Peepal Capital

Price is what you pay. Value is what you get. - Profound or cliché? Treatise after treatise has been written on valuations. Some swear by value investing and some renounce it saying it does not work in India. My personal belief does require me to pay credence to how much I am willing to pay up when I buy a security. In this note I try to capture with a few examples on how to go about calculating in a quick way the intrinsic value of a share. But first a disclaimer. Whatever will follow is just the beginning steps to building a model of your own. Models are for guidance and not prediction. If all models could predict with accuracy all of us would have our own Medallion funds. What is Price? Have you ever asked yourself this question? Think about it. Try to break your answer into deeper layers say like in the movie inception. Something like this: I want to buy Nestle India's stock. It is priced at 17,000 rupees Does 1 share give me a portion of the net profit to...

One of the key drivers of value accretion is ROIC. Value is only created when a firm generates cash flows at rates of return which is greater than its cost of capital. Else value is destroyed. A derivative of this principle is that any firm activity which does not increase cash flows (at rates greater than the cost of capital) does not increase value. Value is more sensitive to ROICs than growth rates. Different industries have different dynamics of ROIC. If ROIC is negative and the company grows its top line that actually results in value destruction. McKinsey did a study of 5000 companies from 1963 to 2007 of ROICs of various industries. I being an average investor would strictly avoid some of the industries. I have luckily done so. Diagrams: Courtesy McKinsey