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Equity Valuation Techniques
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vijayM
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Quote vijayM Replybullet Posted: 25/Jan/2009 at 6:01pm

Dear Basantji, & Teddies

In one of the books on WB I found following methods of equity analyisis:

method1: Rate of return analysis:

parameters required:

a)ttmeps
b)ttmpe
c)10y avg growth rate (historic)
d)10y avg pe ratio
e)present price

step1:10 Y forward projected eps = ttmeps*(1+gr rate)**10

step2:10y forward price=10y avg pe * 10y forward eps
 
step3: Rate of return(ROR) is calculated by solving
              present price * (1+ ROR)**10 = 10 y fwd price
 
step4: if ROR > 15%, buy or hold the stock else sell.
 
Ex:1 : L&T
1)10y  fwd price = 40*(1+0.17)**10=192
2)10y fwd price = 25*192=4806 ....based on avg pe of 25
3)ROR=22.5% ....based on cmp of 640
conclusion: ROR>15%:BUY/HOLD
 
EX:2 : HDFC Bank
1)10y  fwd price = 510*(1+0.3)**10=703
2)10y fwd price = 30*703=21000  ....based on avg pe of 30
3)ROR=37.2% ....based on cmp of 872
conclusion: ROR>15% & >30%:Strong BUY/HOLD
 
Method 2:
analysis based on comparison with bond yield
 
required parameters:
a)bond yield
b)ttmeps & ttmpe
c)10 y avg historic growth rate
 
procedur: calculate earnings yield = 1/ pe for current year and a few projected years. If earnings yield crosses bond yield in 3 years, buy the stock else it is overvalued.
 
ex1: L&T
parameters: ttmeps=40,cmp=640, bond yield(current)=6%
earnings yield:
present:40/640 = 6.25%
1 y fwd:40*1.17/640=7.3%
2y fwd:40*1.17**2/640=8.5%
3y fwd:40*1.17**3/640=10%
Conclusion: buy/hold since yield>bond yield now itself and reaching 10% in 3 years
 
ex1: HDFC BK
parameters: ttmeps=51,cmp=872, bond yield(current)=6%
earnings yield:
present:51/872 = 5.84%
1 y fwd:51*1.3/872=7.6%
2y fwd:51*1.3**2/872=9.88%
3y fwd:51*1.3**3/872=12.8%
Conclusion: strong buy/ hold since yield though less than bond yield now, it is growing fast &  reaching 12.8% in 3 years
Conclusion: buy/hold since yield>bond yield now itself
 
 
comments/suggestions on above methods welcome.
 
regards
vijayM
 


Edited by vijayM - 25/Jan/2009 at 6:04pm
If a business does well, the stock eventually follows:Warren Buffett
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Quote basant Replybullet Posted: 25/Jan/2009 at 6:06pm
I would think that these are different methods t one goal. Now if you run that 30% for 10 years it means that LT and HDFC Bank would be US$ 100 billion companies in 10 years and that does seem veryu challenging.
 
It is better to take a 2-3 year view and proceed along.
 
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Quote vijayM Replybullet Posted: 25/Jan/2009 at 6:16pm
Basant ji
 
did you see the graham's equation:
 
value= ttmeps*(8.5+2* GRowth rate)*4.4/bond yield
 
what is your view on that?
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Quote vijayM Replybullet Posted: 25/Jan/2009 at 6:17pm
Originally posted by basant

I would think that these are different methods t one goal. Now if you run that 30% for 10 years it means that LT and HDFC Bank would be US$ 100 billion companies in 10 years and that does seem veryu challenging.
 
It is better to take a 2-3 year view and proceed along.
 
There is a difference in growth rates. L&T 17% and HDFCBK 30%
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Quote 9StockPortfolio Replybullet Posted: 25/Jan/2009 at 8:21pm
Originally posted by vijayM

Basant ji
 
did you see the graham's equation:
 
value= ttmeps*(8.5+2* GRowth rate)*4.4/bond yield
 
what is your view on that?

