Valuation

 Valuation is the Buzz word for all finance guys in the financial market. But what is valuation. Valuation basically means what a company is worth now and likely to be in future.

While what a company is worth now can be obtained from its assets and liabilities in the balance sheet as well as how it has done in the past, valuing a company in the future is at best a shot in the dark. Why do I say that? Because nobody can predict the future. Future is so uncertain and has political, policy, regulatory, business impact, alternate business impact, competition and so many other variables to correctly predict the future.

When it is difficult to predict what is going to happen in the next minute (if it can be predicted, there will be zero accidents or disastrous events), how can one look at a crystal ball of the future many years hence.

Another non physical factor in a Valuation is a bias like if your job is to do a valuation for a client, you will try to match the figures of valuation that looks nice to the client, irrespective of what your model says. eg. If your model growth of sales is 5% and you value the company at $50 and client's expectation is $100, you tend to bump up the sales growth to 15% or 20%. This bias is evaluator bias as he wants to finish this deal with the client and earn a fat bonus for himself. How else does one explain a Paytm valued at 2000 Rs and crashes to 400 Rs or many such IPO companies.

Valuation also depends on the bias you carry because of the environment you live in. Eg ITC was poorly valued a few years back and even if somebody had valued  at that time, he would have valued at 150 Rs or 200 Rs. Now with the prices touching 600 Rs, if the same evaluator does the valuation he will do around Rs 550-600. This bias of going towards the market price valuation happens because you do not want to be proved wrong. If it goes down, you can always say, Everybody said so. You do not want to put your head out like the guy Michael Burry - on whom the movie The Big Short was made. He bet against the market in 2008, as his data showed him it was going to crash. Very few in the world can take such a contrarian call.

So, how do we value a company. My personal belief is the PE ratio should be reasonable (<20 or what is the average in the industry and much less than that. Eg Tech PEs are 60-80. I prefer valuing them at 30-40- even a 50% drop is bearable. Why do I do that? Tech is a very unpredictable beast. Anything can happen with in matter of days or months. Nokia is one eg, Netscape is another, Lotus 123 the pre excel pioneer, EVs of today and possibly AIs of the future. AIs can technically replace CAs, Lawyers, MBAs or knowledge based industry. MIT courses, for eg are available for free on You tube and so many other DIY courses for which once upon a time you paid huge amounts to learn.

I follow the following 5 pointed star valuation

a) PE at a reasonable rate (<20)

b) Sales Growth - 3-5 years - growing at 15-20% per year (Rolling returns)

c) Ebitda - 3-5 years - growing at 15-20% per year

d) ROCE- 3-5 years growing at 15% per year

e) ROI -3-5 years growing at 15% per year

If all the boxed at b) to e) get ticked and PE is <20, I multiply the EPS * PE to get the value of the company.

I do not say, I will be right all the time, but hopefully most of the time as stock prices are a function of many factors- momentum, shorting, margin calls, valuation bias and a lot more.

Solar - Aditya

With the PM's first task after Sri Ram temple inauguration was the launch of Suryodaya Scheme or every house with rooftop solar, the question that quickly comes is what happens to the distributors and generators of electricity  companies.

The way electricity works so far is that Power companies generate power using a variety of methods/fuels- Coal, gas, diesel, solar, wind etc. These sell to Power Transmission companies which in turn sells to the final consumer. Many of the Power Transmission companies are in serious financial situation either because govt. is asking them to give free up to a limit and more than that the illegal drawal of electricity by many.

With smart meters and net monitoring, while the meter manipulation is reduced, the issue is still of illegal drawdown of electricity during transmission. If only Tesla had popularised the wireless electricity, this issue would not have come as like internet everyone has to prepay or get a postpaid connection to tap the electricity. No need for cables and wires and a huge savings due to that. But fortunately for Power Transmission companies Tesla's wireless electricity remained in books only.

Now the next issue to hit the power transmission and power generating companies is the rooftop solar. There are two types of rooftop solar - One is called Off grid and one is called On grid. Off grid is expensive and difficult to maintain. It calls for a series of costly batteries to be kept for storage and will have to be changed after a few years. The other one On grid is with the help of a switch/meter the power generated is delivered to the power company. A separate standard connection is given for the electricity consumption. End of each month, the solar electricity generated vs the electricity consumed is netted and payment is made to electricity company if consumed more than generated. The other way around is credited to your account and not paid.

