.
The key person is passionate about business, very ambitious & loves to see the
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company grow. Learns from failures, see challenges as opportunity and comes out
big after every down turn. Shareholder’s wealth creation is accorded priority.
This is a heavy weight topic. Will plan a separate presentation in future. For now you
may check Chapter 7-9 of “The Investment Checklist” by Michael Shearn.
QUALITY - KEY TAKE AWAYS 14
GROWTH
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Growth
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Investors should look for companies with increasing Revenue and Profit. Where does the growth
comes from? Some thoughts:
o E.g. Aviation business: How many people travel now by air and how many would travel by 2025?
• Where does the company in analysis stand in relation to the opportunity size?
o How much share does your XXX Airline company caters in the current Air travel volumes? It is 10% or 50% or 90%
• The capability of the management to exploit (Ethically!) the available opportunity size.
o This is the where the quality of Management that we previous discussed becomes important.
o If the current market share is 90%, can it retain the same till 2025
o If the current market share is 50%, can the management increase to 80-90% by 2025?
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This analysis can be made only, if there is a fair understanding of the industry in which the company
operates. To get a right answer, your own understanding of your company and the industry in which
it operates is important. The question now on you is…
Do you have sufficient understanding of the Industry that you are analyzing to do this analysis?
Size of the Opportunity
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Visualize the Size of Opportunity as a pond and Size of the Fish of your company size. Try answer
this question. What is the size of Fish in relation to the Pond?
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Small fish in a big pond Big fish in a big pond Big fish in a small pond Small fish in a small pond
Case 1 and 2 are ideal i.e. Small fish in big pond & Big fish in a big pond. This understanding is very crucial
for understanding the growth ahead.
Note: The contents of this slide - Fish/Pond Analogy picked from the book “” by Mr. Bharat Shah. Refer the book for further details and understanding of this
concept ‘Size of the Opportunity’ On Long-Term Value & Wealth Creation from Equity Investing’.
GROWTH - KEY TAKE AWAYS 18
• WE TEMPT TO BUY-IN COMPANIES OR INDUSTRY THAT IS A CURRENT MARKET FAD.
• HOUSING FINANCE COMPANIES (HFC) AND NON-BANKING FINANCIAL
CORPORATIONS (NBFC) WAS THE MUCH DISCUSSED SECTOR. HOW MANY REALLY
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MANY INVESTORS FAIL AT THIS STAGE, DUE TO LACK OF UNDERSTANDING OF THE INDUSTRY
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Disruption to Growth
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We are in times, where the business dynamics can change overnight. This consideration
factors the RISK to growth of our investments. In the previous two steps a investor estimates:
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Both these factors can face disruption (1) Lower growth rates (2) Lesser longevity of growth
i.e. 10 years to 5 years. Disruptions could be due to the following factors:
1. Competition Note: These five factors are well discussed in “Porters Five Forces
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2. Buyer Power Analysis”. A lot of materials is available about this tool in the internet.
3. Supplier Power Kindly use the same to better understanding this subject.
4. New entry However, will see a bit about disruption due to competition and
5. Threat of substitution technology.
Competitive Landscape
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How many players are there in that industry? Is it a Monopoly, Duopoly or Oligopoly
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* How the company in analysis stacks against other close competitors? – Compare financial and quality data of at
least 3-4 competitors (Applicable only in case of Oligopoly)
SOMETHING INTERESTING CAN HAPPEN DURING THIS ANALYSIS...YOU MIGHT COME ACROSS A COMPETITOR COMPANY
BETTER THAN THE TARGET COMPANY!
Technology Disruptions
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This analysis is easier, if your company/industry is immune to Technology changes. Few pointers
below.
• Look in the future. Which technology change would disrupt your company?
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The above are only some pointers. Disruptions could be due to other factors (i.e. regulatory
changes) and not necessarily due to technology alone. Consider other possible disruptors.
Financial Statement Analysis
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Has your company passed all the previous stages? YES
• Analyze the Financial statements for 5-10 years.
• Go through the Annual Reports for Financial Statements and the notes that accompany
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them.
• For financial ratios and calculated values better to have your own excel file with the
formulas, where you enter the source data from Annual Reports.
• This will help you to get a feel year wise changes happening in different financial entries
and also consider/exclude extra ordinary items as required.
• Charts help to interpret the data more easily.
• Choose appropriate ratios aligning with the industry/sector your company belongs to.
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• When you look at the numbers/trends for 5-10 year data, they tell something to us. We as
investors must be capable to decode/interpret the meaning.
• Key Ratios: Check thoroughly the key parameters that indicate the operation and financial
health of the company. A few to name are: Gross/PAT Margins, RoE, Debt levels,
Sales/Profit growth.
