Investment Valuation in India

Facebook's recent announcement of the USD 19 billion acquisition of WhatsApp has stirred the social network and finance fraternity. Surprisingly, many financial analysts have been justifying the valuation calling it Facebook's (more specifically, Mark Zuckerberg's) move towards achieving the objective of "connecting the world". Here's a quick peek at how the valuation plays out. WhatsApp's model WhatsApp has been a huge success in terms of user engagement and its its average 450 million active users are usually very active on the application sending millions of text messages and photos (even videos). Recently, WhatsApp also added the voice messaging system on its application. From Revenue perspective, WhatsApp is free for 1st year of service and then charges $1 per annum. However, the system can be bypassed easily and there are millions of users who have never paid despite using the application for years. This is a major snag in WhatsApp's re...

It is nearly impossible to document all ideas, issues, terms and techniques that an investment analysis professional encompasses during his or her work. Analysts often use one or more of the strategies while analysing a potential investment opportunity. Personally I believe that no literature can be complete and authoritative on this subject, though many authors, including myself, have attempted to cover as much as possible. This article only aims at stimulating and imaginative and holistic approach to dealing with investment matters and what questions one should be asking while analysing a company. What is the size of the firm (large, small)? What stage is the company and industry in (new, mature, declining)? Who are the customers of the company (individuals, industry, institutions)? Is the company project oriented (drugs, mining, oil & gas producers, construction)? How is the company socially responsible (is it a source of pollution, land contamination)...

With just 10 working days for the year 2010 to complete, here is a small analysis of the sectors that have consistently outperformed the Sensex over the last 6 years. Average Yearly Return of the Sensex over from 2005 - 2010 = 29.0% [Max return in Yr 2009 - 77.3%] Sectors that have outperformed the Sensex in terms of Average Yearly Returns: Realty ........................ 98.6%  [Max return in Yr 2006 - 469.0%] (Realty Index introduced in 2006) Consumer Goods ..... 51.5%  [Max return in Yr 2007 - 114.8%] Metals ........................ 50.9%  [Max return in Yr 2009 - 220.4%] Consumer Durables .49.1%  [Max return in Yr 2005 - 110.6%] Auto ........................... 42.7%  [Max return in Yr 2009 - 200.5%] Power ........................ 35.8%  [Max return in Yr 2007 - 125.0%] Oil & Gas ................... 35.0%  [Max return in Yr 2007 - 112.8%] Banks ......................... 32.5%  [Max return in Yr 2009 - 81.0%] On a ...

Gordon Model (Constant Growth rate) The Gordon model assumes a constant growth rate for infinity. The value of the stock is given by: V = D1 / (Re - g) Where, D1 = Expected dividend at the end of the year Re = Required rate of return on equity g = Expected growth rate for a long period of time (mathematically, infinite period) For example, A Ltd. Reported earnings per share (EPS) of Rs 15 last year and paid out 52% of its earnings as dividend. The earnings and dividends are expected to grow at the rate of 8% in the long term as in the past. If the required rate of return on equity shares of A Ltd. is 12%, the value of the security is calculated as follows; EPS = Rs 15 The Current dividend per share is given by the payout ratio times the EPS. Dividend per share (D0) = 15 x 0.52 = Rs. 7.8 So the expected dividend would be given by multiplying the current dividend with the expected growth rate. Dividend per share (D1) = 7.8 x 1.08 = Rs. 8.42 Expected growth rate = 8% Required rate of retu...

The term dividend refers to that part of after-tax profit which is distributed to the owners (shareholders) of the company. The undistributed part of the profit is known as Retained earnings. Higher the dividend payout, lower will be retained earnings. The dividend policy of a company refers to the views and policies of the management with respect of distribution of dividends. The dividend policy of a company should aim at shareholder-wealth maximization. The essence of dividend policy is: If the company is confident of generating more than market returns then only it should retain higher profits and pay less as dividends (or pay no dividends at all), as the shareholders can expect higher share prices based on higher RoI of the company. However, if the company is not confident of generating more than market returns, it should pay out more dividends (or 100% dividends). This is done for two reasons. One, the shareholders prefer early receipt of cash (liquidity preference theory) and sec...

