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How many of you all like number crunching and How many likes story telling?
Usually bankers are number crunchers & VC's are story tellers
So what is exactly valuation?
Valuation is a bridge between numbers and story
Story leads --> Numbers leads --> Valuation
With world is changing value of young companies keeps on changing
Don’t mistake modelling for valuation (Not a spreadsheet to enter numbers)
Every valuation starts with a narrative, a story that you see unfolding for your company in future
In developing this narrative, you will be making assetmnets of
-Your company its products, management and its history
-Market that you see as growing
-Competition it fcaes
-Macro environment in which it operates
For eg: Auto business is bad business --> low margin business, have low growth, require high and inc reinvestmnets
Now here what makes Ferrari different ?
Ferrari sold only 7,255 cars in all in 2014
Had a profit margins of 18%, partly because of sky high prices and partly coz it spends very less on advertising
Ferrari sales have grown very little in tha last decadeand have been stable
Ferrair have not invested in new plants
Shell company
Oil company --> riskly business --> valuation differ
Clean energy --> tech company --> valuation differ
Tech to deliver energy at lower cost and higher output
So valuation diifers with differnet story
2nd narrative --> Will have dominant market share, by reding margins to 10%
Valutions --> 28 bn
The real world intrududes --> Be ready to modify narrative as events unfold
When you read Annual reports they are more accoutant driven stuff and you get caught in trap od accounting
Your job as an investor is looking for specific set of numbers
Like where is the capital getting reinvested, what is the cost of capital, what growth are we getting on that invested capital,
invested capital giving growth
Don’t shy away from negative cashflows if a company has --> Look where the new capital is invested
Younger companies will have faster revenue growth and should have higher re investment and lower margins. So they get n
say after 1,2 or 3 years later these companies have have the ability to create disproportionate postive cashflows for the ea
cashflows
Mature companies will have lower revenue growth and lower re investment and higher margins
But a company with higher revenue growth and lower re investmnents with growing margins --> Looks absurd
How a financial balance sheet should be made: Different from accounting balance sheet
Investments already made -Existing investments generate cashflows today
Investments yet to be made - Expected value that will be created with future investments
Debt -Borrowed money
Equity - Owner's funds
Accouting statements gets less and less useful if you are looking earlier in the life cycle
As companies age, balance sheets mean more but they also become more cluttered
Balance sheet based valuation, which is what most accounting valuation is useless in young companies. It is most useful in
without accounting clutter
Companies where accounting miscategorizes expenses, balance sheet get even more meaningless
Fair value accounting is destined for failure, because accountants cannot be imaginative or creative
- At mature stage --> defend your business from new competitors and find new markets
-On decline scale down your business as the market shrinks
Operating profits:
Large op. losses--> Op. losses narrow--> Op. profits turn positive--> Op. profits grows quickly--> Op. profits level off--> Op. p
Reinvestments:
Very high--> High--> Remains large, but scale down as percent of firm--> decrease --> scale down further --> Divestment
FCF to firm:
Negative --> Negative--> Cross over to positive territory--> Positive and growing--> Positibe and stable--> Positive and dropp
Investing :
Option investing (Go for the upside)--> Growth investing (Maximize value from growth) --> Scaling investing (Scale up grow
investing (Protect your competitive advantage) --> Maintenance investing (Preserve your value) --> Divesting
Financing:
All equity (usually pvt)--> All equity (shift to public)--> First signs of debt capacity, but benefits are small --> Debt capacity e
cautionary notes --> Benefits of borrowing significantly exceeds costs---> Pay down debt as assets are sold
Dividend:
Need cash from equity investors--> Cash needs multiply (beyong pvt mkt)--> Move towards sufficiency (cash flow meet inve
Internal cash flows exceed investment needs--> Significant excess free cash flows--> Internal cashflows decline
Biggest concerns:
Lack of capital--> Allocating limited capital across competiting investments--> Balance existing investments with new ventu
with less attractive investments --> Too much capital chasing too few investments --> Deciding which investment to pull cap
Investment Technique:
Options models, all about upside--> Maximizing IRR--> Profitability index(NPV as % of investments --> NPV as capital constr
and excess returns models --> Divesiture and Liquidation Analysis
Large losses & neg cashflows --> losses narrow but cashflows still negative--> Profits turns positive but reinvestments make
low/negative --> Cashflows turn positive as profits grows & reinvestment drops --> Cashflows continues to rise, as earnings
profits decline but divestitures add to cashflow
Tax benefits
None --> None --> Low as NOLS shelter income --> Rising as NOLS expire --> High --> Positive, but dropping
Debt capacity
Non existent --> Very low--> Low--> Rising --> High --> High but dropping
Debt
No debt -->No debt --> Low debt --> Medium debt --> High debt --> Retiring debt
Narrative drivers
How big is the narrative--> How plausibkle is the narrative--> How profitable is the narrative?--> How scalable is the narrati
happy ending?
Tell a compelling and plausible story with potential of huge profits --> Stay consistent with words and actions to story --> St
numbers to back up the story --> Keep your narrative in sync with your numbers --> Adjust your narrative to reflect where y
cycle
Pricing metrics
EV/market, cash burn ratio--> EV/user--->EV/ sales--> PEG--> PE, EV/EBIDTA ---> Price to Book, EV/Invested Cap
Using a metric that is designed for one stage in the life cycle to price companies in different stage will yield results that can
to catastrophic
-Old time value investors who use PE ratios will always find young companies to be over priced, no matter what their pricin
-Growth investors who uses revenue multiples will find mature companies look like bargains at all times
Drawing line between Tech and Non Tech companies is getting more & more difficult
Equity research analysts work into sectors silos
Now where a company like Amozon is placed can make a difference in how it is analysed
Is a retail, tech, ecom?
