Welcome to the Wealth management course <br />S G Raja Sekharan<br />
Equity investment <br />Session 3<br />
.<br />World’s wealthiest five - Forbes Feb 2010<br />Carlos Slim Helu –Mexico -$ 53.3 B – Mobile companies<br />William H...
.<br />Warren Buffet –The sage of Omaha<br />One of the most successful investors in the world<br />Noted for his adherenc...
.<br />Warren Buffet –The sage of Omaha<br />Benjamin Graham refused to hire him –saying Stock broking and Wall street was...
.<br />Warren Buffet –The sage of Omaha<br />In 1956, he came back to Omaha and launched Buffet Associates Ltd<br />In 196...
.<br />Warren Buffet –The sage of Omaha<br />Buffet pick up stocks in what he believes are well managed under valued compa...
.<br />Warren Buffet –The sage of Omaha<br />An investor and a businessperson should look at a company in the same way. Th...
.<br />Warren Buffet –his investment philosophy<br />The basic idea of investing are to look at stocks as business, use th...
.<br />Warren Buffet –his investment philosophy<br />Buffett seeks businesses whose product or service will be in constant...
.<br />Warren Buffet –his investment philosophy<br />Buffett seeks businesses whose product or service will be in constant...
.<br />Warren Buffet – there are three types of consumer monopolies<br />Businesses that make products that wear out fast ...
.<br />Warren Buffet – how does he spot a commodity based business<br />The firm has low profit margins (net income divide...
.<br />Warren Buffet – how does he spot a consumer monopoly<br />The firm has managed to create a product or service that ...
.<br />Warren Buffet –his investment philosophy<br />While Buffett is considered a value investor, he passes up the stocks...
.<br />Warren Buffet –his investment philosophy<br />Investment in stocks based on their intrinsic value, where value is m...
We will now get into specifics<br />There are 14 questions that we need to answer<br />We will take one corporate example ...
.<br />Questions to determine the attractiveness of business – Q1<br />Is it a consumer monopoly or commodity business –do...
.<br />Questions to determine the attractiveness of business – Q2<br />Do you understand how the product /service/business...
.<br />Questions to determine the attractiveness of business – Q3<br />What is the chance that the product /service/busine...
.<br />Questions to determine the attractiveness of business – Q4<br />Does the company allocate capital exclusively in th...
.<br />Questions to determine the attractiveness of business – Q5<br />What has been the company’s EPS history and growth ...
CRISIL’s EPS growth rate ( last 10 years)<br />CAGR of EPS adjusted for shares issued for the period is - 27.8%<br />
.<br />Questions to determine the attractiveness of business – Q6<br />Is the company consistently earning high Return on ...
.<br />Questions to determine the attractiveness of business – Q7<br />Is the company consistently earning high Return on ...
.<br />Questions to determine the attractiveness of business – Q8<br />Is the company conservatively financed?<br />Consum...
.<br />Questions to determine the attractiveness of business – Q9<br />Has the company been buying back its shares?<br />B...
.<br />Questions to determine the attractiveness of business – Q10<br />Is the company free to adjust prices to inflation?...
.<br />Questions to determine the attractiveness of business – Q11<br />Does company need to constantly reinvest in capita...
.<br />Questions to determine the attractiveness of business – Q12<br />What is the initial rate of return (IRR) and relat...
.<br />Questions to determine the attractiveness of business – Q13<br />What is the projected share value and return on in...
.<br />Questions to determine the attractiveness of business – Q13<br />What is the projected share value and return on in...
Crisil –Historical earnings growth rate method<br />
.<br />Questions to determine the attractiveness of business – Q13<br />What is the projected share value and return on in...
Crisil –Historical earnings growth rate method<br />
.<br />Questions to determine the attractiveness of business – Q14<br />What is the projected share value and return on in...
.<br />Questions to determine the attractiveness of business – Q14<br />What is the projected share value and return on in...
Sustainable growth rate model<br />
.<br />Questions to determine the attractiveness of business – Q14<br />What is the projected share value and return on in...
