Thread by @abhishec_s

PE, EV/EBITDA, P/Sales or DCF?

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Any analyst assigning X multiple to a stock based on either 1. Historical 2. Relative (sector) averages is not ‘valuing’ the company. He is assuming market has been right in the past about the stock & at present about the sector.

In which case shouldn’t TP = CMP?

Every trade one makes, every target price that is different from CMP is an assertion that — The Market is Wrong!

Multiples are derived form value. They don’t determine it.

‘ABC deserves X multiple & hence the market cap should be Y’ is one of the most asinine claims in investing.

“You should use EV/Ebitda for companies with debt”.

At what D/E do you move from PE to EV/E? 10%, 20%, 70%? Should a commodity stock be valued on EV/E? If that stock pays off its debt should we start using PE?

Slapping a multiple is something any monkey can do. And most monkeys end up doing it.

Valuation is more intricate, more nuanced, more demanding. And hence there is a whole industry trying to sell you short cuts.

DCF is highly sensitive to change in assumptions but at least the assumptions are explicit & hence easier to keep track of.

Using multiple just gives you a false sense of having done your due diligence and having ‘valued’ the company.

With a reverse DCF you can create different scenarios & a band for the value of the company (which is hazy & dynamic). You want to buy things preferably at a discount to even the lowest point in this band.

So if multiples are often useless and DCF can be unwieldy how do we value anything?

Look for boundary value violations.

A 2W company was trading at negative growth multiple a couple of months back (a simple calculation would have revealed that). So when you are buying the company the only assumption is earnings are going to grow (with similar ROIC).

You want your inbuilt assumptions to be as conservative as possible. This is what Buffett means when he says “price is my due diligence”.

On the other hand on certain occasions some sectors were assuming they would do numbers for India in 10 years that would be higher than those of China currently. They are shorting opportunities for me.

Will an informed (intelligent) promoter ever pay 60 times earnings for a firm just because it has traded at that multiple for the last 5 years? (Although a lot of managements might be quite keen to do so).

Valuation is complex. And this is not a problem to solve. It is simply how investing is.

Today the whole world is telling you valuations don’t matter.

They do.

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PS: McKinsey on Valuations (section 1) is a good start for anyone interested in this.

And this:

eipny.com/white-papers/t…