Rajen Gala

Let us imagine there is a “bhelpuri Wala” who has a stall in a famous marketplace. He has been in this business for a long time and has quite a reputation. He sells “Bhel” under the brand “Crispy Snacks.” With time his business starts growing. He soon has money to stock other products. So, he introduces Sev Puri, Dahi Puri, Chaat etc. under the “Crispy Snacks” banner. The addition of new products gives further impetus to his business. This kind of growth is what we typically call, “Organic” growth. It is growth that comes from within the same business. As time goes by and his business grows further, he starts accumulating a lot of money. With all the money at his disposal, he gets more ambitious and wants to invest the money in his business to make it grow even faster. But he realizes that even if he invests the money, it would not be possible to grow the business within a short span. So, he starts to think of another approach to attain quick growth. He hits upon another idea. He purchases four new snack shops in the same area lock stock and barrel and brings them all under the “Crispy Snacks” banner. Such growth which can be purchased, and which is essentially from the outside is known as “inorganic” growth.

Two friends A and B were sitting under a tree and engrossed in some discussion. They had a problem on hand. A’s father had agreed to pay him Rs 1 Cr. to help him settle in life But B’s father had made another arrangement. Not sure of B’s maturity, he was promised Rs 1.2 Cr after 3 years. B was showing off his offer to A saying that his father had given a much better deal. However, A not ready to give up argued that his deal was better because he was getting paid immediately. Now this argument went on for several hours till it was evening. However, this problem was just not getting resolved. This argument was taking place just in front of my office. Seeing these guys’ argument stretch across the entire day, I got curious and walked up to them to understand their problem. When they explained their positions, I offered to intervene provided they stopped their argument. I told them that in order to compare their situations it would be necessary to find out the net present value of the Rs 1.2 Cr that B had been promised after 3 years. Here, it is important to understand that the purchasing power of money reduces almost every day due to the rise in price of goods and services due to inflation. Therefore, the value of Rs 1.2 Crores after 3 years needs to be discounted by an assumed rate of inflation. Let us say the rate of inflation we assume is 8%per annum! The formula for calculating the net present value or NPV = Amount / (1+R) ^n where Amount is the Rs 1.2 Cr that B would get after 3 years. “R” is the rate of assumed inflation and “n” stands for a 3-year period. So, using the formula we get NPV = 1.2/ (1+.08) ^3 =  1.2/ (1.08) ^3 = Rs 95 lakhs Thus, I told B that the net present value of the money promised to him is Rs. 95 lakhs and hence it less than what A is receiving. I thus told them that one should simply not get blindly excited by the amount being offered in the future. Inflation is our constant companion and hence, it is imperative to calculate the present value of all future cash flows for comparison.

Quality at Reasonable Price, is investing in well-managed businesses that exhibit superior returns, generate strong cash flow and are available at attractive valuations. QARP investors, think in terms of economic value, which a business can create by delivering growth with superior returns. Quality at Reasonable Price ensures you invest in quality companies. Buying quality stocks at a reasonable price reduces the chances and extent of a fall in your net worth and thereby dramatically increase your chances of staying invested. Wealth is the natural outcome of staying invested and compounding growth of your investment. QARP can be based on the careful consideration of both investment risk (quality) and expected returns (price). This produce a portfolio that is style unaware and can include both value and growth, depending on the risk / return. Generally, investment is done in high quality companies, particularly those with suitable dividends which are available at reasonable price. This leads to improve long-term investor returns, while also providing downside protection in adverse markets.