Sustainable growth rate model<br />
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  • Anil Ambani is 13.5 B
  • Wealth management session 3

    1. 1. Welcome to the Wealth management course <br />S G Raja Sekharan<br />
    2. 2. Equity investment <br />Session 3<br />
    3. 3. .<br />World’s wealthiest five - Forbes Feb 2010<br />Carlos Slim Helu –Mexico -$ 53.3 B – Mobile companies<br />William Henry Gates –US - $ 53 B –Microsoft<br />Warren Buffet – US - $ 47 B –Berkshire Hathway<br />MukeshAmbani –India $ 29 B – Reliance Industries<br />LakshmiMittal –UK -$ 28.7 B – ArcelorMittal<br />
    4. 4. .<br />Warren Buffet –The sage of Omaha<br />One of the most successful investors in the world<br />Noted for his adherence to “Value Investing”<br />Also known for his personal frugality<br />Born in 1930, second of three children, father was a stock broker and politician<br />Early in school age, he started earning by selling soft drinks and delivering paper<br />At 14 years, with his earning, he bought 40 acres of land –which he rented out<br />He went to Columbia for graduation - studied under Benjamin Graham –father of Value investing<br />
    5. 5. .<br />Warren Buffet –The sage of Omaha<br />Benjamin Graham refused to hire him –saying Stock broking and Wall street was not for him<br />Warren Buffet came back –got married and stayed in Omaha with his father’s brokerage<br />Benjamin Graham changed his mind and gave him a job in his NY office<br />Value investing means seeking stocks selling at extraordinary discounts to the value of it’s underlying assets –defined as “Intrinsic value”<br />Buffet went a step beyond Value investing – he looked at the value of a good management team, product’s competitive advantage in marketplace<br />
    6. 6. .<br />Warren Buffet –The sage of Omaha<br />In 1956, he came back to Omaha and launched Buffet Associates Ltd<br />In 1962, already a 30 year old millionaire –he joined forces with Charlie Munger<br />This collaboration eventually resulted in the investment philosophy of Value investing that helped Buffet to get where he is today <br />Along they way, they purchased a dying textile mill called Berkshire Hathaway - as a long term investment<br />Cash flows from this mill were used to fund other investments – eventually other investments overshadowed the textile business <br />In 1985, Buffet shut down the textile business – but continued with the company as a holding company<br />
    7. 7. .<br />Warren Buffet –The sage of Omaha<br />Buffet pick up stocks in what he believes are well managed under valued companies<br />When he purchases any stock – his intention is to hold the stocks for infinite period of time <br />Coke, Amex, Gillette etc are such stocks held by him for many decades<br />He also purchases companies outright and let’s their management teams handle their day to day business<br />
    8. 8. .<br />Warren Buffet –The sage of Omaha<br />An investor and a businessperson should look at a company in the same way. The businessperson wants to buy the entire company while an investor wants a part <br />The first question any businessperson will ask is, ‘‘What is the cash generating potential of this company?’’ <br />Over time, there will always be a direct correlation between the value of a company and its cash generating capacity. The investor would benefit by using the same business purchase criteria as the businessperson<br />
    9. 9. .<br />Warren Buffet –his investment philosophy<br />The basic idea of investing are to look at stocks as business, use the market’s fluctuations to your advantage, and seek a margin of safety.<br />Warren Buffett seeks first to identify an excellent business and then to acquire the firm if the price is right<br /> Once a good company is identified and purchased at an attractive price, it is held for the long-term until the business loses its attractiveness or until a more attractive alternative investment becomes available.<br />
    10. 10. .<br />Warren Buffet –his investment philosophy<br />Buffett seeks businesses whose product or service will be in constant and growing demand. In his view, businesses can be divided into two basic types: <br />Commodity-based firms, selling products where price is the single most important factor determining purchase. Buffett avoids commodity-based firms. They are characterized with high levels of competition in which the low-cost producer wins because of the freedom to establish prices. Management is key for the long-term success of these types of firms. <br />
    11. 11. .<br />Warren Buffet –his investment philosophy<br />Buffett seeks businesses whose product or service will be in constant and growing demand. In his view, businesses can be divided into two basic types: <br />Consumer monopolies, selling products where there is no effective competitor, either due to a patent or brand name or similar intangible that makes the product or service unique. <br />
    12. 12. .<br />Warren Buffet – there are three types of consumer monopolies<br />Businesses that make products that wear out fast or are used up quickly and have brand-name appeal that merchants must carry to attract customers. Nike, McDonalds, Drug companies with patents are good examples<br />Communications firms that provide a repetitive service that manufacturers must use to persuade the public to buy the manufacturer's products. Advertising agencies, magazine publishers, newspapers, and telecommunications networks are good examples<br />Businesses that provide repetitive consumer services that people and businesses are in constant need of. Tax preparers, insurance companies, investment firms are good examples<br />
