Posted by Felicity > 2017-04-08 09:43 | Report Abuse

A very good article and very accurate, Keep it up!

Posted by bracoli > 2017-04-08 09:47 | Report Abuse

Nice. Thanks rick

Posted by tong01 > 2017-04-08 10:30 | Report Abuse

I find myself benefit greatly from this article, it open my eye!!! Thanks Rick.

Posted by stockraider > 2017-04-08 10:50 | Report Abuse

As investor u need to understand growth v value when u invest and at the end u still need benchmark....the equivalent IRR rates loh...!!

Say u bought a stock with a historical 30% growth and at a PE 35%....is it better than a stock with PE 6x with no growth leh ??

It is very subjective loh.....bcos for growth stock....u need to ask yourself....how long the growth can sustained loh ??
Say there is 50% probability the growth can sustained at 30% over next 3 yrs worthwhile and then taper of to 10% over next 2 yrs....then flat return or not ??

For the value stock...if 50% can sustain the eps at PE 6x for next 5 yrs....which one will u pick leh ??

Assuming risk free interest rate at 3% pa loh..!!

Conservative investor will pick the value stock...bcos it is already giving a high earning yield of 16% pa based on PE 6x.

For growth investor...they look at the growth upside...the EPS will double 1st 3 yrs and then gain another 30% the next 2 yrs loh...!!

Raider will prefer to chose option 1 the value stock....bcos it already giving good return with above 16% pa yield although without eps growth loh.....!!

But there is uncertainty....notice the probability is 50% apply for both stock loh.....!!

Still it is better to invest then not invest bcos the alternative risk free rate is only 3% pa mah....!!

Posted by probability > 2017-04-08 12:46 | Report Abuse

this comparison is too crude..P/E is being prejudiced again:(

we need to know how did the Equity of Company A went up so high resulting in reduced ROE despite a phenomenal increase in earnings..

Posted by probability > 2017-04-08 13:35 | Report Abuse

very true...all this Cost of Capital..doctorate lectures is indeed useless in practical sense...its all about relative valuation...at the end you are comparing with risk free interest rate....and if at all you need to consider more variable (internationally) - u can add the currency direction as factor.

Posted by stockraider > Apr 8, 2017 10:50 AM | Report Abuse

As investor u need to understand growth v value when u invest and at the end u still need benchmark....the equivalent IRR rates loh...!!

Say u bought a stock with a historical 30% growth and at a PE 35%....is it better than a stock with PE 6x with no growth leh ??

It is very subjective loh.....bcos for growth stock....u need to ask yourself....how long the growth can sustained loh ??
Say there is 50% probability the growth can sustained at 30% over next 3 yrs worthwhile and then taper of to 10% over next 2 yrs....then flat return or not ??

For the value stock...if 50% can sustain the eps at PE 6x for next 5 yrs....which one will u pick leh ??

Assuming risk free interest rate at 3% pa loh..!!

Conservative investor will pick the value stock...bcos it is already giving a high earning yield of 16% pa based on PE 6x.

For growth investor...they look at the growth upside...the EPS will double 1st 3 yrs and then gain another 30% the next 2 yrs loh...!!

Raider will prefer to chose option 1 the value stock....bcos it already giving good return with above 16% pa yield although without eps growth loh.....!!

But there is uncertainty....notice the probability is 50% apply for both stock loh.....!!

Still it is better to invest then not invest bcos the alternative risk free rate is only 3% pa mah....!!

Posted by yfchong > 2017-04-08 13:55 | Report Abuse

Value your writing bro ricky

Posted by cheoky > 2017-04-08 15:06 | Report Abuse

great clarification to me from this article. question pop up in mind and greatly answered by raider. double benefits. very done raider and ricky...

Posted by Ricky Yeo > 2017-04-08 15:07 | Report Abuse

Tell me if risk free rate doesn't form the leg of cost of capital then what is?

Posted by Risk Rider > 2017-04-08 15:10 | Report Abuse

Ricky Yeo is another good talker, all talk only but never proved his skill in picking up good stocks CONSISTENTLY.

Posted by Risk Rider > 2017-04-08 15:13 | Report Abuse

Ricky, until you proved your investment skills, all your opinions are still your personal opinions.

Posted by Risk Rider > 2017-04-08 15:13 | Report Abuse

Don't question me if I contribute anything, I do not come here to teach people, I come here for stock information, not school materials.

Posted by probability > 2017-04-08 15:15 | Report Abuse

yes Risk free rate forms the leg of COC....but that should be the only leg. all others are incorporated for nothing but considering risk factors only.

Thus if one really look at buying stock as buying a piece of business...and depending on 'how much he knows the business' these 'additional factors to consider risks' which are incorporated into the risk free interest rate can easily be evaporated...

Posted by 张天师买股票 > 2017-04-08 15:16 | Report Abuse

如果一个哲学可以完胜另一个哲学，那哲学就不是哲学了。

何必浪费时间争论呢？

Posted by stockmanmy > 2017-04-08 15:23 | Report Abuse

ricky

thanks for a fine effort but,

DCF can be used to justify practically any price that needs justifying.

