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@VenkateshJayar2 1

APPROACH TO
STOCK
VALUATION
@VenkateshJayar2

@VenkateshJayar2
Disclaimer
2
• Any examples, sectors, stocks and cases discussed in this presentation are only for educational
purpose.
@VenkateshJayar2

• These are not BUY or SELL recommendations.


• Readers must do their own research and run their calculations before investing.
• I have made best efforts to ensure accuracy of contents in this presentation. However, errors
could creep in beyond my best effort. Kindly bring to my notice and the same shall be rectified.
• I shall in no way be responsible to any one (directly or indirectly) for any kind of loss that might
arise from using or sharing the information in this presentation.
@VenkateshJayar2
• The contents discussed are for a high level understanding with a few pointers for your thoughts
and not a (1) exhaustive nor (2) a ‘ready-to-implement’ nor (3) my complete investment
philosophy.
• This presentation is ONLY to show the thought process and questions to consider before valuing a
stock.
Background of this Presentation
3
I had read 50-60 different books on investing. The knowledge was in silos and could not
connect them well to create a meaning process or framework or a investment philosophy.
@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.

Some contents in this presentation


are picked from speeches of Mr.
@VenkateshJayar2
Raamdeo Agrawal. These are super
imposed by my thoughts/approach
and reference materials.
Background of this Presentation (Contd.)
4
“People know the price of everything, but not its Value” – Thunders Mr.
Raamdeo Agrawal in one of his speeches.
@VenkateshJayar2

• 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
@VenkateshJayar2
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
@VenkateshJayar2

STEP 3 – LENGTH OF GROWTH PERIOD


• How long can the growth estimated in Step – 2 sustain?

STEP 2 - GROWTH
• Opportunity Size
STEP 6 - ??? • Size of Business within the opportunity

LAST STEP 6, SHALL BE STEP 1 – QUALITY


DISCUSSED TOWARDS THE
@VenkateshJayar2
• Quality of Business
END AFTER SETTING THE TONE • Quality of Management
FOR REMAINING STEPS !
@VenkateshJayar2

QUALITY
ANALYSIS OF A There are Two Facets of Quality
• Quality of Business

STOCK • Quality of Management


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Quality of Business
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Analyzing the Quality of Business
Are there Good and Bad Business? If YES, What constitutes a Good Business?
A Good Business:
• Generates huge amount of cash every year
@VenkateshJayar2

• Generates lot of money by deploying less money


• Has low or no CAPEX requirements
• The business must have huge entry barriers to new players
READ THE TWO RESOURCES BY WARREN BUFFETT AND RAAMDEO AGRAWAL TO UNDERSTAND MORE ABOUT
QUALITY OF BUSINESS

Read the interview by Raamdeo Agrawal


on Great, Good and Gruesome @VenkateshJayar2
companies in Indian context. Warren Buffett classifies business as
Great, Good and Gruesome with
details in 2007 Berkshire Annual
Report (Page 6 and 7). Read it for
more information about Quality of
Business
Quality of Management
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Analyzing the Quality of Management
Before discussing this further, let us quickly see a few real life examples….
• Chit fund a common mode of investment. Imagine if you were to invest in Chit funds. Would you
entrust your money with a person with shoddy credentials? Would you not ensure that your
@VenkateshJayar2

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?

It is no different, when it comes to the management of a company? @VenkateshJayar2


• The quality of management determines the future growth of the company and
• Safety and growth of your invested money.

Now comes the next question…

IS IT POSSIBLE TO MEASURE THE QUALITY OF MANAGEMENT?


Qualities of a Good Management
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Analyzing the Quality of Management (Contd.)
There are some qualities and attributes of a Good Management. What are they? (1) Competent (2)
Honest (3) Passionate
@VenkateshJayar2
of a Good Management

Minimum skill set required to do the To better explain, assume a


task in hand situation of you having a driver for
your car. Let us see how these 3
qualities stack up in this example.
Achieving the task goals with integrity
@VenkateshJayar2
Qualities

Enthusiasm in doing the task


Traits of a Good Management (Contd.)
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• Driver must be competent enough to drive in all conditions i.e. City traffic, high-way,
day/night, rainy weather etc. and take you safely to the required destination.
• If your driver sleeps on wheels, then you will loose your sleep! You need to keep a eye on
@VenkateshJayar2

the driver for the entire journey.

• You give the driver a 2000 for filling fuel.


• He fills fuel for 1800 and pockets the rest.
• Would you compromise and have that driver? You will not have that driver for even a
minute after this.!

@VenkateshJayar2
• 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
@VenkateshJayar2

@VenkateshJayar2
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
@VenkateshJayar2

down, economy boom, increasing competition, regulations etc.

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
@VenkateshJayar2
company grow. Learns from failures, see challenges as opportunity and comes out
big after every down turn. Shareholder’s wealth creation is accorded priority.

How can I measure or get all these details?