    13. 13. .<br />Warren Buffet – how does he spot a commodity based business<br />The firm has low profit margins (net income divided by sales)<br /> The firm has low return on equity (earnings per share divided by book value per share)<br /> Absence of any brand-name loyalty for its products<br />The presence of multiple producers<br /> The existence of substantial excess capacity<br /> Profits tend to be erratic<br /> The firm's profitability depends upon management's ability to optimize the use of tangible assets.<br />
    14. 14. .<br />Warren Buffet – how does he spot a consumer monopoly<br />The firm has managed to create a product or service that is somehow unique and difficult to reproduce by competitors due to<br />Brand name loyalty<br />A particular niche that only a limited number of companies can enter<br />An unregulated but legal monopoly like patents<br />A strong upward trend in earnings<br />Conservative financing<br /> A consistently high return on shareholder's equity <br /> A high level of retained earnings <br /> Low level of spending needed to maintain current operations<br /> Profitable use of retained earnings <br />
    15. 15. .<br />Warren Buffet –his investment philosophy<br />While Buffett is considered a value investor, he passes up the stocks of commodity-based firms even if they can be purchased at a price below the intrinsic value of the firm. An enterprise with poor inherent economics often remains that way. <br />
    16. 16. .<br />Warren Buffet –his investment philosophy<br />Investment in stocks based on their intrinsic value, where value is measured by the ability to generate earnings and dividends over the years. Buffett targets successful businesses--those with expanding intrinsic values, which he seeks to buy at a price that makes economic sense, defined as earning an annual rate of return of at least 15% for at least five or 10 years. <br />
    17. 17. We will now get into specifics<br />There are 14 questions that we need to answer<br />We will take one corporate example –CRISIL to understand the overall flow of thoughts<br />
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    20. 20. .<br />Questions to determine the attractiveness of business – Q1<br />Is it a consumer monopoly or commodity business –does it have an identifiable durable competitive advantage?<br />Consumer monopolies typically have high profit margins because of their unique niche<br />Beyond high profit margins, look for companies with operating margins and net profit margins above their industry norms<br />Also look for strong earnings and high return on equity will also help to identify consumer monopolies. <br />Look at a detailed study of the firm's position in the industry and how it might change over time.<br />CRISIL – Yes –it is a pioneer, market leader and an well known brand in India<br />
    21. 21. .<br />Questions to determine the attractiveness of business – Q2<br />Do you understand how the product /service/business model works?<br />Only invest in industries that you understand – for example Buffet refused to invest in ecommerce companies during the dot com boom because he did not understand their business<br />CRISIL – Yes – corporates want their financial instruments rated –Crisil rates them and corporates use this rating to advertise their credibility.<br />
    22. 22. .<br />Questions to determine the attractiveness of business – Q3<br />What is the chance that the product /service/business model would be obsolete in the next 20 years?<br />Will there be a market for this product 20 years from now <br />If there is going to be technological changes envisaged, then will this company have an upper hand still?<br />CRISIL –rating is an expert’s job that cannot be automated. There will always be need for rating and corporates will need this service<br />
    23. 23. .<br />Questions to determine the attractiveness of business – Q4<br />Does the company allocate capital exclusively in the realm of expertise?<br />Where have been their investments in the past 5-10 years?<br />Does the company stick with what it knows?<br />CRISIL – Yes it does not seem to be spending outside it’s area of expertise<br />
    24. 24. .<br />Questions to determine the attractiveness of business – Q5<br />What has been the company’s EPS history and growth rate<br />The company must show a consistent growth in EPS over the past 10 years<br />Erratic growth and dips in EPS would mostly make the company unattractive for investment unless there is a clear enough reason visible as to why it happened.<br />
    25. 25. CRISIL’s EPS growth rate ( last 10 years)<br />CAGR of EPS adjusted for shares issued for the period is - 27.8%<br />
    26. 26. .<br />Questions to determine the attractiveness of business – Q6<br />Is the company consistently earning high Return on equity<br />The company must show a consistently high ROE over the past 10 years – <br />ROE = reported net profit /Net worth <br />CRISIL – has an ROE ranging from 13.5% to 39.5% with an average ROE of 23%<br />
    27. 27. .<br />Questions to determine the attractiveness of business – Q7<br />Is the company consistently earning high Return on total capital?<br />The company must show a consistently high Return on total capital employed over the past 10 years<br />ROCE = Reported net profit /Total liabilities in BS<br />CRISIL – as they have no loans – the ROE and ROCE are the same and the average ROCE is 23%<br />