Sales are the lifeblood of any company, and getting a reasonable estimate of sales revenue scale and growth is highly critical in any ensuring business planning exercise, such as capital investment decisions, hiring of staff, expansion of business operations and allocation of operating budgets, etc. Hence, forecasting demand for a company’s products and services, and the resulting revenues accrued is probably the most critical step a financial analyst needs to undertake when building a financial model. In order to arrive at a realistic and reasonable revenue forecast for a business, a good financial analyst should conduct a detailed revenue modeling / demand analysis of a company’s products and services, by examining its usage potential and a customer’s willingness and ability to pay. A demand analysis would entail determining current demand and using assumptions for demand build up to predict future demand over the time period of the financial model. There are a number of qualitative ...

When most investors think about the fundamental value of a company, they usually think of the price to earnings ratio. The P/E ratio tells you how much you are paying for each rupee of a company's earnings (profit). It is popular because it's easy to understand, but in some situations it can be misleading and is not a substitute for real fundamental research. Still, it is a useful tool for valuing an individual stock and can also be used to help you form an opinion on the likely future direction of the stock market as a whole. Understanding the Price to Earnings Ratio The P/E ratio is simply a mathematical calculation. It is the current price of one share of stock divided by earnings per share. The first thing to understand about the P/E ratio is that it is designed to value a share of stock, not a company, and stocks are priced per share. The P/E ratio tells you what the market is willing to pay right now for anticipated future earnings, assuming that the earnings remain const...

SEBI has made rules for valuation of securities by Mutual Funds. Lets look at the valuation Equity Securities for now. Mutual funds shall categorise the securities according to the following norms 1. TRADED SECURITIES : When a security (other than Government Securities) is not traded on any stock exchange on a particular valuation day, the value at which it was traded on the selected stock exchange or any other stock exchange, as the case may be, on the earliest previous day may be used provided such date is not more than thirty days prior to valuation date. 2. THINLY TRADED SECURITIES : (i) Thinly Traded Equity/Equity Related Securities : When trading in an equity/equity related security (such as convertible debentures, equity warrants, etc.) in a month is less than Rs. 5 lacs or the total volume is less than 50,000 shares, it shall be considered as a thinly traded security and valued accordingly. Where a stock exchange identifies the "thinly traded" securities by applyi...

A good financial modeler has the discipline of adhering to a list of guiding principles to help ensure that the development of the financial model achieves the desired results. By following these simple steps, a financial modeler should be able to build a financial model that is simple, accurate and most importantly consistent, to help build confidence in a financial decision making process. Financial Modeling Discipline can be acquired in all 3 stages of the financial modeling process: Specification Stage Design Stage Build Stage Specification Stage Be very clear on the effort involved and the dependencies before committing to deadlines - the financial modeling exercise is usually on the critical path! Get the algebra right — make sure all revenues, cash flow inwards and assets are positive while expenses, cash outflows and liabilities are negative. This will ensure that we rarely use the minus sign in formulae and can use the sum() function. Avoid all calculations that will cause cir...

A good financial modeler should also be aware that besides the most commonly used Discounted Cash Flow (DCF) approach and Market Multiples approach, there are a number of alternative financial valuation techniques that can be used to provide different viewpoints in a financial modeling and valuation exercise. Alternative valuation techniques, when used in combination with the DCF or Market Multiples approach, allow investors or business owners form a holistic view through multiple perspectives on the value of the business under consideration. Alternative valuation concepts include Asset Replacement Cost and Control Premium. Asset Replacement Cost Assessing the adjusted cost of replacing the useful assets of a business is a useful way of valuing capital intensive businesses such as those in the infrastructure and industrial related sectors. Control Premium The term “Control Premium” refers the the extra that typically must be paid to gain operating control of the business. An acquirer w...

Security Analysis Security analysis is about valuing the assets, debt, warrants, and equity of companies from the perspective of outside investors using publicly available information. The security analyst must have a thorough understanding of financial statements, which are an important source of this information. As such, the ability to value equity securities requires cross-disciplinary knowledge in both finance and financial accounting. While there is much overlap between the analytical tools used in security analysis and those used in corporate finance,security analysis tends to take the perspective of potential investors, whereas corporate finance tends to takean inside perspective such as that of a corporate financial manager. Equity Value and Enterprise Value The equity value of a firm is simply its market capitalization; that is, the market price per share multiplied by the number of outstanding shares. The enterprise value, also referred to as the firm value, is the equity va...