Growth at a reasonable price (GARP) is an equity investment strategy that combines growth and value investing attributes. It is a fundamental driven investment strategy that balances pure growth and pure valuation, as the former tends to invest in high-growth, yet expensive stocks, while the latter may take a long-term investment to pay off. GARP investors are looking for a stock that is trading for slightly less than its estimated value that also has earnings growth potential. GARP investors do not necessarily stick to specific ratios or valuation metrics to help them select stocks. GARP investors usually do follow price/earnings (P/E = current share price/earnings per share) valuations in order to find investments that have been slightly discounted by the market. For instance, if XYZ Co., is currently trading at Rs.200 and its forecast earnings per share is Rs.12.5, the stock is trading at 16x its earnings. Depending on the industry, this P/E ratio could be high or low. A GARP investor would compare XYZ’s multiple to the multiples of other companies operating in the same industry. Typically, a P/E ratio in the 10x-20x range is reasonable for a GARP investor. Higher P/E multiples tend to indicate that the business is overvalued. GARP investors also look for low price/book ratios (P/B = current share price/book value per share) and a PEG ratio of less than 1 (PEG = P/E ratio/projected growth in earnings). While the criteria used to identify a quality company can differ, some shared attributes typically include Sustainable business model Sustainable business model and a strong competitive advantage are better positioned to maintain their market position and generate consistent profits over time. Consistent earnings growth Investors are typically more attracted to companies that have a track record of consistent earnings growth, as this is indicative of the company’s ability to sustain its growth in the future. Strong financials Companies that possess a robust financial position, characterised by a low level of debt, a healthy balance sheet, and strong cash flow, are typically regarded as being of higher quality when compared to those with weak financials. Management quality Companies with competent management team that have a proven track record of making sound business decisions are generally considered to be of higher quality. Since, GARP strategy is a hybrid solution for growth and value stock-picking, a GARP investor will experience a combination of returns.  For instance, a value investor will do better when markets are falling, while a growth investor will do best as markets rise. A GARP investor will be somewhere in the middle.

Simply speaking, the Price-to-book ratio (i.e., P/B ratio) is the ratio of Price of a stock to that of the value of its tangible assets and is used to compare a stock\’s market value to its book value. Book value is an accounting term denoting the tangible value of the company. It is the total tangible value made up of the assets of the company. Intangibles like “brand” name and “goodwill” are not a part of the book value. It is calculated as: P/B Ratio        =                                  Stock Price                                     Total Assets – Intangible Assets and Liabilities Therefore… What this means is that the lower the P/B, the better the value. A lower P/B ratio could mean the price that the market is quoting does not justify the current value of the assets of the company that it presently holds. One must remember that people pay a price of a stock not only based on its current assets but also based on future prospects of the company or industry in which it operates. Secondly… The value of intangibles such as goodwill, brand name, management team etc. can be considerable and stock buyers pay quite a premium for such intangibles. Hence, if the intangibles are valuable or if people believe that the company has good prospects in the future, they normally would be willing to pay a much higher price as compared with the value of its current assets. Hence… Despite positive outlook for the industry, if the P/B of the company is quoting low, it calls for more introspection about the company. Something could be fundamentally wrong in the company for the market to be quoting a low price. Perhaps the management is unstable or there is a leadership problem or there could be underlying labour problems in the company or any other factor that perhaps cannot be easily determined. But how is it useful to you & me? This ratio guards you against paying a very high price for a company because it compares the price to what you could recover if the company were to suddenly close down. Hence, while paying a price for a stock one should keep in mind its tangible and intangible assets on one hand and the prospects of both the company as well as the industry on the other hand. As with most ratios, it varies a fair amount by industry. For example… In the telecom sector, this ratio can be expected to be high in keeping with the bright prospects of the industry. Further to this, if the company is a leader in the industry, like Reliance Jio, the market will be able to sustain a high P/B ratio. This is one reason why the stock price of companies like Reliance Jio is high as compared to its book value. Therefore… A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else being equal. P/B ratios do not, however, directly provide any information on the ability of the firm to generate profits or cash for shareholders.  To Sum Up What: The Price-to-book ratio (i.e., P/B ratio) is used to compare a stock\’s market value to its book value. How: It is calculated by dividing the current closing price of the stock by the latest quarter\’s book value per share. Why: This ratio guards you against paying a very high price for a company because it compares the price to what you could recover if the company were to suddenly close down.