{"id":1078,"date":"2020-12-26T22:02:00","date_gmt":"2020-12-26T22:02:00","guid":{"rendered":"http:\/\/oscillationss.blogspot.com\/?p=1078"},"modified":"2020-12-26T22:02:00","modified_gmt":"2020-12-26T22:02:00","slug":"value-intrinsic-or-subjective","status":"publish","type":"post","link":"https:\/\/oscillations.in\/?p=1078","title":{"rendered":"Value: Intrinsic or Subjective"},"content":{"rendered":"<\/p>\n

(Click here<\/a> for old post on value investing)<\/p>\n

Recently, a young student was
\ndiscussing business valuation with me. The young fellow was quite intrigued by
\nthe business valuation models particularly DCF. He asked me about my
\npreferred model for valuation and I told him that in my view these valuation
\nmodels are good for having a theoretical viewpoint and conceptual framework but
\nthese are very primitive methods and not practical most of the time in the real
\nworld. So we need much better valuation theory\/methods which can stand on its
\nfeet during the evaluation process.<\/span><\/p>\n

I know many hardcore Value
\ninvesting followers and once during our discussions one fellow asked (challenged)
\nme if I could suggest a better fundamental valuation method to value the
\nintrinsic value of a business\/stock. But I asked him- whether things really
\nhave intrinsic value? We value Roses and consider grass to be inferior to roses
\nbut just keep humans aside and nothing is more valuable than the others. Things
\nare just IS. So Roses are Red only for us. The valuation we do is not linked
\nwith the individuality of that thing (standalone value) but to the relevancy of
\nthat thing to us. Without humanity, roses and grass have same value but it is different when they are \u201cvalued\u201d. So value is different from valuation. Leave
\naside human beings and all and everything has same value\u2026objectively everything
\nis equal. But a three dimensional human being can trade all the grain of the
\nworld for a glass of water when he is dying of thirst in Sahara desert\u2026.a human
\ncan kill thousand others for something as abstract as religious sentiments. Can
\nwe value the embedded value of a handful of wheat or a glass of water objectively?
\nSo value is intrinsic but valuation is subjective. Objective valuation may not
\neven exist (at least for businesses\/stocks).<\/span><\/p>\n

Value is intrinsic but valuation is
\nsubjective<\/span><\/u><\/b><\/p>\n

Every asset that generates cash flows has an intrinsic value.<\/i><\/b><\/span><\/p>\n

Value investing postulates that
\nprices will oscillate towards intrinsic value (one and only one) and so this
\nintrinsic value is an objective value. I have seen many commentaries on value
\ninvesting and seen many value analysts (like Buffet) criticizing efficient
\nmarket theory (CAMP model) but at the fundamental level if we can see even
\nvalue investing believes that price and value should coincide. But first of
\nall, why there is a difference in market price of an asset and its value
\nbecause theoretically market price and value of an asset should be equal? Value
\ninvesting assigns <\/span>irrational behavior<\/i><\/b> (by market) as the reason
\nfor this difference. Value investing accuses market to be guided by temporal forces
\nof greed, fear and its changing mood where it completely ignores the economic considerations
\nrelated to that asset. So if we can see this irrational behavior is the
\nbackbone of value investing where they try to unearth hidden gems ignored by wisdom-less
\nmarket.<\/span><\/p>\n

So Value investing declares itself
\nto be far superior to the other irrational players of the market and it feels
\nthat it is superior just because they try to calculate intrinsic value (though
\nwith large numbers of highly subjective assumptions). But this \u201cirrational behavior\u201d
\nis a very weak rationale for the most fundamental part of the value investing
\nsince presumed foolishness of others can\u2019t create something very fundamental
\nrelated to most valuable aspect of human life- Valuation of assets. It is
\npossible that during Covid lockdown in India from Mar-2020 one investor might
\nhave sold Laurus labs at 70 due to the fear of covid related unknown or another
\ninvestor might have sold it in order to arrange money to help poor migrant labors.
\nCan we say that their behavior is irrational just because they sold Laurus labs
\nat 70 which later on touched 350? Were they foolish for the choices they have
\nopted? No, definitely not.<\/span><\/p>\n

Fear and optimism are the
\nfundamental forces responsible for the direction of the economy. These are as
\nabstract as something can be but still they have the powers to drive and
\nmotivate something as material as an economy. When people and entrepreneurs are
\nhopeful and optimist they spend and invest which drives the overall growth of
\nan economy. Major function of the governments is not micro managing productive
\nresources and their allocation but to create an environment where people have
\nthe faith and optimism in the government policies and administration. Like, GST
\nwas a great financial engineering having the capability to transform and revolutionize
\nthe business models and supply chains in India but a Government can
\nalways make a mess of this by making unnecessary rules and large number of
\ncompliances which will only create confusions, increase the compliance costs,
\nrestricts the flow of Input credit\u2026and this will hit the confidence of
\ninvestors and industrialists hard and they may choose to invest in some other
\ncountry or cancel their planned investments in India forever. So fear and
\noptimism are not irrational behavior but are the driving forces responsible for
\ngrowth and preservation in adversity.<\/span><\/p>\n

