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Q4. Do you have reliable source - which has achieved this fete and also outlined the process of doing
Ans. Yes. The Valuepickr forum - is an outstanding source of learning the Art of Investing - and can bo
for achieving it.
Q5. Lets begin. We start with the all important Question of what drives a Stock Price?
Ans. There are Multiple factors -
a. Growth - Actual & Expected (Sales and Profits)
b. Absolute Undervaluation - Stock battered down due to - bad overall markets / some temporary
c. Relative Undervaluation - Stock is cheaper than it's peers / than it's potential valuation - as mk
d. Market Sentiments - the "P" in the PE is often due to sentiments - while earnings are more or le
There could be many more - but seem to have covered the most obvious ones.
Q7. Superb - these are good pointers - Do you have a detailed checklist for the same
Ans. Yes. Pls refer to the sheets titled "Donald Checklist" and "Hitesh Checklist". There is one Rohit Cha
It is kept in the VP Folder for reference.
Q8. Following the above exercise will land us with a few set of stocks we would like to invest in. How d
In short can we separate Wheat from the Chaff? Can we classify them into a Quality pedigree?
Ans. Super question and the answer is equally superb. I shall enumerate views of VP members as to w
Pls note - Valuation is a separate issue - Great business may not be great investment if acquired a
addressing what is a great business (and not great investment).
C I would look for a business that is able to grow at reasonably high rate for a long period of time b
on invested capital mostly financed through internal accruals.
Business is able to grow at reasonably high rate for a long period of time:
We can compute the ratio Opportunity Size/Current Revenue -
Second - how fast is the industry expected to grow
generating consistently high rate of return on invested capital:
Ones growing with a balanced mix of Capital Turnover and Operating Margins
mostly financed through internal accruals.
Low levered business
D Businesses could be classified based on it's Quality Pedigree. Best businesses are the A+
Businesses with strong Quantitative matrix - and consistent performances - (Mayur, Atul CERA)
Businesses with consistent performance with some intellectual property (Kaveri / Shriram Transpo
Businesses with consistent performance, intellectual property and high visibility of CAGR growth fo
Businesses with consistent performance, intellectual property and high probability of disproportion
Q9. Having classified the great businesses - is there a way to Value them?
Ans. Technically, Value of Business = Sum total of all cashflows generated during the life time of the co
Simpler way - consider you purchased an asset, say a computer - The value of the computer = su
it's life, discounted to present value. This method is called Discounted Cash Flow (DCF).
GREAT BUSINESSES ARE THE ONES WHICH - FOR A GIVEN INVESTMENT - GENERATE HIGHER FR
HIGHER THE FREE CASHFLOWS - HIGHER THE VALUE.
Q14. Is crunching such numbers sufficient to identify multibaggers? Can they tell the whole story?
Ans. No & No. Numbers are neither sufficient nor do they tell the whole story. But they can certainly le
The question we are trying to identify here is
- Which businesses are more efficient than the others? Which businesses have superior economic
- Given that both businesses are likely to grow at healthy pace - where should I allocate more ca
Q15. Introducing another concept - Economic Profit Added. What is Economic Profit Added?
Ans. Value of company = Invested Capital + Present Value of projected Economic Profit.
Economic Profit = Inv. Capital x (RoIC - CoC)
Economic Profit translates the 2 drivers of Value, RoIC & Growth, in Rupee Terms.
Q16. How does Economic Profit help understand more about value drivers?
Ans. As explained above - Economic Profit = Inv. Capital x (RoIC - CoC)
If ROIC of business is below the CoC, too much capital investment, will destroys value. The more
If Inv Capital in the business is too low, though RoIC is high - it would mean missed opportuntiies
The key therefore lies in understanding and building conviction that the company will b
Q17. What about return on incremental capital? That tells us how much the company is earning on incr
Ans Yes. Great ratio. RoIIC = Increase in EBIT / Increase in Capital Invested. Tells you how much extr
Pls Note - Both the above ratios need to be computed over 3 to 5 yr CAGR -to even put the impac
Q18. ROIC = Operating Margin x Capital Turnover. Which one them is more controllable and therefore
Ans. Yes. Of the 2 parameters Capital Turnover seems to be more sustainable due to the following
a. High Operating Margin Businesses often face competition thereby posing a threat
b. Operating Margins are dependent on number of factors - and many times beyond the control of
Having understood that High margins are difficult to sustain - High capital turnover businesses be
Hence, Asset light companies - ones which are able to generate high turnover without too much in
Asset heavy ones - even if the Asset heavy businesses have high margins.
For e.g. Co A (Op Margins 15% x Capital Turnover 1 time) & Co B(Op Margins 5% x Cap Turn 3 ti
So, for every 1 of Invested capital - Co A can generate 1 Rs of Sales, whereas Co. B can generate
Now, for every 1% increase in margins - Co A can increase RoIC by 1% vs 3% for Co. B
Revised ROIC Co A = (15% + 1%) x 1 = 16%
Revised ROIC Co B = (5% + 1%) x 3 = 18%
Pls note - it works adversely as well if the margins drop.
