If you are a long-term investor, it is far more important for you to understand what drives a company’s value creation than a company’s managerial ability, stock price and return performance. In the long run, creating lasting value is not simply a function of exceptional managerial skill. Competing forces drive returns towards the cost of capital or expected return. The two key determinants of evaluating a business’s potential for sustainable value creation are the industry in which it operates and the size of the opportunity it has.
In order to analyze how or whether a company can create value in a sustainable way, the industry is the right place to start. Every investor should be able to easily estimate the annual growth of an industry and the size of the industry at least 10 years from now.
For example, let us consider the asset management company (AMC) business. The assets under management (AUM) in the AMC industry of India is ₹35.15 trillion by 2021. Suppose, in the population of 139.58 crore in the country, which segment can invest for 20 to 50 years i.e. about 50% of the population. This means that the per capita AUM is approximately . Is ₹50,000, i.e., the total AUM of India divided by its investable population.
Now, if we expect the industry to grow at a 15% annual rate over the next 10 years by 2030, the estimated per capita AUM in that year is approximately ₹2 lakhs.
Then, we move on to understand the following: Will India’s population growth slow significantly over the next decade? Will financial literacy increase the lifespan of the investable population? With these questions answered, one can easily estimate the size of the industry opportunity in 2030.
Once we have the estimated opportunity size of the industry, it is time to further study the growth drivers of the industry. With extremely poor financial literacy, access to various financial products in India is much lower than the world average and other developed countries. According to some articles, while the AUM in the US exceeds the country’s GDP by 103%, it is only 15% in India.
Moving on to the company, we must not forget that sustainable value creation is also largely the result of company-specific factors usually driven by a business’s gap or competitive advantage such as their internal strategies for self-improvement. . Regardless of whether a company is a leader in the industry or not, it is important to determine the growth potential of a company within the relevant industry in the coming years. Then ask yourself whether the company’s market share will increase, and by how much? In terms of the gap and other opportunities in the industry, you can arrive at 2030 revenue, ie (industry size multiplied by the chosen company’s market share).
Again, in terms of industry earnings before interest and tax margin (assessed through operating, financing and combined leverage), we can easily calculate a company’s operating profit and calculate whether to maintain this growth or increase market share. Deduct the estimated capital expenditure required for in industry. Finally, this brings us to the free cash flow that the business will earn in 2030, which, discounting back on the cost of capital (the business’s required rate of return or long-term average ROE), gives us the value of the business by 2021. .
Kaushik Mohan is the fund manager of Mott PMS.
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