It is a misconception that man,
\nmaterial, money and technology are the most important forces driving the economies.
\nActually economies are just like a big truck. But which part of the truck bears
\nthe maximum weight of the cargo\/truck? I ask this question all the time and many time I get answers like axle, wheel etc. But this is not correct as it is
\nthe humble AIR in the tyres which bears the maximum weight. So, the most
\ninsignificant, subtle and least-physical part holds together the most
\nsignificant. Similarly, Confidence of the people in the economy and the
\nGovernment is the most important factor driving the investments and thus
\ngrowth.<\/span><\/p>\n

Role of Market in \u201cValue\u201d and \u201cPrice\u201d<\/span><\/u><\/b><\/p>\n

So what explain the difference in
\nprice and value? Actually I have always felt that the fallacy may be related to
\nthe role of the market. Contrary to the general perception, the role of the
\nmarket is not to \u201cfind the Value\u201d<\/i><\/b> of an asset\/stock\/commodity but
\nthe role of the market is to \u201cprice\u2019<\/i><\/b> these things as an
\nintermediary of the forces of supply and demand.<\/span> Price of wheat in the market in
\nthe year of short production is high and it is low when there is bumper
\nproduction of wheat in the following year. The price of wheat is not determined
\nby the market keeping in view the relative value (which is same) but as an
\noutcome of demand supply forces. So, the value is perceived individually while
\nthe price is determined collectively by demand-supply forces. <\/span>It is not the role of
\nmarket to find the true \u201cvalue\u201d of an asset\/commodity but only to \u201cprice\u201d it
\nwhich is impacted and directed by large numbers of complex and diversified variables.
\n<\/span>Hence,
\neven when value investing finds that value and price are same; market is not
\ndoing anything to Value but it is just doing in which it is most efficient- to
\nprice.<\/span><\/p>\n

And all of a sudden, we can feel
\nthat this \u201cprice\u201d is more objectively arrived at than the \u201cvalue\u201d.<\/span><\/i><\/b> Value investing use highly
\nsubjective assumptions like discount rate, growth rate, terminal value, no
\ngrowth PE ratio etc. and so this makes intrinsic value highly subjective. <\/span>For example, expected
\ncash flows of an asset are subject to the wisdom\/strategy\/decision making of an
\nable manager who manages to extract much more value out of an asset due to his
\nwisdom and decision making. And that\u2019s why valuation is subjective- there is no
\nstandalone value which accrues to an asset on its own. Value is created by able
\nmanagers with wisdom and price is paid (and accepted) for this value subject to
\nprevailing market and general economic conditions.<\/span>
\n<\/span>Price
\nis what we know and value is what we perceive.<\/span><\/p>\n

In Real Life Valuation is
\nSubjective<\/span><\/u><\/b><\/p>\n

In real life things are also
\nlike that. Valuation is subjective- just take the recent case of coffee retail
\nchain Caf\u00e9 coffee day (CCD) which is on the verge of sale. Can we say that CCD
\nhas one and only one intrinsic value? No, because its value will accrue
\ndifferently to each buyer. Tata coffee\/Tata-Starbucks can extract big synergy
\nby consolidating CCD with them and thus creating more value as compared to
\nother buyers with unrelated business like Dabur or even Coca cola. But the
\nlikes of ITC who are trying hard for long time to build a branded FMCG business
\ncan see this as a big opportunity and will be ready to pay much higher price
\nbecause they will be hopeful of creating more \u201cvalue\u201d than by spending the same
\nmoney for promoting their other in-house brands. So whenever this will happen
\nthere will be a fierce fight for the control of CCD.<\/span><\/p>\n

Let\u2019s take the case of ITC. ITC
\nhas not performed that well in last 10 years or so. So how value investing would have valued
\nITC 10 years ago could have been very interesting. ITC was churning massive
\nvolumes of cash and it had grand plans for doing big in FMCG business. Value
\ninvesting would have arrived at a very lucrative value keeping in view the past
\nrecord (in creating a great FMCG brand in Aashirwad) and low cost of capital of
\nITC. But the most significant part in any business valuation is qualitative part
\n(and impact of intangibles) which is not captured that well by value investing.
\nJust like our traditional accounting which has no tools to evaluate intangible
\nassets. But we all know that net worth in fact is the minimum value as
\nbusinesses get maximum value from the intangibles like brands, technology,
\nPatents, customer loyalty, information and data which are not assigned any
\nvalue in the balance sheets by traditional accounting (not much even by Value
\ninvesting).<\/span><\/p>\n