Also, Asset light businesses, generally fund their capex through internal capital and hence are less
Q19. Having identified great companies to invest in - How do we allocate capital to set of stocks identifi
Ans. Great - lets address capital allocation using the following model
Sr. Under
No. Valued Conviction Allocation
* % Allocation given above are flexible and based on the individuals risk appetite
a Meaning of Undervalued in table above is - absolute / sheer under valuation and not relative to m
b Conviction - Means the level of homework / research / understanding of businesses company you
c Conviction should be such that one can explain the stock idea in a few phrases
d How do you tackle illiquidity - Illiquidity in fundamentally good stocks with high growth has actual
this is a long term Portfolio - Illiquidity should not be much of a concern
e Capital Allocation model should always provide for ability to take advantage of massive fall in the
Q20. This way I will be running 2 portfolios - long term and short term. How do I allocate capital across
Ans. Follow the Mental Model below.
Portfolio 2
Emerging bluechips 50% long term compounding Doubling in 2-3 years
Opportunistic 50% short term mispricing upwards of 50% in <1 yr
Cash incl. in above Averaging down on bets not missing out on unexpected
Q21. What if one stock fares better on conviction and other on valuation. How do I allocate capital in su
Ans. Total Rating (TR) = Weights (w) x Conviction Rating (CR) + Weights (w) x Valuation Ra
One can decide the weights based on preferences - Donald prefers higher weights to Conviction (6
E.g. Stock A has 8 on CR and 6 on VR, whereas Stock B has 6 on CR and 8 on VR.
Stock A TR = 0.6 x 8 + 0.4 x 6 = 7.2
Stock B TR = 0.6 x 6 + 0.4 x 6 = 6
Stock A gets higher ranking than stock B - so allocate more.
Q24. What's the general opinion on - WHAT IS THE MOST VALUABLE BUSINESS?
Ans. Most think it is
- Size of Opportunity
- Integrity of the Management
- High ROCE / ROIC
- Best EPA
While the above tangibles go a long way in Valuing a business - moment you wear an acquirer's h
it is the INTANGIBLE ASSETS IN THE BUSINESS IN ADDITION TO THE ABOVE TANGIBLES - WHIC
Q25. So what can be those things which an acquirer looks for - which can be termed as Intangibles?
Ans Few thoughts
a. Evaluation of how much will it cost to re-create an existing intangible, based on original cost of
b. Something which could bring Strategic benefits to the specific buyer
Intangibles could take various forms like
- Brands and Pricing Power
- Intellectual Property
- Proprietary Products
- Customer Loyalty and concentration
- Trade Secrets and process know-how
- Skilled management and skilled employees
- Strong distribution network
Q26. Wouldn't a high ROCE / ROIC business already reflect these characteristics - wouldn't it be captur
Ans. Big No. Else a business like Mayur having an ROCE of 47-56% range would have been more valua
Mkts have always valued Astral more than Mayur. Why? Lets have a few pointer comparison
MAYUR
1. Processor Co. - No scope of differentiation except process and quality
2. Competition can really squeeze the Margin
3. Possibility of Product Substitutes and New entrants
4. Many Variables and hence higher vulnerability
Conclusion - Business Quality is far more important than numbers - once you operate ab
Q31. Having a Moat is easy - but is also temporary - What makes a Moat enduring?
Ans. THE RIGHT ARCHITECTURE - IF A BUSINESS HAS THE RIGHT ARCHITECTURE, IT WILL KEEP REIN
Nothing can be enduring - if you donot keep investing in protecting your turf - whether Brands, In
The themes that emerge from the acquisition examples in technology are:
a) Multiple suitors with access to large cash.
b) Time taken in creating intangibles is very high.
c) Competitive risk arising for the acquirer in the absence of acquisition.
d) Network effect leading to no alternative to grow in a segment.
upon a method which is more predictable and aims at indentifying 2x and above in a span of 3 to 5 years.
tock Price?
r the same
list". There is one Rohit Chauhans Checklist also - far more detailed with many excels
od of time:
est businesses are the A+ category
ces - (Mayur, Atul CERA)
y (Kaveri / Shriram Transport Finance) -
visibility of CAGR growth for 5 to 10 yrs (Astral / Amara raja) - Category A
probability of disproportionate growth (PI / Poly / MCX) - Category A+
Stable PE
Range
15 - 20
iness - future end game isn't that exciting 20 - 25
portionate future can be visualized 25 - 30
quite certain - some evidence of the end game 30 - 35
hing 8%p.a. risk free / equities fetching 15% p.a. So discounting rate is your opportunity cost of
d from assets with similar risk profile as your prospective investment. So for equities say 12% / 15%
r RoIC, if it has higher operating profit margin or higher capital turnover or both.
ic Profit Added?
nomic Profit.
Rupee Terms.
l destroys value. The more you invest - the more you destroy.
mean missed opportuntiies - as absolute gains are less.
that the company will be able to deliver great RoIC on increased capital investment.
company is earning on incremental capital
ed. Tells you how much extra returns did the company earned for additional rupee invested.
