Equity Valuation: An alphabetic soup!

Financial advisor designations and Equity valuations – there are so many of them that you put all together, you can create an alphabetic soup.

And life comes a full circle for me. When I started life (a few moons ago in the ‘80s) as a Chartered Accountant, I naively thought and believed that people invested to get returns. Working on that assumption, we made research reports for clients (imagine, they paid for the reports!!). Here we would compute the “Dividend per share” as a ratio to the price paid for the share. The contention being that the only thing of interest to a retail share holder is the dividend. It is only the promoter who can use the cash in a technology company to buy an infrastructure company – why then should it matter to the retail shareholder?

Then the best ratio was PDR (price dividend ratio). Terms like “how many years of dividend will be required to recover the price – in terms of dividend alone” were numbers which were prominently put in the report. A blue chip meant a company with a AAA rating for its debt instruments and a 10-year increasing dividend track record. Dividends, is what mattered.

However, we were told we were too conservative and we should at least use “PER” – after all management knew “how much to re-invest, and how much to pay out”. We succumbed and accepted “PER”.

Then we got an opportunity to do the brand valuation of Mr. Ramesh Chauhan’s soft-drink business – we used archaic systems like “number of years of sustainable super normal profits” – and the final price was very close to the “theoretically arrived at price”.

Then we were told forget earnings, after all how much interest a company pays, the amount of depreciation, the taxation, and the amount of money capitalized is after all a view. So the earnings prior to all these “opinions” is far more important. Surely, it took a little while before we understood the word “EBIDTA”. A few meetings were attended without picking up the courage or guts to ask “what is EBIDTA” – fearing the suited MBAs sitting in plush conference rooms. However, our research reports contained this new fangled valuation tool. We succumbed and accepted EBIDTA despite the fact that it did not look far away from the sales figure.

Then we were told, we were “not being practical” and we should actually look at the “Sales to Market capitalisation” ratio. So being practical, again we succumbed. Meanwhile Harshad had made the “asset replacement theory” very popular and we all applauded it. It made a lot of sense that if it costs Rs. 13,000 crores to set up a chemical based film manufacturing plant and the market capitalisation of the company was only Rs. 1300 crores, it was a great buy. Some of us did not see the world going to digital photography that is all.

Then came the mother of all valuations – “Eye-balls and hits valuation”. Here we were told “how many people come to the site” and how many “feet fell” were the basis of valuation. We baulked, but being ‘practical’ people we succumbed. We were told if websites were set up by doctors, Tamilians, Mumbaikars, iyers, senior citizens, lions club members, all their members would one day buy all their requirements form their websites. All of them forgot the tamilian mumbaikar iyer senior citizen doctor who was a lions club member. Unfortunately he bought only one toothpaste a month, one television a decade, one sofa in 20 years.

The index cheered us along all the way. When we started the valuation game (oops sorry!) there was no index. Then it got constructed, it was at 100, then 500, then 5000, then 21,000. Then it came down slowly, sharply, and finally to 8900. Then it inched up to 10,000.

Now in a class room they ask me things like “Dividend-yield”, “why is dividend pay-out ratio” important. I seriously do not know, what to tell these kids.

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One Response to “Equity Valuation: An alphabetic soup!”

  1. Amazing article 🙂

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