Analysts are a very creative lot....even if they are not very good at making you rich.

Posted by Ricky Yeo > 2017-04-08 15:27 | Report Abuse

Don't quite get you. You saying only risk free rate should be used but not other stuff like risk premium?

@ Cikgu Zhang, this is mental model not philopshy

Posted by probability > 2017-04-08 15:35 | Report Abuse

Ricky, actually i am saying..

there is even no need to bring the risk free rate into the picture...as it does not really add value to the decision making of stock selection...as you are just comparing the end value of the cash you will receive (accumulate) with the cash your forked out and compare this CAGR with a reference minimum achievable CAGR.

I dont see an issue of it (risk free interest rate or COE) being any arbitrary value... when its about stock comparison and selectivity...provided you are able to & are predicting the FCF-E flows in the future accurately with certainty.

Posted by Ricky Yeo > 2017-04-08 15:36 | Report Abuse

ok all, that's why I title this 'How not to do valuation' not how to. If I write it as how to, there will be countless valuation methods that can be use besides DCF depending on the business. DCF is a model, thus it is not perfect, everyone needs to understand its limit, so does every other valuation model out there - Dividend model, Ben Graham model, Steady State + Future State valuation, Net-net, assets-based, reverse DCF etc.

But the more pressing problem is people not considering the cost side of growth.

Posted by probability > 2017-04-08 15:39 | Report Abuse

Please elaborate more on this "But the more pressing problem is people not considering the cost side of growth."..

your sharing is definitely appreciated...as it stimulates contrary thinking..he he

Posted by Ricky Yeo > 2017-04-08 15:48 | Report Abuse

ok probability, you are right, it is all about how much you put in vs how much you can take out.

If there's 2 investment, one you put in $100 now, and you get $200 (including principle) by year 5, in between you don't get any.

Another you put in $100 as well, and you get $20 Yr1, $20 Yr2, $20 Yr3, $20 Yr 4 and $20 + $100 principle on Yr 5.

Both have the same amount of in and out, same CAGR, would you value both differently or the same?

Posted by probability > 2017-04-08 15:58 | Report Abuse

Ricky...i would go for second investment (co. B), but that's provided the following:

- company B provides dividend cash flow as you had mentioned above
- & there are no other potential investment with CAGR higher than CAGR of Co. A &B that i can use the Dividend to reinvest....if co. B is the only second option i have i will reinvest dividend in Co.B.


but in reality how many company pay dividends...and do we really need to make our standard reference COC at 10% value? why not go for 20%?
and whats the average return of BURSA? thats like risk free interest rate right?

again...my decision making to select Co. A or Co. B did not take any consideration on any absolute COC...its only relative valuation.

Posted by popo92 > 2017-04-08 16:10 | Report Abuse

Good writing!

Posted by Ricky Yeo > 2017-04-08 16:30 | Report Abuse

yea dont worry about whether it is dividend or not. If both are a sure thing, majority would go for 2nd over 1st even though CAGR wise, both are the same.

And you are right you get those amount out to reinvest whereas on 1st case you have to wait to year 5. It is time value of money concept. We discount them differently because the difference in the timing of cash flow. It is a form of opportunity cost. You get compensated earlier for 2nd than the 1st.

Posted by probability > 2017-04-08 16:46 | Report Abuse

a very high COE in your valuation will cause us to over-appreciate dividends....imagine if instead of paying dividends, Co.A chose to reinvest on their own business which provides say g = ROIC x RR = 20% x 40% = 8%......one may under-appreciate this growth of Co.A though it is evidently visible as 8% compared to Co.B if one values Co.B by sticking to COE of 10% having seen the dividend payout of 40%.

(Assume the dividend payout rate of co.B is the same as Co.A's reinvestment rate but without any re-investments taking place in Co. B due to lack of scope/opportunity).

I am saying dividends are over-appreciated because in reality it is not true that we can make returns more than 8%....when one can see what has been the average market return is here in Malaysia. Lets not compare Bursa with U.S.

Posted by valuelurker > 2017-04-08 16:51 | Report Abuse

Stop misleading ppl la who says you cant use PE

I pity all the aunty's and uncle's and general public who read this who are going to dismiss earnings multiples

There's a thing called Fundamental PE, google it and let Damodaran lead the way. It ties in all the ROC/ROIC/ROE and costs of capitals (ie 'excess returns'), with growth, and how a deficit actually destroys value when you grow etc

When it comes to the mathematical / theoretical, the very foundations of intrinsic valuation, youre weak. You need to ask yourself, how many years have you been doing this, and if you read and spent that much time but still do not 'see' or are able to 'connect' these concepts......

Youre a pro or youre a noob, thats life

Posted by Ricky Yeo > 2017-04-08 17:29 | Report Abuse

Probability I know there are many things we can discuss, the topics are endless. I am just showing you everything else the same, you would prefer B over A, even if both are bonds, because you are taking into the consideration of opportunity cost right?

Posted by Ricky Yeo > 2017-04-08 17:31 | Report Abuse

Valuelurker, good to see you are back again. You either understand the article or you don't, or read again, that's life indeed.

