Identifying the Value of the stock for the identified great company
Perpetuity - Equal amount at equal interval forever
Companies that create perpetuity - Coke, Gillette
Say, you invest 1cr in Bank or Bonds with 10% fixed interest rate. it would give 10L per year forever
Means, here PV of 10L\year is 1cr
Case-1: PV of constant Perpetuity = PMT/rate = 10L/10% = 1cr
Now, Fair Value FV of 10L\yr is 1cr
Suppose RBI require money and gives discount, pay 90L and it would give 10L\yr
Suppose RBI doesn't require money and ask premium, pay 1.1cr and it would give 10L\yr
Growing Perpetuity - Future Cash flow. Say Bonds ask you to invest 1cr and it would be give 10L\year growing at 5% per year. Assume 7% rate of return
Case-2: PV of Growing Perpetuity = PMT/(Rate - G) = 1000000 (0.07 - 0.05) = 5cr
Case-3: Suppose a company e.g. ITC says it would give 10L\yr contant perpetuity. Due to higher risk with stock, rate of return needs to be higher say 15%
B-School of thought
PV Constant Perpetuity = PMT\Rate = 1000000/0.15 ( Due to higher risk keep rate higher say 15%)
Warren Buffer though
Rate is an perception, needs to be consistent logic. However different people might take different rate.
PV of Constant Perpetuity = PMT/Rate = 1000000/0.07 (Keep rate same as that of RBI 10 yr bond) = 1.42cr
However, wanna keep 50% margin of safety means, 1.42 cr\2 = 71L as Fair Value
Case-4: Growing Perpetuity
PMT/rate - g = 1000000/0.7-0.5 = 5cr
Apply margin of safety, 5cr\2 = 2.5cr
TBD
What should be the fair market value of ITC
FCF = 75000 M
PV of Constant perpetuity = PMT/rate = 75000/0.07 (RBI bonds rate) = 1072243 M INR, 1072 B INR
Next year perpetuity = 75000 + 5% = 78809
PV of Growing perpetuity = PMT/r-g = 78809/0.07-0.05 = 3940 B INR
Margin of Safety = 3940/2 = 1970 B INR (Compare with Market Cap 3355 B INR)
Value with Faster to Slower Growth (5%)
Example - ITC
Identify the growth - Historical Data And Industry Reports
Historical Data Growth = 21% p.a. (May not be true for future growth)
FCF Average of 2008, 2009, 2010 = 18808 M INR (2009)
FCF Average of 2015, 2016, 2017 = 71787 M INR (2016)
Rate =rate(7,0,-18808,71787) = 21%
Industry Growth
Ciggrette Industry + FMCG Industry = Assume as 15% (Boston consulting etc)
Dont pick company report, pick industry report
Say 2018-2022, 5 yrs growth is 15%
Say 2022-2027, 5 yrs growth is 10%
Say 2028-forever growth is 5%, calculate growing perpetuity
2028 FCF = 255290 (After 15% and 10% growth for 10 yrs)
FV at 2027 = PMT/rate - growth = 255290/0.07-0.05 = 12764480 (called as terminal value)
Calculate PV (by =pv formula) for every year
Sum of PV for all future year and divide by 2
Check if this value is less than current value
TBD