What to look for to gage the Managements
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The aspect of evaluating the management is not straight forward and cannot be easily
gaged with any metric like the conventional financial ratios. A few pointers below will help:
• Observe the tone of the management during Con-call/Investor presentations and AGM.
@VenkateshJayar2

• Pointers from Annual reports:


o How did they explain lesser revenue/Profits – Did they blame economy or took ownership
o Reading prior 5-7 years annual report will give a idea of what promises/plans were made earlier and
if it was achieved later
o Payment packages/Share holding pattern of key management personnel
o Transparency of their disclosures
o Details of Related Party Transactions
• At times of crisis, how do they react? – Management can be best judged at
@VenkateshJayar2
times of crisis
o Are they candid in communication of what went wrong?
o How they device a action plan and turn around the situation?

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

• THIS IS THE BIGGEST, TIME CONSUMING ANALYSIS THAT A INVESTOR MUST


DO METICULOUSLY
@VenkateshJayar2

• COMPLETING THIS ACTIVITY PROPERLY IS LIKE NEARLY HALF JOB DONE


• IF THE QUALITY OF BUSINESS / MANAGEMENT IS NOT GOOD, FURTHER
ANALYSIS NOT REQUIRED
• WHAT IS THE USE OF FOCUSSING ON ANY BUSINESS THAT DOES NOT HAVE A
EXCITING BUSINESS PROSPECTS RUN BY A GOOD MANAGEMENT?
@VenkateshJayar2

MANY COMPANIES FAIL AT THIS STAGE


@VenkateshJayar2

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:

• The overall Size of the opportunity.


@VenkateshJayar2

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?
@VenkateshJayar2

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?
@VenkateshJayar2

@VenkateshJayar2
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
@VenkateshJayar2

UNDERSTOOD THE INDUSTRY DYNAMICS/RISK BEFORE INVESTING IN THESE


COMPANIES?
• THIS STAGE OF ANALYSIS HELPS NOT ONLY TO SEE HOW LONG RUN-WAY OF GROWTH
DOES THIS COMPANY HAS… BUT ALSO TO REFLECT ON OURSELF TO SEE, IF WE
UNDERSTAND THE INDUSTRY AND COMPANY WELL.
• IF WE CANNOT SATISFACTORILY PERFORM THIS ANALYSIS, REST THE IDEA FOR
@VenkateshJayar2
SOMETIME, TILL YOU GET TO UNDERSTAND THE INDUSTRY. TALK TO PEOPLE IN THE
INDUSTRY AND LEARN MORE.

MANY INVESTORS FAIL AT THIS STAGE, DUE TO LACK OF UNDERSTANDING OF THE INDUSTRY
@VenkateshJayar2

LENGTH OF GROWTH PERIOD 19


Length of Growth Period
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In the Compound Interest formula the time period (n = number of years) is the most powerful
parameter than Return (R). While Return (%) is unpredictable and not fully in investor’s hands,
But the time period of association with the investment is purely in investor’s hand.
@VenkateshJayar2

• How long is the growth estimated in the previous step sustainable?


o A long term investor should hope for 15-20 years
o But there are very few such opportunities
o 3 years or 5 years or 10 years?
• Do some basic calculations: @VenkateshJayar2
o Longer the duration of growth, better the returns due to Compounding
o 20% for 10 years would be better than 40% for 3-4 years (One is 6 times and other is 2.5
times)
@VenkateshJayar2

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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:
@VenkateshJayar2

• Expected future growth rate


• Longevity of this expected growth

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
@VenkateshJayar2
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
@VenkateshJayar2

Monopoly Duopoly Oligopoly * Are there possibilities of new


• One player in the Industry • Two players in the Industry • Many players players entering the industry?
• Pricing power • Pricing power – The leader raise • Cut throat competition
the price the other follows • During bad times, highly leveraged@VenkateshJayar2
How easy it is for a new player
companies get hit to enter the industry?

* 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?
@VenkateshJayar2

• Internet/online is the Mother of all disruptions.


• Ask some basic questions
o Is there a online way to paint a house? No… A Paint industry has many years of runway
o Is there a online way to consume liquor? No… A Brewery industry has many years of runway
o Is there any substitution or threat coming in future to shoes/sandal that we have to wear?
No…Footwear has many years of runway
o Is there a way that a Automobile engine manufacturing company have a substitute?
@VenkateshJayar2
Yes…Possible with the growth of Electric Vehicle (EV).
• Yes does not mean, that the company must be skipped without investing. But a indicator
to probe more on how long can the estimated growth sustain before being disrupted.

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
25
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
@VenkateshJayar2

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.
@VenkateshJayar2
• 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.
@VenkateshJayar2

VALUATION
26
Valuation
27
You Are Ready to Start Valuation, If Your Stock Has Successfully
Passed All The Previous Steps.
@VenkateshJayar2

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?
@VenkateshJayar2
• 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
28
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
@VenkateshJayar2

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.