    28. 28. .<br />Questions to determine the attractiveness of business – Q8<br />Is the company conservatively financed?<br />Consumer monopolies tend to have strong cash flows, with little need for long-term debt<br />Screen for companies with no debt or low debt – look at the interest coverage ratio –compare with industry peers<br />CRISIL – has no loans in it’s balance sheet – it is very conservatively financed<br />
    29. 29. .<br />Questions to determine the attractiveness of business – Q9<br />Has the company been buying back its shares?<br />Buffett prefers that firms reinvest their earnings within the company, provided that profitable opportunities exist. When companies have excess cash flow, Buffett favours shareholder- enhancing manoeuvres such as share buybacks<br />CRISIL – No -it has not yet bought back shares – in fact it has issued small amount of shares in the period 2003 to 2007<br />
    30. 30. .<br />Questions to determine the attractiveness of business – Q10<br />Is the company free to adjust prices to inflation?<br />True consumer monopolies are able to adjust prices to inflation without the risk of losing significant unit sales.<br />CRISIL – Yes – it can increase it’s prices as it is in a near monopoly market<br />
    31. 31. .<br />Questions to determine the attractiveness of business – Q11<br />Does company need to constantly reinvest in capital?<br />Retained earnings must first go toward maintaining current operations at competitive levels, so the lower the amount needed to maintain current operations, the better.<br />CRISIL –Really no - it’s business model depends on it’s credibility and quality of manpower employed and the knowledge retention – these do not need large amount of investments<br />
    32. 32. .<br />Questions to determine the attractiveness of business – Q12<br />What is the initial rate of return (IRR) and relative value to a Govt bond?<br />EPS for the year divided by the long-term government bond interest rate. The resulting figure is the relative value - the price that would result in an initial return equal to the return paid on government bonds.<br />We then have to look at the CAGR of the EPS as well.<br />CRISIL – assuming a 8% govt bond rate – and based on the current EPS of 212.43 – the relative value of govt bond would be –Rs 2655.37. <br />With the current share price of Rs. 6132 – the Crisil share gives a pretax return of 3.46% with the returns growing at 27.8% pa<br />
    33. 33. .<br />Questions to determine the attractiveness of business – Q13<br />What is the projected share value and return on investment using historical earnings growth rate:<br />Calculate the CAGR of EPS for the past 10 years<br />Calculate the average dividend payout ratio (DPS/EPS) for the past 10 years<br />Calculate the average PE for the last 10 years<br />CRISIL – <br />CAGR of EPS is 27.8%<br />Average Dividend payout ratio is 33.95%<br />Average PE for the last 10 years has been – 20.55<br />
    34. 34. .<br />Questions to determine the attractiveness of business – Q13<br />What is the projected share value and return on investment using historical earnings growth rate:<br />Calculate the EPS for the next 10 years as follows:<br /> EPS of year 2 = EPS of year 1 * CAGR of EPS<br />Calculate the dividend payout for the next 10 years as follows:<br /> Dividend payout for year 2 =EPS for year 2 * average DP ratio<br />Calculate the sum of all the dividends paid for the next 10 years<br />
    35. 35. Crisil –Historical earnings growth rate method<br />
    36. 36. .<br />Questions to determine the attractiveness of business – Q13<br />What is the projected share value and return on investment using historical earnings growth rate:<br />Projected share price at 10th year = EPS at 10th year * Average PE ratio<br />Total estimated gain at the end of 10th year = Projected share price at 10th year + Sum of all dividends for 10 years<br />Calculate the CAGR of your investment in 10 years – FOR CRISIL THIS IS 24.37%<br />
    37. 37. Crisil –Historical earnings growth rate method<br />
    38. 38. .<br />Questions to determine the attractiveness of business – Q14<br />What is the projected share value and return on investment using sustainable growth rate:<br />Calculate the average PE ratio for the past 10 years -20.545<br />Calculate the average ROE for the past 10 years -23%<br />Calculate the average dividend payout ratio for the past 10 years – 33.95%<br />
    39. 39. .<br />Questions to determine the attractiveness of business – Q14<br />What is the projected share value and return on investment using sustainable growth rate:<br />Calculate the Book value of the share for the next 10 years using the formula:<br />BV for year 2 = BV for year 0 + Retained earnings for year 1<br />Retained earnings for year 1 = Projected EPS for year 1– Projected Dividend Payout for year 1 <br />Projected EPS for Year 1 = average ROE * BV for Year 0<br />Projected dividend payout for year 1 = <br /> EPS for year 1* average Dividend payout ratio for past 10 years<br />
    40. 40. Sustainable growth rate model<br />
    41. 41. .<br />Questions to determine the attractiveness of business – Q14<br />What is the projected share value and return on investment using sustainable growth rate:<br />Calculate the EPS for year 10<br />Calculate the expected Share Price for year 10 = EPS (FY10)* Average PE<br />To this share price estimate, add the estimated dividends paid for the next 10 years<br />Calculate the expected CAGR of your investment today<br />
    42. 42. Sustainable growth rate model<br />
    43. 43.
    44. 44. Thank you<br />

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