So the story moves forward and
\nITC couldn\u2019t create the value. First, it was not vry wise in allocating
\ncapital. It wasted it in hotel business which is highly capital intensive but
\nlow return business. In FMCG- apart from Aashirwad it failed miserably. It
\ninvested and focused on second standard products in crowded segments like
\nYippee, Sunfeast, Bingo which are forced choices…nowhere near Maggi, Lays
\netc. I don’t think it could ever be a leader in any of these products…when
\nMaggi was hit badly due to bad press it could not do anything even at that time.
\nActually Aashirwad was a great venture and I was thinking at that time that ITC
\nwould make a killing in Pulses\/Spices with its Aashirwad brand but instead they
\nfocused on other low margin businesses like stationary\/Hotels and other crowded
\nFMCG products with very strong brands. The main reason for me to buy Tata
\nchemicals (Before demerger of branded product business) was their foray into branded Pulses and Spices business and Tata has
\ncreated a great brand in the last 5 years or so. Tata chemicals has really
\nleveraged its supply chain and brand recall in creating niche products (Tata
\nSampann Brand). That\u2019s why Tata chemicals is already giving almost three times
\nreturns (Including value of Tata consumer post-demerger).<\/span><\/p>\n

It is very tough to create strong
\nbrands in FMCG sector which is already having strong brands. Inorganic growth
\nvia acquisitions should have been a much better strategy than building brands
\nfrom the scratch. In today\u2019s world it is very costly. So I feel a better way
\nfor ITC was to acquire a good company in FMCG with good brands like last year
\nZydus wellness did by picking Complan\/Glucon-D and Horlicks was acquired by
\nHUL. These are master steps; CEOs are paid for this. Sometimes I felt ITC
\nshould have sensed the opportunity in premium whisky in India and instead of
\ninvesting capital and efforts in creating new brands in highly competitive FMCG
\nsector related to snacks etc. It should have attempted at acquisitions
\npreferably in liquor sector like Radico Khaitan (who once was looking for a partner). United spirits and UB were
\npicked by Diageo and Heineken but investing 20000-25000 cr for buying these
\ngiant Indian brands in high entry barrier Indian liquor industry would have
\nbeen a much better strategy for ITC and cash was never a problem for ITC. Liquor business is a much better extension
\nof its cigarette business and ITC understands the dynamics of this complex
\nregulated business in India much better than others and that\u2019s why I think ITC
\ncould have created more value for United spirits and UB businesses than by the likes of Diageo and Heineken.<\/span><\/p>\n

So the value is not created in a
\nlinear mathematical formula but by human wisdom and strategy which are not
\nconfined to any formula or any boundaries. Value is created and perceived subjectively.<\/span><\/p>\n

Here I remember something- the
\ndivine lovers Laila Majnu!! You know Laila wasn’t very beautiful but Majnu was
\na handsome guy. The king of the city liked him and he was very concerned to see
\nMajnu dying for Laila, an ordinary girl. So he invited Majnu to his palace and
\noffered him to pick any girl from his harem having the most beautiful girls of
\nthat time. But Majnu declined; king was shocked and asked, \u201cbut how can you
\ndecline these pretty girls for that ordinary girl Laila\u2026she is nothing against
\nthese women?”.<\/span><\/p>\n

“Well, my dear King, to see
\nthe divine beauty of Laila…you need my Eyes”, was the reply from Majnu.<\/span><\/p>\n

(Every asset that generates cash flows has an intrinsic value so can we say that Money has an intrinsic value? I have asked this question to the young fellow as his next assignment)<\/i><\/b><\/p>\n

(Views are personal. This post is taken from monthly Newsletter of this Blog. Reach me at oscillationss@yahoo.in)<\/p>\n","protected":false},"excerpt":{"rendered":"

(Click here for old post on value investing) Recently, a young student was discussing business valuation with me. The young fellow was quite intrigued by the business valuation models particularly DCF. He asked me about my preferred model for valuation and I told him that in my view these valuation models are good for having a theoretical viewpoint and conceptual framework but these are very primitive methods and not practical most of the time in the real world. So we need much better valuation theory\/methods which can stand on its feet during the evaluation process. I know many hardcore Value…<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-1078","post","type-post","status-publish","format-standard","hentry","category-blog"],"_links":{"self":[{"href":"https:\/\/oscillations.in\/index.php?rest_route=\/wp\/v2\/posts\/1078","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/oscillations.in\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/oscillations.in\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/oscillations.in\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/oscillations.in\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1078"}],"version-history":[{"count":0,"href":"https:\/\/oscillations.in\/index.php?rest_route=\/wp\/v2\/posts\/1078\/revisions"}],"wp:attachment":[{"href":"https:\/\/oscillations.in\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1078"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/oscillations.in\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1078"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/oscillations.in\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1078"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}