The issue comes if a large number of people opt for the solar electricity that the demand side from suppliers gets reduced.  The transmission company has now to pay for the electricity generated by these numerous solar roof tops. Thus to make these transmission companies profitable, they may introduce a minimum drawdown payment i.e. even if you travel and lock your house, while the solar is generating, you are not consuming. To offset this Transmission Companies may seek a minimum drawdown payment which is assumed to be consumed even if not consumed. i.e if you say that you want a minimum drawdown of 100 units at time of connection, and you use 20 units of electricity, you will be assumed to have consumed 100 units of electricity.  This mechanism is essential as electricity generated cannot be stored and has to be consumed on production.

As the electricity cannot be stored, one more issue that arises is the skewed production. During day, Solar will generate electricity, while at night it won't. Power generating companies have to work full load in the night to provide power.

These are the issues that need to be discussed by experts  in making the Suryodaya project a success.

 

EGO vs SANITY

It is often noted, ad nauseum, that once people taste a wee bit of success, they start to feel that they are demigods and anything they touch will turn into Gold.

Success often does not come in leaps and bounds, but through steady work. Yes, sometime luck turns the table, but do not think those as Midas touch.

Take the example of Anil Ambani, one of the richest businessman at that time. After the split between brothers and got lot of money and modern era business - like ICE- Infrastructure, Communication and Entertainment. He went on to establish Ultra Mega Power Station, he went on to buy internet cable companies and set up a huge infra for mobile and internet and of course the Bollywood area thanks to his actress wife- the entertainment business. All these businesses required huge amount of CASH and TIME for it to fructify. He was on steroids, borrowing left, right center to finish his projects. End of the day, he ended up in such a huge pile of debt, that he has not been able to come out till today. His brother helped to buy for a pittance, the communication part of the business and renamed it Jio.

His elder brother has refinery, which is a cash cow and generates cash, which he can slowly deploy into communication and wait it out. No need to go in for large borrowings or Ego issues to grow big quickly.

 The fundamental lesson you learn from above is that taking a small debt where you have the ability to repay by sale of some of your assets is fine for a short term, but longer growth financed by debt where the outcome is not a certainty would land you in one big hole that will be difficult to come out.

Ego in business may be good, but has to be accompanied by Sanity. Ego helps you to push forward, but Sanity roots you to the ground. When the going is good, repay Debts, try to hoard cash for a rainy day and when opportunity comes you can use it. Life is a cycle. It is not that you miss one you are out, there will come a time to join the cycle. One has to wait out. This equally applies to our investments. Just because everyone is making money on a flavor, you may be tempted to join. But just check out and do not put everything into that as one day the flavor goes out you have huge debts and unable to sell. That is the most difficult situation for a businessman.

 In any case, ensure that family is assured of a steady income stream not linked to any business venture to avoid creditors and govt. to come after that. 

Trade Skills vs Knowledge Skills- The fear of AI

 With Artificial Intelligence gaining ascendancy and everyone jumping on to the band wagon, a thought occurred to me that the Knowledge based skills like finance, MBA's, lawyers etc. will soon become redundant as the knowledge will be all with the likes of google and anyone can search and use AI to get a solution.

Many clarifications, like what computer I want to buy based on my requirement, what type of agreement required for a particular action, etc is easily done with the help of CHATGPT. And this is just one of the tool. So, what does knowledge based AI do that a human can also do. It takes the information available and analyses and provides solution as per your requirement. Take for eg. to file a tax return, it will seek some basic information and then use the database of knowledge of the tax information and churn out a tax return for submission to the IT department. Eg is clear tax. Thus a CA or Tax consultant is made redundant.

Or to prepare a business plan, one may not need an MBA to do. Put in the basic inputs or even that is not needed in an ERP environment(Enterprise Resource Planning), which may have past data and looks at trends (which an MBA also does) and churns out a 10 year forward Business plan, cashflow and various other reports.

Even for doctors, the symptoms put out and AI generated reports of your blood, pressure, heart rate etc. makes an ordinary doctor redundant as all the 5 years knowledge from the Harrison's Principle of Internal Medicine, Gray's Anatomy etc. are input in AI.

Even for translators, Google and other machines fluently translate and speak on your behalf in a language you choose.

