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Nestle India Limited | NESTLEIND | NSE - Food and food processing

INR in Million. Fiscal year ends in December. Figures are consolidated and restated.

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Intrinsic value and stock valuation

Market Capitalization and Net Worth

Net worth also called as "Shareholder Equity", "Stockholder's Equity", "Net Asset Value" or "Book Value". It essentially means total assets minus total liabilities.

When you buy shares of a company, you are essentially buying a share of the company's net worth and a share of the company's future cash flows. If the company's net worth and cash is growing, the value of the company is going up because of which the company's share price goes up.

The above chart displays the share price and the book value per share. Generally the share price is above the book value price but during a recession (e.g. 2008) or due to some other factors, the share price can go below the book value per share. Smart bargain investors buy shares when the current market price is below the book value i.e. the stock is undervalued but at the same time you have to ask yourself why the current market price is going below the book value price. Is it because of some serious fundamental problems with the company?

Current Market Price : 4728.95 Rs. on 23-April-2014

Enterprise Value of Nestle India Limited is ___ Rs.   (Sign up for Premium Service to see the enterprise value.)

Market Capitalization = Share price x No. of shares ( theoretical price at which you can buy the whole company )
Enterprise Value = Market Capitalization + Short term debt + Leases + Long term Debt + Preferred Stock - Cash in hand

Owner Earnings - Nestle India Limited

The term Owner Earnings was introduced by Warren Buffet. It basically shows us the cash that a business can generate for its silent partners (shareholders). It tells us the amount of cash that remains after subtracting average capital expenditure. Capex is the money required to maintain or expand the company's Property, Plant and Equipment.

Net Income can be easily manipulated but it's difficult to manipulate Owner Earnings. You should focus on owner earnings rather than reported earnings because it gives you better insight into the company's operations and tells us if the company can stand on its own feet or does it need to sell more stock and get loans to operate and grow. Invest in companies which have positive and growing owner earnings.

Owner Earnings = Net Income + Depreciation + Amortization + Changes in Working Capital - Average Capital Expenditures.

Note - For more information on Owner Earnings check Warren Buffet's 1986 Letter to Shareholders.

CROIC - Cash Returned on Invested Capital

What the hell is CROIC aka CROCI, Cash Returned on Invested Capital, tells us how efficiently a company's operations and management can invest and reinvest capital to generate even more cash. Capital intensive companies such as airlines and auto manufacturers tend to have very low CROIC because they require huge capital investments to generate relatively small amounts of cash.

Look for companies with positive and increasing CROIC ideally above 10% but it should not be extremely high (e.g. 45%) because that cannot be sustained for long.

2 year Median CROIC for Nestle India Limited is 0.8 %. Taking a median, unlike averaging, does not skew the number to either the high or low side.

CROIC = Free Cash Flow / Invested Capital
Invested Capital = Short term debt + Capital Leases + Long term Debt + Total Equity

Stock Valuation Models

Valuation in simple words is the process of estimating what something is worth. The valuation models given below are used by investors like Warren Buffet, Investment bankers and private equity firms as the starting point for evaluating potential mergers and stock acquisitions. You can use the same models to figure out if the current market price of the stock is overvalued or undervalued. Do not blindly buy or sell stocks just because one valuation model tells you to although if three or more models come to the same result then it may be wise to act on that decision.

Remember investing is a combination of science and art. These models give you an estimate which may or may not be accurate. There are some things which cannot be captured by these models such as the value of a brand name or the value of a patent and other intangible assets. So keeping these few things in mind explore the section below and see the real picture of the company as seen by market professionals.

Free Cash Flow Yield

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Assume you are in the market to buy a running company. You look at Company 'A', the owner of 'A' wants 50 Lakh Rs. The company has 10 Lakh Rs. of debt and 1 Lakh Rs. cash in bank. So you calculate the Enterprise Value for 'A' which is 50 + 10 - 1 = 59 Lakh Rs. You calculate free cash flow from the cash flow statement which is 5 lakh Rs. From this data you get the FCF Yield 0.0847 (5/59) or 8.47%. All things equal, for your investment of 59 Lakh Rs, you can expect an 8.47% return yearly. You do the same calculation for company 'B' and get FCF Yield of 20%. So it makes more sense to buy company 'B' instead of 'A'. Now compare the latest value shown in the above chart with FCF yield of some other company whose shares you want to purchase. Buy the shares of the company which has a higher yield. Ideally the yield should be greater than 8%.

FCF Yield is not a make or break valuation, it's a quick and dirty number that applies to slower growth companies than rapidly growing ones. Don't put all your faith in Cash Yield. A high Cash Yield can quickly tell you that a company may be grossly underpriced. A low cash yield does not necessarily tell you the opposite.

