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Archive for the ‘The Science of Investing’ Category

How to value angel investments

Posted by fairval on July 13, 2016

My column in Hindu Businessline this Monday focussed on the issue of – how to value an angel deal.

In short – there is no method really to value angel deals. Most investors use absolute numbers within a certain range to invest, without necessarily linking them to business numbers.

For example, Silicon valley entity Y Combinator, which is more of a accelerator than an angel, has a specific, one size fits all formula. It invests $120K for 7% stake, which means it values the startup at $1.71m post money. This is roughly about Rs 10 crore pre money.

Some Indian startup funds seem to follow this also. India Quotient invested Rs 2 crore in one company I know at Rs 10 crore pre-money. Don’t know whether it is their standard formula.

Most HNIs though tend to be stingy. They like to stay in single digits in pre money valuations.

Instead of a flat valuation, it is possible to do a bit of structuring, like discount to Series A. Or take a metric like orders processed, and link valuation levels to few pre-defined ranges of orders processed. These kind of investments will need a cap/floor ideally. Some investors don’t like to keep such metrics for valuations, since it can skew management focus.





Posted in Angel Investing, The Science of Investing, Valuation | Tagged: , , , , | Leave a Comment »

Shareholder Value Maximisation & Executive Pay hurting real returns, says paper

Posted by fairval on December 4, 2014

A  radical new paper is doing the rounds of the analyst community, and it makes some strongly counter-intuitive assertions. It says the focus on Shareholder Value Maximisation (SVM), which has caught on since the ’90s, is the dumbest idea ever, and it is screwing up real returns. The paper presents some impressive data to support this claim.

It further claims the focus on SVM has also distorted executive pay structures, and the two together are throttling real economy.

Attached here are 2 interesting charts.


Out of control Executive Pay

Out of control Executive Pay

The paper calls the pre-’90s era, the phase of ‘managerialism’. Quoting the paper – ‘During the era of managerialsim, the vast majority (i.e., over 90%) of the total compensation for CEOs came through salary and bonus. In the last two decades one can see the increasing dominance of stock-related pay. In the last decade some two-thirds of total CEO compensation has come through stock and options. This kind of compensation strucutre gives executives all of the upside and none of the downside of equity ownership. Effectively they create a heads I win, tails you lose situation.

Another reflection of the role of SVM in creating inequality can be seen by examining the ratio of CEO-to-worker compensation. Before you look at the evidence, ask yourself what you think that ratio is today and what you think is “fair.” A recent study by Kiatpongsan and Norton (2014) asked these exact questions. The average American thought the ratio was around 30x, and that “fair” would be around 7x.
The actual ratio is shown in Exhibit 16. It turns out the average American was off by an order to magnitude! If we measure CEO compensation including salary, bonus, restricted stock grants, options exercised, and long-term incentive payouts then the ratio has increased from 20x in 1965 to a peak of 383x in 2000, and today sits somewhere just short of 300x!

The actual paper has lots more interesting stuff. For ex, as a pre-amble it trashes most holy cows of modern finance:  CAPM, Efficient Market Hypothesis, Beta, VaR, portfolio insurance, tail risk hedging, smart beta, leverage, structured finance products, benchmarks, hedge funds, risk premia, and risk parity to name but a few.


Posted in Anal(yst) Humour, Corporate Finance, The Science of Investing | Tagged: , , , , , , , , , , , , | 2 Comments »

This blog flagged Opto Circuits on 17 Jan’12

Posted by fairval on January 24, 2013

In a post on 17 Jan’12, this blog had raised flagged a warning on Opto Circuits. Here is  a link to that post:

Is the bull market back? And is Opto a shady stock..

What caught my eye was an announcement on BSE Opto made about a really trivial order. Some companies tend to start making announcements on BSE the moment they smell a bull market. Often, these companies are shady. There are are few others, which are otherwise fancied by the market, but are highly pro-cyclical with bull markets. Sintex is another company, which seems heavily pro-cyclical, but that is probably a better company.

The Jan post was based mainly on the innocuous announcement, which sounded highly shady to me. Subsequently, one also heard some negative stuff from banking friends in Bangalore.

The share price of Opto on 17 Jan was around Rs 224, which is close to its 52 week high (Rs 225), hit around Feb. Since then, the stock has headed down, and is now Rs 85. Given the turn of events in recent days, it seems investors have turned jittery over deteriorating financials.

