Thread by @BMTheEquityDesk

For a company paying 35% tax earlier now 25.17% the PAT will jump by 15.12% . As this isn’t a guidance but an increased cash flow till eternity the P/E even if it expands by the same ‘if not more’ should lead to a stock price move of (1.1512 x 1.1512)-1=32.52%. Lot more to come?

In the above case I have assumed a growth of 15%. So the 15% saved in year one grows at 15% which means that it grows to 17.25 in year 2 and 19.83 in year 3.

Growth is a function of RoE (1- payout ratio) which means higher the RoE and lower the payout ratio - more the impact !

Now, if the RoE is 25% and so is growth and payout ratio 0 then this cash of Rs 15 will grow at 15 x 1.25 = 18.75 in year 2 and 18.75 x 1.25 = 23.43 in year 3.

In this case, where the RoE and growth is 25% the price should move up by (1.15 x 1.25 -1) = 43.75%.

Yes, 43.75%.

So here we are looking for a) Higher Tax saving post Govt. announcement b) Scalable business with high RoE and higher growth and c) ) Low payout ratio.

A high payout destroys our compounding chain. We want scalable businesses that use and retain money till eternity,

Need to identify businesses that grow earnings at high rates through a higher RoE and pay minimum divided.

Banking and financial services fits this bill because they qualify for all of the above. Consumers with growth & minimum payout will also show stupendous upmoves.

Consumers with low growth & high payout won’t continue long with the rally as the free cash flow is not being used in the business - it moves out as dividends.

So the easiest thing to do is check the RoE and the tax saved. The RoE - payout ratio is assumed to be the growth.

As indicated if the tax saved is 15% and RoE is 25% then the price should move up by 43.75%.

If the RoE is 26% then the price should move up by 44.9%

The theory will work great for non-cyclical businesses where the company has a large entry barrier. A moat !

For cyclicals the gains will fritter away with time.

That’s why the rally has been so hard and shows little signs of abating - in stocks meeting the above criteria.

* This post is only for academic purposes & does not constitute any recommendation to buy or sell any stock.