Business Analysis Post 5: Multi-bagger stocks & Huge opportunity size (1/n)
As a business analyst its extremely crucial to understand the opportunity size/target Addressable market that's available in front of a company to grow. Everyone wants a big and growing market. (2/n)
Although this term is used directly in the start up space the listed market professional use it in a different way i.e. long runway of growth which simply means company's potential to achieve higher revenues should not get saturated quickly. (3/n)
The companies which are smaller in size, run by great management with no corporate governance issues & Huge opportunity size in front of them with competitive advantages getting build generally get "out of the park" valuation multiples by the market (4/n)
To quote Charlie Munger "Invert, always Invert" - Does it than mean that being a Big fish (large company) in a small pond (small/medium industry size) a bad thing? The answer is a straight NO! (5/n)
There are tremendous e.g of companies which started with focusing on a Niche (1 product/1 segment/1 consumer problem) & have scaled up really well over the yrs by becoming dominant players in their niches with higher mkt shares & entering into similar adjacent territories. (6/n)
E.g: Eicher Motors
Eicher could have competed with the large fish (Hero & Bajaj) in a large pond (100cc mkt), but chose to carve its own niche & decided to become a big fish in a small pond (300cc segment). That has paid off for Eicher. (7/n)
Eicher could have competed with the large fish (Hero & Bajaj) in a large pond (100cc mkt), but chose to carve its own niche & decided to become a big fish in a small pond (300cc segment). That has paid off for Eicher. (7/n)
Now Let's understand 6 various angles to why the phrase "We have a big opportunity size" by promoters keeps money managers super excited & such companies become "hot" stories to invest in. In this thread we will be understanding 4 angles out of 6. (8/n)
And remaining 2 angles we will be covering in next business analysis thread.
First Logic-The Simple math
Expected Revenues = Expected Quantity you can sell * Price per unit
OR with a different angle it can also be written as
Expected Revenue = Industry Size * Market Share (9/n)
First Logic-The Simple math
Expected Revenues = Expected Quantity you can sell * Price per unit
OR with a different angle it can also be written as
Expected Revenue = Industry Size * Market Share (9/n)
Hence a large customer base/Industry Size provides an opportunity to sell more quantity by increasing Market Share.
2nd logic - "Even if We capture 1% of this market we will become a billion dollar company" ClichΓ©
Imagine industry of size 1,00,000 crs.(10/n)
2nd logic - "Even if We capture 1% of this market we will become a billion dollar company" ClichΓ©
Imagine industry of size 1,00,000 crs.(10/n)
Even if you are able to capture a 5% mkt share that turns out to be a 5000 crs revenue run rate business easily putting you among the top quartile in terms of scale in India.
Whereas even if we have 50% mkt share in a 1000 crs industry. (11/n)
Whereas even if we have 50% mkt share in a 1000 crs industry. (11/n)
That gives you a revenue run rate of just 500 Crores per Annum.
3rd Logic-High Potential Topline=Mkt going nuts=High valuation metric=Easy Equity Dilution
Let's assume a company is entering into a new segment & you are trying to identify the market size of the new segment.(12/n)
3rd Logic-High Potential Topline=Mkt going nuts=High valuation metric=Easy Equity Dilution
Let's assume a company is entering into a new segment & you are trying to identify the market size of the new segment.(12/n)
Assume it comes out to be 5000 crores. After reading companyβs action plans you come to a conclusion that can the company gain sizeable market share (lets say approx 15-20%) in next 10 yrs?
Your confidence on management based on their past execution will guide you here. (13/n)
Your confidence on management based on their past execution will guide you here. (13/n)
Imagine after doing this you conclude-yes, mgnt will be able to capture market share
Assuming industry remains at the same level even after 5 yrs from now at 5000 crores this means that a company would be generating approx 750-1000 crores additional revenue in next 5 yrs (14/n)
Assuming industry remains at the same level even after 5 yrs from now at 5000 crores this means that a company would be generating approx 750-1000 crores additional revenue in next 5 yrs (14/n)
Now you estimate what margins the company will be able to maintain given company's product quality & competition in the industry to arrive at the incremental profit the company can generate and that will lead to valuations.
For example: (15/n)
For example: (15/n)
You believe the company can maintain 10% margins on this incremental topline you can have additional profits of 75-100 crores from this new segment (10% * 750-100 crores).
After which through help of exit multiple you decide what incremental mkt cap this company can obtain(16/n)
After which through help of exit multiple you decide what incremental mkt cap this company can obtain(16/n)
(Note: We have kept concept like conglomerate discount, Sum of total parts and incremental Capex requirement calculations etc out of this discussion for time being)
Let's say the exit multiple to this segment is 20. So we derive at the incremental Mkt cap of 1500-2000 Crs (17/n)
Let's say the exit multiple to this segment is 20. So we derive at the incremental Mkt cap of 1500-2000 Crs (17/n)
Do one thing increase the mkt size of new segment company is entering to 10000 crs & the the additional valuations you can get rises to 3000-4000 crs!
This is why mkt gets excited if some capable mgnt announces it plans to enter into a new segment which has huge opportunity size
This is why mkt gets excited if some capable mgnt announces it plans to enter into a new segment which has huge opportunity size
4th Logic-The "Re-investment" Headache
The valuation of a business depends a lot of whether it has re-investment opportunities. No one, especially in a growth economy like India, likes a dead cash throwing business or a business which has achieved it's steady state growth(19/n)
The valuation of a business depends a lot of whether it has re-investment opportunities. No one, especially in a growth economy like India, likes a dead cash throwing business or a business which has achieved it's steady state growth(19/n)
Ps: pls don't quote Warren Buffett's Coca-Cola Investments, we will get to that in later posts of why for him that investment may have made tremendous sense.
When a business has opportunity size it can re-invest great amount of capital back into the business.(20/n)
When a business has opportunity size it can re-invest great amount of capital back into the business.(20/n)
This give investors a peaceful sleep as the capital allocation by the mgnt, one of the main problems in Indian capital mkts,is taken care of. Investors mainly fear mgnt not ploughing back money into it's main business (Condition Applied:ROIC>Cost of capital as it leads to: (21/n)
1)Cash getting accumulated on B/s which basically destroys ROCEs/ROEs as cash yields/returns are much lower than core operating business
2)Wrong usage of Cash:Related Party Loans given to promoter's private entities,parking money into MFs like an investment vehicle etc
2)Wrong usage of Cash:Related Party Loans given to promoter's private entities,parking money into MFs like an investment vehicle etc
3)Cash being used for inorganic growth in acquiring companies (very problematic if it's the acquisition are also into another industries)at unreasonable high valuations leading to excessive goodwill
4)Mkts derating PE of your stock due to lower re-investment opportunities.
4)Mkts derating PE of your stock due to lower re-investment opportunities.
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