Thus Knowledge based info is thus passe'. What will be required in future is the physical aspect of skills. That is someone whose physical presence may be required to help out. Examples of such ones are Nurses, Plumbers, Farmers, Electricians, Surgeons etc. who has to physically come and sort out the issue. Even software guys will be made redundant - already with GITHUB, standard routines are put up there and people can easily copy the coding.

Trade skills will be the key learning of the future. And the value of those will increase.

THINK - Do you still want to send your child to a high paying college getting a knowledge based education or to a Trade School.

RISK Profile

 Risk profile is generally asked by any financial advisor. What does Risk Profile mean? In simple terms it is your capacity to take risks. You may want to take a 100% risk with your capital, but the questions they ask before slotting you in a particular risk profile is the real risk YOU can take. I may have 10 Lakhs and may want to invest it in a 100% risky investment. It can fetch you good returns after a few years or it may not. But till such time how are you going to survive. So, the risk profile takes your income, expenses, emergency fund etc and your age (key) to determine the risk profile.

Risk Profiling is important and I have categorised as follows: 

a) 20 years to 35 years (assuming you start earning) - High Risk (Equity/Ipos/crypto/nft) - Risk (Equity/Mutual fund) - Safety (some long term debt funds)

b) 36 years to 45 years (assuming you have invested above and have some capital)- Risk (Primarily Equity, Index funds and some IPO's)- Risk (Mutual fund -aggressive ones/sectoral)-Safety (some medium term debt funds)

c) 46-59 (assuming you have made a neat pile by now)- Risk (Mutual fund- Multi asset/Multicap/some sectoral, Equity large caps/index)- Safety (More medium and short term debt fund)- Income (funds/equity that generate dividends or deferred annuity plans)

d)60 and above - Safety (liquid funds, short term funds)- Income ( funds that get you regular income). By this time, your investment should focus on Safety and getting regular income for living a normal life. If over and above that you have funds, you can risk by trading/playing the market for time pass.

The above may or may not be applicable to all as each one may have some other commitments in terms of debt of house/family commitments/health issues etc. But investments like above sample is required for ensuring a financial freedom, at the age of 60

Spend or Save

 It is always a conundrum for young earners who are told to save, but they have their own aspirations/desires and FOMO and to be seen as part of the young up swinging crowd.

While it may stem from pent up desires to spend on things you want, UNLESS you are earning a phenomenal amount of money, SAVING is a key ingredient for life long success.

Going out, travelling, buying things for short term use etc. should be done if at least 30% of your salary saving is done apart from your day to day expenses. If money is still left over after that, think of spending. Till such time, belt tightening or holding on to your gratification is key for a financially peaceful old age.

In older generation, investment in the house was key  and once that was done, pension used to take care or expenses were kept to minimal in terms of food/health.

Expectations from children were very high to take them through old age. Saving and Investment was not possible given the frugal income, large family of own and taking care of their parents.

But today's world is changing. The children have their own life and parents should have saved. The children also should start saving as they will be left in a no man's land with parents not leaving much and having spent their money in their youth, find themselves in a difficult situation.

Most of the realizations come when someone is in their 40's when they start to panic as they feel that in next 10-15 years they will retire and do not have the CASH or financial comfort to manage their old age.

40's also brings in panic investment and Banks usually bank on this insecurity and provide products which are more to get commissions than a safety net for the investor.

Believe it or not, a comfortable financial security at the time of retirement will bring far more happiness than the spends done at young age and in particular taking Debts or EMIs. If gratification can be postponed, and savings encouraged when young could lead to a peaceful retirement without the need to worry about the next meal. 

Read an interesting post and thought I will update this post on saving.

Method 1

Suppose you earn 100 - You will spend ,say, 60 on Needs like food/shelter/basics etc., you will spend 40 on Wants - like buying a new phone, new clothes, eating out, entertainment etc. You will end up saving Zero, which will impact you going forward.

Take the other saving scenario. 

Method 2

Suppose you earn 100- you save 20. You will spend 60 on Needs like food/shelter/basics etc. Now you are left with only 20 for your Wants and that will decide which of the want is critical and will buy or wait till you have enough money.

This will ensure you save going by the 2nd method.

The thumb rule for spending money wisely is

50% on Needs - housing, food, transportation, utilities, insurance etc.