AGR -to even put the impact of immediate Capex
pital to set of stocks identified. Where does the valuation come into play?
100%
duals risk appetite
with high growth has actually worked to our advantage. Also, since
ntage of massive fall in the portfolio stocks - always have 20% cash set aside for such scenario
ubling in 2-3 years 5 years Only when it can't double from here
wards of 50% in <1 yr max 1 year closely review post target/holding period
missing out on unexpected bonanzas -
ow do I allocate capital in such case?
eights (w) x Valuation Rating (VR)
her weights to Conviction (6) and lower to Valuation (4) - Quality over cheapness.
nd 8 on VR.
traordinary and seemingly richly valued businesses - KNOWING THESE CAN BE UP FOR SALE
would be to acquire it.
e termed as Intangibles?
ne which can deploy the most amount of incremental capital at high rates
eed to focus on Companies having
etwork, patents, etc
t higher rates. ROIC (-) CoC
higher ROCE's - if the moat will disappear in a few years - business is in trouble. Brand, Patents etc
sity, Entry barriers
ate on Architecture
m together - is a reality.
architecture), customers and suppliers (external architecture) and networks ( relationship among
opportunistic behaviour.
ECTURE, IT WILL KEEP REINVESTING IN AND NURTURING TALENT AND TEAMS AND KNOWHOW.
ur turf - whether Brands, Intellectual Property and People.
Chain of Intangibles - which will help us evaluate the kind and durability of the Moat.
hrough improving efficiency by 10%. Then comes a company which improves it by 50%.
e cannot put a value to it.
ompanies happen primarily for intangibles and not based on ratios / numbers.
osoft, Google, FB all three were interested in WhatsApp and that drove the price significantly up.
B and others. Here too there was a bidding war between FB and Google.
nce in Mobile was only due to Nokia because most other OEMs of Windows Phone had given up on it.
Google. Here too there was a bidding war with a lot of other suitors like Yahoo and AOL interested.
titors (30% combined). This difference of 35% actually resulted in a very large ad revenues in favor of Google.
ip among
of Google.
20% 15%
Yrs Start Cap Rate Capital Yrs Start Cap Rate Capital
1 Nature of business
(commodity, commodity processors, high-tech, cost plus, price setters, monopoly/ oligopoly, fiercely
4 Cyclicality
(Sales and earnings growth cycles over 5 to 10 year periods)
1 Opportunity Size
There could be 2 co's each leading their niches - but size of niche may be very different - Astral
2 Ability to Scale up
a Industry Growth - (Curr Size, annual growth rates, projected CAGR)
b Company Growth - (Organic, Inorganic, Sales growth, earnings growth)
c Ability to Fund growth - (Existing D/E, Industry median D/E, previous track record, industry con
d Barrier to Entry - (From competence to manage growth, regulatory approvals, govt approvals,
economies of scale, nearest competition)
e 1 year Earnings Estimate - (TTM EPS, Half year EPS, Prev Yr YoY Growth, YoY Growth Estimate
5 Disclosure Norms
(Annual reports, prompt announcement on developments, auditors qualifications)
6 Follow-Through
(Walking the talk, 5 year track plans and execution record, deliver on commitments)
10 Regulatory / Compliance
(SEBI strictures, penalty, fines, IT Raids, BSE NSE bans)
, monopoly/ oligopoly, fiercely competitive)
uditors qualifications)
eliver on commitments)
Management Quality
Fundammentals
1 Kind of Growth - Fast / Medium / Slow?
2 Whether Growth is achieved through excessive debt / equity dilution
3 ROE / ROCE /
4 Chances of sudden change in the business fundamentals for better or worse? Is the company at
5 Is the company at it's peak of earnings - and going forward the earnings are likely to slow down
6 Div Payout - Increasing div with increasing profits?
7 Free cash generation / cashflows over past few years?
Valuations
1 Current Valuation I am paying for this business
2 Is there a flawed mkt perception which is giving a chance to participate in company's growth rat
3 What is the current mkt phase - bull / bear / sideways mkt
4 One should look at Enterprise Value instead of pure mkt cap
mart pace over the next 3 to 5 years?
e sufficiently high returns to justify the efforts of the capx?
h the prospect of the business?
e passed on to the customers?
water waste management, cloud computing etc) / Steady growth sector (FMCG, Consumers) /
xcessive risks / aggressive debt? Bets taken by them in past have failed / paid off.
n small cap cos' is great sign that profits are real.
convert them and at what price? Whether they sell holdings at opportune times in mkt?
r vice-a-versa
room to grow beyond a size. Small Nimble player with some advantage can do good.
why / what is separating it from others?
panies growing Profits without increase in Sales.
Innovation Describe
- Leader Vs Follower
- Doing Things differently
- Replicability / Catchup distance
Branding Describe
- Price Premium Vs Peers
- Branding spen - % of sales
- Time since leadership position
- Media Recognition
Ratings
Ratings
Ratings
Ratings