FCF Yield of Nestle India Limited is ____ %

FCF Yield = Free Cash Flow / Enterprise Value
Enterprise Value = Market Capitalization + Short term debt + Leases + Long term Debt + Preferred Stock - Cash in hand

Note - A negative FCF Yield tells you that after buying the whole company you will have to put more cash in the business to keep it running instead of taking cash out of the business.

Current & Historical Price to Earnings Ratio of Nestle India Limited

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The P/E ratio looks at the relationship between the stock price and the company's earnings. The higher the P/E the more the market is willing to pay for the company's earnings.

By comparing price and earnings per share for a company, one can analyze the Market's stock valuation of a company and its shares relative to the income the company is actually generating. It is usually used to compare the P/E ratios of one company to other companies in the same industry sector. Ideally you should avoid investing in a company which has a PE Ratio greater than 20.

P/E Ratio = Market Price per Share / Consolidated Earnings per Share

PE Ratio Valuation

Price per share = 10 Years Median P/E Ratio x Last 3 years median EPS

Since this intrinsic value depends on Earnings per Share which is based on reported earnings or "accounting profits" which can be manipulated. We take the median EPS of the last 3 years instead of the current EPS and median P/E ratio for the last 10 years instead of the last trailing 12 month P/E ratio.

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Discounted Cash Flow Valuation

The purpose of a discounted cash flow is to find the sum of the future cash flow of the business and discount it back to the present value.

We start with an assumption that we want to earn 10 percent on our investment yearly. So the question we are going to answer is "What price can I pay for Nestle India Limited if I want to earn 10 percent annual return. Our discount rate for this model is 10%. We use the multi-year median Free Cash Flow growth rate for DCF valuation. Terminal growth rate in this model is 0%. The discount rate and the forecasted cash flow numbers are then used in the net present value formula which calculates the intrinsic value of the company as well as the intrinsic value per share.

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NPV of Nestle India Limited is ____ Rs.

DCF Intrinsic value per share : ____ Rs.

2 Stage Discounted Cash Flow Valuation

The DCF valuation model given above uses the Free Cash Flow growth rate of the past to forecast the future free cash flows. This approach has one problem, what if the company is not able to sustain the past growth rate?

The 2 stage discounted cash flow valuation calculates Nestle India Limited's future cash flow for the next 10 years assuming 2 different rates of growth in cash flows of 10% (years 1 to 5) and 8% (years 6 to 10). The best practice is to keep growth rates as low as possible. Discount rate is 10% because we want to earn 10 percent on our investment yearly. The terminal growth rate in this model is 0%. As equity investors, we are intrested in the value of the company's shares so we deduct its net debt from the net present value.

Net Debt20,001,200,000 Rs.
Shares Outstanding96,415,716

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NPV of Nestle India Limited is ____ Rs.

2 Stage DCF Intrinsic value per share : ____ Rs.

Net Debt = Long Term liabilites - Cash

EPS Growth Valuation

Similar to Free cash flow valuation model we project the Earnings Per Share for the next ten years. Then we use an estimated Price/Earnings ratio to calculate the future stock price which is then discounted back to present value giving us an intrinsic value per share.

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Graham Number Valuation

Graham Number was created by Benjamin Graham, the father of value investing. It calculates the stock's maximum fair value based of its Earnings per share and Book value per share. Stocks trading below their Graham Number may be undervalued.

Graham's Fair Value Price = Square Root of (22.5 x EPS x BVPS)

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Note - We have modified the formula a bit, instead of taking the trailing 12 month EPS we take the median of trailing three years Diluted EPS.

Note - Graham number is useful for companies which depend more on their tangible assets (e.g. Manufacturing, Oil & Gas). It is not so useful for companies which depend more on their intangible assets (e.g. Pharma, IT).

Intrinsic Fair Value Share Price Range for Nestle India Limited

DCF valuation: ____ Rs.
2 Stage DCF: ____ Rs.
PE Ratio valuation: ____ Rs.
EPS Growth Valuation: ____ Rs.
Graham Number: ____ Rs.
Book Value: 186 Rs.

Median Fair Value: ____ Rs.
20% Margin of Safety: ____ Rs.
Current market price: 4,729 Rs.
PEG Ratio: ____

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Note - Ideally EV/EBIT multiple should be approximately 30% lower than PE Ratio but if large debt is involved, the EV/EBIT tells the true story and is higher than the PE ratio.

Note - Margin of safety is a principle of investing in which an investor purchases stock only when the market price is significantly below its intrinsic value. This difference allows an investment to be made with minimal downside risk. The term Margin of Safety was introduced by Benjamin Graham (Warren Buffett's teacher) in his famous book The Intelligent Investor

Note - Adjusted PE Ratio is calculated as Current market price / 3 year median EPS.