- Value of information is maximum under uncertainty.In inefficient markets like India, that is much more important.
- Analysts often take the easy way out by doing relative valuation. And even if they perform DCF valuations, few retail investors get to see the assumptions(and never the spreadsheets), which are shared with the big daddies. Hence, free riding on analyst recommendations is not safe.
- Since individual investors would invest larger sums(otherwise index funds make sense), they should do the ground work of understanding stocks and making the basic investing model.
- Under high growth situations as promised in many Indian companies, it is easy to get carried away and give triple digit P/E multiples to stocks, and overprice them for future growth. A DCF valuation helps to understand the sensitivity of future growth assumptions on the firm value, and allows an investor to see whether he's comfortable with that or not.Also, it forces the investor to think about WHEN would growth slow down/end, and that itself is an exercise in critical thinking.
- Few Indian companies upload spreadsheets, making investors manually extract numbers from PDF annual reports. While some aggregators like moneycontrol.com offer the free download facility, that may go in the future as sites are under pressure to show profitability. Still, investors CAN download the basic numbers from those sites till then for their models.
- In the high inflation environment, stocks are NOT neutral to inflation. Indeed, many 'lifestyle' sectors suffer slowdowns and commodities players may see margin erosion. Hence, valuation MUST incorporate the estimated inflation effect on revenues and costs(especially for companies with uncontrollable cost base like power transmission, coal based power plants etc), and thus doing a DCF model helps
- Mental models as advised by Charlie Munger etc are a poor substitute for analysis. After all, no good company is a buy at ANY price, nor are bad companies a sell at ALL prices. Excel features like Data Tables help to understand the implied growth/margins at which the prices would reflect the intrinsic value as per model.
Monday, February 6, 2012
DCF valuation is relevant in India despite information issues & high growth
As any finance student would know, DCF valuations are easier learnt than done. In markets like India, where financials are not too reliable and companies are quite diversified and high growth, the DCF valuations may be unreliable and tend to understate the company valuations(nice, ain't it). But high growth brings with it high capex/debt, and that can destroy a company fast. Hence, DCF is not easy even then. But Indian investors should not give up on DCF in my opinion because