After you have studied the business and industry, you understand the prospects. Once you are confident of the prospects of the business, you understand the range of the price you may be willing to pay.
After you have studied the business and industry, you understand the prospects. Once you are confident of the prospects of the business, you understand the range of the price you may be willing to pay. On one side the past data, which may or may not be replicated in the future, and on the other side, there is the completely unknown future. With this challenge, the investor is left with more of an artwork rather than a simple mathematical calculation.
After my years of experience, I have realized that valuation is a reference point rather than a sacrosanct number. As an investor, you should understand whether the range is a buy range or a selling range. Any price which is in the middle will not lead to any conclusion.
Although there are investors who prefer complicated valuation models, I suggest simple reference points.
In the case of a financial company, you can refer to the price to book. A financial company’s book value is a more current number rather than the historical cost. In the case of a non-financial company, you can refer to enterprise value divided by net operating profit after tax. This comparison must be made with the company’s history as well as with the company’s peers. Another ratio that I prefer to at is FCF yield, a high yield indicates buying range.
I do not like using discounted cash flow (DCF) model because it uses a lot of assumptions about the future. No one knows what the future looks like what we know is only the present. Another way to use the DCF model is to reverse it. The purpose of reversing the DCF model is to understand what the market expects. This is called market expectation or implied growth. If the implied growth is unusually high or low, it is an indication of a buy or a selling range.
As an investor, you should never fall into the trap of ‘paying any price’ for quality. There is a price for everything, the purpose of understanding these ranges is to figure out whether it is worth entering or waiting it out.
Disclaimers
Investment in securities market are subject to market risks. Read all the related documents carefully before investing.
The securities quoted are for illustration only and are not recommendatory.
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Details of the advisor
Advisor: Ankur Kapur
SEBI RIA No.: INA100001406
BASL Member ID: BASL1337