30% on Savings -investments, emergency funds

20% on Wants - Travel, entertainment, clothes, electronic purchase etc.

1 and 2 can vary, but ensure the 2nd is maintained as closely as possible to the %age to avoid retirement worries.

 

 

 

THE DEBT TRAP

 Debt - such a simple word, but that is one which puts people into so much trouble.

It is primarily using tomorrow's income today. Debt is such a compounding quicksand that once you fall into it, it is near impossible to retrieve yourself.

When you are borrowing, you are not doing a simple debt, but you are borrowing your future. Living within your means is a universal truth for peace and harmony, but the moment you step into debt, your life is marooned and some at end feel giving away life as the only solution.

Why is DEBT such a bad word. It is because of poor management and thinking. A person in dire strait thinks he can quickly repay the debt, not understanding the interest, the penal interest etc and the pressure to meet the deadline.

Eg. You take 10,000 Rs for 1 year at an interest rate of 8% (which is normally 2-3% higher than fixed deposit interest in normal circumstances, but depending on whom you go to and your credibility and collateral can be 10% or more too).

Thus 10,000 @8% is 800 rs interest. So, you assume you pay 10,800 Rs at end of year. But the loan giver generally deducts interest upfront. So you are given 9,200 only. This makes the rate go to 8.7%. A subtle nuance but significant change.

You default in the first year, saying you will pay in 2nd year as you have used that money and income is not supporting the repayment.

Now it jumps to 10,000*8%=800 or you have to pay overall 10800 when you got only 9200. That is 10800/9200= 17.4%. This quickly jumps if there is a penal interest or you have hoodlums coming and knocking your door.

So many farmers commit suicide in India, till a bit of micro finance came. The local lenders used to charge 50-60% interest and take the children from the parents to work for them. The farmers take small loans thinking their crop will be good their prices will be good and can pay 50-60% interest and return their loan. But unfortunately, they are bonded and whole life they work for these money lenders who exploit them and also take away their lands.

Thus DEBT IS ONE OF THE DEADLIEST MEDICINE TO TAKE AND I AM TELLING ABOUT PERSONAL DEBT.

Companies taking debt, is though equally bad, however has a logic as they expand their business (i.e for revenue generation) by building more capital items. Thus if demand exists, say a cola company, as predicted by a hot summer and company puts manufacturing plant to make extra bottles of cola and sells it, it can recover its money and pay off the loans. Where instead of a hot summer, it is a cool weather, the Company can get into a debt trap.

Reason why the Companies take Debt is something called Debt Leveraging. For a company to get equity funds (no expectation of return, but take the risk that company will pay you good dividends if it makes profit) is difficult as equity holders give out at say Risk free govt bond rate (say 7%) PLUS Risk premium (which can be say, 4%). That is equity holders expect a 11% return. If company can get from Bank @ 8%, and generates income, it effectively saves 3% (11%-8%).

Investors when investing thus look at financials and see if the Debt is reasonable for a company- what is called the Debt/Equity ratio, which is a standard 2:1. You are taking Debt at max of 2 times your equity. Normally, business without hiccups can manage this and still pay a good dividend and helps in expansion in a growth economy. Investors will not touch a Company with Debt in declining growth company as they know that the Company will not be able to service their Debt. This is calculated in another ration called Debt Servicing Ratio (EBIT/Interest). This shows how many times you interest is covered by Profit. Higher the ratio, better is the Company.

On a personal Debt, 

1) Never borrow, unless you have sufficient Assets that can pay off the loans if required. (If you have gold or other FD amount invested and for short term you need Debt, you may take a chance as when time comes to pay Debt, you can sell gold or liquidate FD)

2) Never borrow on the assumption that your income in future will be sufficient to pay off the installments. If income stops for any reason, a huge burden will fall.

3) Never borrow, if you are not 500% sure that it can be repaid in your life time. You may die, but your children, wife carry that burden through generations.

4) Always maximize down payment, in case of large purchase like house, which will keep Debt at a Sane level as well as save on interest to avoid falling into a Debt trap.

5) The Debt trap is sometimes so bad that you get BP, Diabetes (all stress related) and on top of Debt you are burdened with medical expenses and repayment becomes near impossible.

6) Like someone said, Debt is like modern day slavery. Be free.

7) Debt induces Ostrich effect - Bury the head in Sand thinking Danger will be over.