Vijay
4.4/Risk Free Rate was added later when Bond rates were changed.
Always remember "Past performance is not an indicator for future."

I learned few things on this and i am following it. Try using Free cash flow.
Set a process for identifying future cash flows and based on that try to calculate intrinsic value of a company.

I will suggest that stop reading books on WB, and read what is written by WB in his letters to shareholders.

While writing about Calculation of Intrinsic value in the Owners manual Buffet says...

Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.
The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at the same set of facts, moreover — and this would apply even to Charlie and me — will almost inevitably come up with at least slightly different intrinsic value figures. That is one reason we never give you our estimates of intrinsic value. What our annual reports do supply, though, are the facts that we ourselves use to calculate this value.

Read owners manual on http://www.berkshirehathaway.com/

My experience is that i get good figure of any company by this method he has mentioned. and if one follows this method can get good picks at attractive prices. for me rest of the words like Fwd PE, Multiple of X  are greek. I never look at them.


Regards
9StockPortfolio



Edited by basant - 03/Sep/2009 at 5:00pm
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Quote 9StockPortfolio Replybullet Posted: 25/Jan/2009 at 8:31pm
Originally posted by vijayM

Originally posted by basant

I would think that these are different methods t one goal. Now if you run that 30% for 10 years it means that LT and HDFC Bank would be US$ 100 billion companies in 10 years and that does seem veryu challenging.
 
It is better to take a 2-3 year view and proceed along.
 
There is a difference in growth rates. L&T 17% and HDFCBK 30%

My experience says in current days following assumptions will give you fantastic results.

1) Owners Earnings growth rate of 8.5% for first 7 years, then 3% next 3 years. (Free Cashflow/PAT/ Net profit)
2) Growth in Depreciation 10% every year.
3) Growth in Capital expenditure 10%
4) Discount all the future cash flows with internal rate of return 13%

I use 7 + 3 years time frame. that means My company will grow at 8.5% annually for 7 years. then next 3 years it will grow at 3% after 10th year it will stop growing forever. what will be value at 11th year.

At the end whatever you get a today intrinsic value of a company that will produce so & so cash for next 10 years.

Then I apply 50% margin of safety to that Value and i get my Buy price. On or below that price i buy.

Read Margin of safety by seth klarman. Buffet always writes about Margin of safety in his letters.

All figures in % above are my comfort level figures


Edited by 9StockPortfolio - 25/Jan/2009 at 8:32pm
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Quote 9StockPortfolio Replybullet Posted: 25/Jan/2009 at 8:37pm
So according to my calculation i get following values for L&T
1) Discounted cash flow for next 10 years
2) Terminal value of the company at 11th year. after that company will never grow.

Intrinsic value= 1) + 2) / Shares outstanding = Rs. 842

Buy Price= Intrinsic value / 50% margin of safety = Rs. 421

I will wait for L&T to come at or below of 421.. otherwise i will not buy no matter how dynamic & high growth company is and how much big it's expansion plans are.

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Quote vijayM Replybullet Posted: 25/Jan/2009 at 11:01pm
Originally posted by 9StockPortfolio

So according to my calculation i get following values for L&T
1) Discounted cash flow for next 10 years
2) Terminal value of the company at 11th year. after that company will never grow.

Intrinsic value= 1) + 2) / Shares outstanding = Rs. 842

Buy Price= Intrinsic value / 50% margin of safety = Rs. 421

I will wait for L&T to come at or below of 421.. otherwise i will not buy no matter how dynamic & high growth company is and how much big it's expansion plans are.

regards
9StockPortfolio
 



 
Basant ji,
 
I am confused with above analysis. Do you agree with this or do you agree with my analysis of L&T and HDFC bank I have given in this thread?
Please solve this confusion.
 
regards
vijayM


Edited by vijayM - 25/Jan/2009 at 11:03pm
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