- Discounted Cash Flow (DCF) - Price Books Multiple


- Reverse DCF - Price Sales Multiple
- Discounted Dividend Model - Price Earnings Multiple
- Discounted Asset Model - Price Cash Multiple @VenkateshJayar2
- Discounted FCF Model and many more - Dividend Yield and many more

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?

1. Add this to your investible universe of stocks and watchlist


@VenkateshJayar2

2. Monitor the price regularly to check if it comes down to your valuation


3. Particularly check at times of panic sell offs

What is the big fun in paying 100 rupees for a 100 rupee bill? Not a buy

• All three actions as above


@VenkateshJayar2

• Congratulations - You have identified a value stock.


• So what next? Place a bulk order the next day at 9 AM?
Valuation (Contd.)
30
Hold on…

• Give a cooling period (2 weeks) after this research.


• Revisit the Investment thesis created during this analysis. [More details about Investment thesis in the
coming slides]
@VenkateshJayar2

• 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?
@VenkateshJayar2
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!
@VenkateshJayar2

WHEN TO SELL STOCK 31


When to Sell a Stock
32
• The decision and point to sell a stock is much difficult to identify and execute than the
decision to Buy a stock.
• Much has been discussed on this by various Investment Gurus.
@VenkateshJayar2

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
@VenkateshJayar2
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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What else can guide


a investor to make a
@VenkateshJayar2

rationale sell
decision
@VenkateshJayar2

Let us quickly look at a Aircraft Pilot and come back to Investor!


A Pilot Takes off and Lands…
34
• Imagine how would it be, if a pilot takes off and flies a aircraft.
But does not know when, where and how to land.
• The very thought is absurd ☺
• So a Pilot does not get trained to “Land” not in the air, just
@VenkateshJayar2

before arriving at the destination…


• His training for landing is done even before he takes off
• When we started to learn driving a bike or car, were we not first
thought how to use the brakes?
• The pilot is allowed to fly only when they are confident to land safely.
• Infact it is much more…The training includes not only regular landing, but special situation
landings like: @VenkateshJayar2
o Landing in complete darkness (No Runway lights),
o Landing in Bad weather and
o Emergency landing procedures (Lighting strike, Shortage of fuel, landing in sea/ocean if needed)

Think over this and try to relate with Investing Buy and Sell Aspect
Sell Triggers in Investment Thesis
35
• 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
@VenkateshJayar2

o Structural changes in the sector/company leading to declined growth rates


• These triggers must be captured well in their investment thesis made before purchase.
• This list of triggers must also be updated regularly in light of the new facts and changing reality in the
industry or the stock.
• Should any (or multiple) of the triggers become a reality, a investor must make a judgement/call and
sell the stocks WITHOUT EMOTIONS!
• Ideally for a “Quality Business/Management”, it may take years for the triggers to become a reality (or)
@VenkateshJayar2
it may never happen at all, making it a perfect long term investment candidate.
• BUT…not all factors are in our control. The triggers could happen very soon due to change in
Technology or regulation or any thing else forcing us to make a SELL decision.
• Also note, that Price levels targets (i.e. 200% gains or 50% loss) are NOT “Sell Triggers”

So, “When to Sell…” is decided “…even before you Buy”


@VenkateshJayar2

INVESTMENT
THESIS

36
Investment Thesis
37
Completely Exhausted???

THIS IS WHAT IT TAKES TO BE A INVESTOR.


@VenkateshJayar2

This only can be called as DIY Investment. DIY investment


is not putting money based on recommendations from
WhatsApp group or Business Channels or gossips from a
party, without all these considerations.
@VenkateshJayar2

You do all the Research, Get Conviction, Make Decision and Then Invest your
Money

How to handle this information load? – ‘Investment Thesis’ is the solution


Investment Thesis (Contd.)
38
• A bit of details about Investment Thesis, that was discussed in a few earlier slides.

• 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
@VenkateshJayar2

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.
@VenkateshJayar2
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.

3. Longevity 6. Sell Trigger


Investment Thesis
@VenkateshJayar2

39
A Important Caution about this Entire Sequence !
40
Following these steps religiously during valuation help you with a fair degree of
accuracy…But that does not mean that:
@VenkateshJayar2

• 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
@VenkateshJayar2
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
@VenkateshJayar2 41

2. Growth 5. Valuation

@VenkateshJayar2
Investment Thesis
Re-Read
42

I was recently reading a article at Farnam Street, to find out how


best we can retain what we read...Re-read was one option.
@VenkateshJayar2

So when to Re-read? I came across a interesting answer.

The best time to re-read a good content is immediately after the


first reading!
@VenkateshJayar2

So, if you liked this presentation and wish to retain the contents,
please go through the slides again now.
43
Good Luck in your
reading &
@VenkateshJayar2

Investment Journey

Please visit my landing page https://www.linkedin.com/pulse/my-notes-compilation-


@VenkateshJayar2
value-investing-venkatesh-jayaraman/ for more such presentations, notes and
compilations on topics related to Personal finance and Value Investing.