Posted in Pharma and Lifesciences, The Science of Investing | Tagged: | Leave a Comment »

A new method to calculate relative PE

Posted by fairval on January 17, 2013

When analysts make their price targets, what PE to use (this being the most common metric) is often quite arbitrary. We have used the following method in a recent report. This is a report on Sona, an auto ancillary. About 45% of its sales are to Maruti, so i decided to derive its PE in relation to Maruti.

Sona should clearly trade at a discount to Maruti, but how much? To give a method to this, we compared cumulative profits over last 10 years. This should be a long enough period to arrive at a assessment of relative profit generating (and therefore wealth creation) abilities of the two businesses.

Here is what we got. FY03 is indexed to 100. Adding up profits, Maruti made about 3x the net profit as compared to Sona. (This is not an absolute number, but an indexed number).  It seems fair to say that Maruti’s PE should be 3x Sona. Brokers currently value Maruti at around 18x FY14. Sona could well get 6x FY14.

If this were true, Sona appears a good buy at current price. And with 5% dividend yield currently, downside is protected.

A metric for relative PE calculation

Posted in Auto, Stock Ideas, The Science of Investing, Valuation | Tagged: , , , | Leave a Comment »

Only 1 in 10 analysts got it right on Infy?

Posted by fairval on July 13, 2012

Only 7 of the 70+ analysts tracking Infy had a Sell or Underperform reco as on July’12.


A Barclay’s India Strat report dated 9 July actually had Infy in top 10 recommendations!

Posted in Technology, The Science of Investing, What was that Again? | 1 Comment »

July IIP makes consensus look silly

Posted by fairval on September 13, 2010

The following para shows how hard it is to predict. June IIP came at around 7%, and consensus quickly became 7%.  This is an excerpt from a broking firm’s report.

July industrial production rose 13.8%, higher than our and consensus estimates (7.0%; Consensus 7.5%). Similar to last month, where incidentally the numbers were revised down from 7.1% to 5.8%, we were expecting single-digit growth in July due to the fading of the base effect. (A quick re-cap, industrial growth which had averaged 0.9% during Oct08-May09 picked up in Jun09 with growth during Jun09-Mar10 averaging 12.1%).

Also, the government data has to be taken with a pinch of salt. The July IIP is principally high due to a sharp 63% jump in capital goods production. Now 63% is steep. Orderbooks of cap goods companies have been going up for the last 2 quarters, but that sharp jump in production? hard to believe.

My own view wasnt too different. I thot IIP should be staying under 10% for the same reason as stated below. Also, with such a high inflation, I am finding it hard to believe final consumer demand can grow at > 10%. Can capex cycle be so strong as to keep IIP above 10% on its own? out of my depth on that one

Posted in Indian Economy, The Science of Investing | Leave a Comment »

The concept of upside risk

Posted by fairval on August 9, 2010

Quite a few broker reports tend to have this line ‘xyz can lead to an upside risk’.  If you are buying long, hard to see how doing better is a risk. For a derivative strategy, it might be.

I suppose brokers like these wont like the Sortino ratio too much, which has become quite popular in evaluating mutual fund performance, compared to the older Sharpe ratio.

See this line from a recent report on Havells..

Successful turnaround of Sylvania is an upside risk

Posted in The Science of Investing, What was that Again? | Leave a Comment »

Example of trendline forecasting

Posted by fairval on July 14, 2010

Reactions to the May IIP data, which showed a 11.5% growth, have been uniformly same. All brokers are calling it – ‘below expectations’.  Which it seems was 16%.  Really, what are our broking economists thinking? Just because for 4-5 months IIP grew at strong growth rates, so now 16% becomes an expectation. Tho I must say, it is a tough job. There is really no tool for form expectations on a monthly basis, but they are forced to, to keep the client service happy

Here’s a note from a report, and the tone is the same in all of them..

India released industrial production figures for May at 11.5% y-o-y, disappointing consensus expectations at 16% yo-
y. We were surprised by the result, too, given that the recent data flow is pointing to strong demand. This represents
a sequential decline of 3.9% m-o-m sa. If anything, we think this disappointing figure is further evidence that capacity
constraints in the economy may be capping growth.

Posted in Indian Economy, The Science of Investing, What was that Again? | Leave a Comment »

The Science of Investing-1

Posted by fairval on May 7, 2010

This is a new category of posts , where we will pick new interesting stuff anlaysts do.

This one is from one of foreign brokers. on HUL. The broker says there a 15% chance of HUL tanking to its lows of the last decade. We are……ahem… impressed.  Full marks for trying ..

HUL scenarios

Posted in Stock Ideas, The Science of Investing, Valuation, What was that Again? | Leave a Comment »