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VALUATION
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Valuation
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You Are Ready to Start Valuation, If Your Stock Has Successfully
Passed All The Previous Steps.
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By Now, Even Without Any Excel Or Valuation Models, You Will Have A Fair Idea
Of Value Of The Company 😊.
Valuation Is The Last Step to calculate After Completing All the Previous Steps…
Why was the previous steps/analysis needed for Valuation?
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• Most of the inputs for valuations comes from the previous stages. Consider a simple DCF which needs future
expected growth rates and duration of the growth. Both these factors can be reasonably arrived from previous steps
rather than pure assumption.
• Also what purpose does valuation serve for a company that has a poor business or management or any other
aspects discussed previous?
VALUATION WITHOUT A DUE DILIGENCE ABOUT THE COMPANY IS A RECIPE FOR DISASTER !!!!!
Valuation Models
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There are many tools and methodologies available for. Not a single model or approach that is
available. The below are few to name:
Absolute Valuation Models Relative Valuation Models
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This valuation tries to determine the intrinsic value This valuation helps to compare the valuation
of company in absolute terms, without between competing companies or industrial
comparing with its competitors. average. Price is a primary variable.
There is also three valuations models discussed in “Buffettology” series of books by Mary Buffett.
There are huge resources (Books, Videos and Lessons) available in the open domain on valuation and all
the models.
Now what next?
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Now you have used the applicable models and arrived at the valuation. There could be three scenarios
as below. What to do in the three scenarios?
What is the big fun in paying 100 rupees for a 100 rupee bill? Not a buy
• Make sure that all available positive/negative information and risks has been factored in valuation.
• It is quite possible, that you had spend a good time analyzing the stock for weeks/months and got
emotionally attached.
• This could have led to UNCONSCIOUSLY lowering the Margin of Safety or having a higher growth rate
or any other assumptions to tilt your valuation plate higher than price
• Revisit the estimates and assumptions. Have all the assumptions considered conservatively for
valuation?
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YES
1. Go ahead and buy the stock. NOT IN BULK. But in a staggered manner to have sufficient
"Dry Gun Powder" to EXPLOIT the situation in case of panic selling in the markets.
2. One last MOST IMPORTANT STEP, that you can do as you buy… ☺ SELL DECISION TRIGGERS!
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One general rule is you could have gone wrong in your analysis about the stock. Once it
becomes clear that
• The analysis you did is wrong or
• The initial investment thesis has changed and no longer valid.
In this circumstance, without further hesitation (or ego) sell the stock irrespective of whether
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the stock shows a gain or a deep loss. Just get out of it.
This is like a situation where you go to a city and stay in a lodge. You realize that something illegal
happening and all is not well in that lodge. You are not in the right place. Will you stay because you
have paid the money or just get out of it to save yourself from any further trouble?
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rationale sell
decision
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Think over this and try to relate with Investing Buy and Sell Aspect
Sell Triggers in Investment Thesis
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• The same analogy can be replicated for investment selling.
• As a Investor buys a stock after analysis they MUST also identify the triggers/conditions/risks in the
Industry or the stock that should make the stock a “SELL” candidate. A few sample pointers:
o Competitor gaining ground – Loss of market share
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INVESTMENT
THESIS
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Investment Thesis
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Completely Exhausted???
You do all the Research, Get Conviction, Make Decision and Then Invest your
Money
• Now you see that there is lot of information extracted from various sources over which comes your
own remarks, observations and comments. All this would be needed when the final decision to buy
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the stock or value the stock. How to handle the information over load?
• Have a "Investment Thesis" document or file for every stock that you analyze. All your findings,
assumptions, details of risk and other things go into this document.
• This document is a dynamic document and shall be updated on a ongoing basis and when new
information is available.
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1. Quality 4. Disruption
This document will be …and also guide you
helpful in analysis, when the situation to
2. Growth 5. Valuation
buying decision… sell arises.
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A Important Caution about this Entire Sequence !
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Following these steps religiously during valuation help you with a fair degree of
accuracy…But that does not mean that:
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• The stock will not fall by 20-30%, when there is a general stock market
correction/panic.
• The stock will not fall steeply by 50-70% during situations like 2008 melt down.
How it helps during such testing times is…You have the conviction to hold (Or
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probably buy more) to the stock till the situation turns around. The stocks will then
recover back and emerge much stronger.
While this turning back is possible in a good quality stocks, junks remain beaten-down.
Wrap up
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2. Growth 5. Valuation
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Investment Thesis
Re-Read
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So, if you liked this presentation and wish to retain the contents,
please go through the slides again now.
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Good Luck in your
reading &
@VenkateshJayar2
Investment Journey