Pricing is often done relative to the sectors that investors decide to put a company into
Tech companies don’t have long mature periods, because disruption is alwasys around the corner. Non tech companies hav
periods where they get to milk their cashflows
Tech companies climb the growth ladder faster because their grwoth requires less investments and products are quickky ac
consumers. Non tech companies take longer tio grow, because their growth requires high reinvestments and partly becaus
is more deeply set
Tech companies also have a faster decline as their growth where as non tech companies declineover long periods and may
live on as smaller and more focussed versisons of their original shelves
The Big Picture
3 decisions maximizes the value of the business (firm)
Investment decision - Invest in assets that earn return higher than min acceptabe hurrdle rate
Financing decision - Find righ kind if debt for your firm & right mix of debt and equity to fund your operations
Dividend decision - If you can dinf investments that make your minimum acceptable rate, return the cash to owners of you
-How you choose to return cash to the owner will depend on whether they are pref div or buybacks
Price Vs Value
Drivers of intrinsic value
-Casflows from existing assets
-Growth in cashflows
-Quality of growth
Drives of price
-Market moods and momentum
-Surface stories about fundamentals
Determinants of price
Mood (behavioural factors) and Momentum
Liquidity and trading ease
Incremental information
Group Think
Twitter had 240 mn users at the time of its IPO? What price would you attcah to the company
The most imp variable in 2013 in determing market value and price in tis sector (Social media) is the no of users that comp
Looking at comparable firms , it looks like the market is paying about 100 $ per user in social media space
Enterprice value --> 240 * 100 = $24 bn
Terminal Value = EBIT (1- tax rate) (1- reinvestment rate)/ Cost of capital - Expected growth
This is a mature company equation not applicable for young growth companies
-Move towards marginal tax rate
-Are you reinvesting enough to sustain your stable growth rate?
-This is a mature company. Its cost of capiatl should reflect that
-This growth rate should be less than the nominal growth rate of the economy
-Mature companies assume consostent growth rate but lesser than the economy
-High growth companies --> high risk --> cost of cap high as compared to mature compnies
-When you reach steady state you have to reinvest perpetual
The government bond rate is not always the risk free rate
-Not all govt bonds are deafult free
-Almost half of all the sovereign defaults in the lst 30 years have been in the local currency
What currency are you using for assumong growth rate ? Ask first
-To value infosys in rupees , you need a risk free rate in rate ( this is imp when you are valueing company, when you are valu
US dollars, you cannot take indian growth or indian discount rate), ypu are should use US
-The indian rupee govt bond was yielding 7.33% on March 28,2018. The bond rating for India is Baa2, with a default spread
risk free rate of 5.38%
RFR --> bond yield - default spread
Also it is easier for country to deafault in bonds , than devalue currency coz these defaults can be recovered easily
Are you consistent with assumptions and calc --> inflationaty rates and discounts
While valuations you can forecast only thigs which are under your control, now you cannot forecast what will be the inte
this is not under your control. Be consistent with those calculations
CIO's discussion
Pricing and valuations two different things
Avoid not good business and high valuations
Vakrangee, PCJ, Gitanjali gems --> no mutual funds invested
Always invest in good business and by looking at peers
Radhakrishnan Damani --> continuosly boughht HDFC stock and became single largest owner post IPO
If I was there I would have asked him why are you buying HDFC bank 10 times the book value when other large banks are a
valuations
He replied "Dekh beta Dharavi mein rehene ka toh dharavi ka price dene ka , peter road pe rehene ka hai toh peter road ka
So with quality --> there comes price
Always go for quality
last decade retail sector was expected to outperform with lots of investment happening but later slowed down
Last 3-4 years, no one wanted to buy retail
After IPO of Dmart this has changed
Lot of businesses start with higher valuations and then come to lower Eg retail
Lot of business have been built on not tested model or copied model, they may take 10 - 15 years to come to growth
Model correcting happeing now --> which were US copied models
In new business , you either catch it faster than the market or be very skeptical and wait for maturity
Prof Ashwat
Portfolio managers play pricing game and that is difficult to win
If you miss big momentum stocks , no matter how fast you are you will lag
In S&P, 4 out of 500 stocks , in the periods were responsible for growth
If you dint had these 4 stocks you were out of the performance game
These 4 stocks --> very difficult to find the intrinsic value
Portfiolio mangers say they do value investing and when I see their portfolio stock they have momentum stocks
Investment banks --> works by deaal, pricing game, here dcf is not needed
CIO
Price today will become EPS of company later not feasible
In 2013, bought pharma, paper, fin played well
-how at twice PE bought earlier
-You should develop your own rules
-even if it has 10 -15 years sustainability
-buying cheap, half of book value
Prof Aswath
Stick to investment philosophy which is right for you, avoid which you are not comfortable with
Failure --> when you try to be someone else (Warren buffett, Peter Lynch)
We spend more time on reading but not on thinking
More time spent on google search than on thinking
Go back and reinvest yourself, you cant be doing the same thing always
Market are reminders you are not the best
People stuck with core philosophies are the winners in the long run
CIO
Which fund had 10% stake in Infosys post IPO
Ent bank mutual funds
Does not exist now
If holded that it would have been 3 bn dollars
Prof Ashwath
How many stocks should we have in our portfolio?
Certainty of valuations , price will adjust to valuations
All you need is one stock