Posted by Amit Khindriya > 2017-04-08 17:38 | Report Abuse

Ricky, very good article, like your style of writing. ...keep it up and ignore some "mean" comments here to condemn.
I totally agree that cost of capital must be considered into the growth story.

Posted by Flintstones > 2017-04-09 06:14 | Report Abuse

You guys dont shoot jt yeo so much la. Although he has no track record in i3, he has posted many good articles which content is original. Please keep up the good work! One must remember investing is not just about making money. It is also about learning.

Posted by 3iii > 2017-04-09 06:27 | Report Abuse

Assuming every thing is equal in 2 comparative companies, you will give a higher PE to the stock with the higher ROE.

It is better to own a great company at a good (fair) price than a good company at a great (cheap) price.

Why do you wish to pay a higher price (higher PE) for a company with lower ROE when you can pay a lower price (lower PE) to acquire a company with higher ROE, which is a better company, assuming everything is equal?

Posted by 3iii > 2017-04-09 06:27 | Report Abuse

Thanks again to KC for educating me.

Posted by stockraider > 2017-04-09 11:19 | Report Abuse

WHETHER GO FOR HIGH ROE WITH HIGH PE OR LOW ROE WITH LOW PE INVESTMENT.....ALL THESE COME TO A SINGLE COMPARISON FOR ALL....THE EFFECTIVE INTERNAL RATE OF RETURN OR IRR OF YOUR INVESTMENT LOH..!!

FOR EXAMPLE BOND THAT PAYS 6% PA....BUT TRADE AT RM 0.50 MEANS U R GETTING PE 8X EFFECTIVE YIELD OF 12.5% LOH.....!!

A STOCK THAT TRADE AT RM 50.00 WITH ROE 60%....WITH EPS OF RM 0.20.....U R GETTING PE 25X OR EARNING YIELD OF 4% PA....BUT U NEED TO FACTOR IN THE POTENTIAL GROWTH IF ANY IF U PAY A PREMIUM PRICE FOR THE INVESTMENT.

A STOCK THAT SHOW ROE 6% PA BUT TRADE AT RM 0.40 BUT WITH EPS OF RM 0.07 WITH NO GROWTH....MEANS THE STOCK HAVE PE 6.7X OR EARNING YIELD OF 15% PA.

NOW U TELL ME WHICH INSTRUMENT U WILL BUY OUT OF THE 3 CHOICES ??

Posted by kcchongnz > 2017-04-09 13:48 | Report Abuse

Posted by Flintstones > Apr 9, 2017 06:14 AM | Report Abuse
You guys dont shoot jt yeo so much la. Although he has no track record in i3, he has posted many good articles which content is original. Please keep up the good work! One must remember investing is not just about making money. It is also about learning.


Good on you Flintstones for coming out with a very good comment.

Come on, this is a very good article, and JT is sharing it here. It deserves good comments.

I cannot imagine there is someone who posted such a comment below. In my opinion, JT Yeo is a much better investor than him, whether theoretically or practically.



Posted by valuelurker > Apr 8, 2017 04:51 PM | Report Abuse
Stop misleading ppl la who says you cant use PE
I pity all the aunty's and uncle's and general public who read this who are going to dismiss earnings multiples
There's a thing called Fundamental PE, google it and let Damodaran lead the way. It ties in all the ROC/ROIC/ROE and costs of capitals (ie 'excess returns'), with growth, and how a deficit actually destroys value when you grow etc
When it comes to the mathematical / theoretical, the very foundations of intrinsic valuation, youre weak. You need to ask yourself, how many years have you been doing this, and if you read and spent that much time but still do not 'see' or are able to 'connect' these concepts......
Youre a pro or youre a noob, thats life

Posted by sunztzhe > 2017-04-09 14:44 | Report Abuse

Is this article "How not to do Valuation" akin to much ado about nothing or "cannot see the wood from the trees"?

Nevertheless I do like the conclusion though which aptly sums up this article

“The first principle is that you must not fool yourself – and you are the easiest person to fool.” - Richard Feynman

Fooling oneself in this article is going about the convoluted way in thinking that a clear message had been brought across but ended up in opaqueness.

There are two basic topics here which was not addressed to adequately
- Basis of determining Intrinsic Valuation
- Efficiency of capital usage vs its cost of capital

I would not wish to dwell into the topic of determining intrinsic valuation. However I am rather intrigued by the writers discussion on efficiency of capital usage without reference to its cost of capital.

I am rather surprised on why ROCE was not brought into this article.

As some of us may very well know, the return on capital employed measures the proportion of adjusted earnings to the amount of capital and debt required for a business to function. 

For a company to remain in business for the long term, its return on capital employed should be higher than its cost of capital

ROCE is commonly used to compare the efficiency of capital usage of businesses within the same industry( I presume the writer is comparing A & B within the same industry)

ROCE is a better measure than return on equity, because ROCE shows how well a company is using both its equity and debt to generate a return whereas ROE ignores debt.

Posted by Ricky Yeo > 2017-04-09 19:12 | Report Abuse

Hi you are right, ROE is not the best if you compare it to ROIC or ROCE. My purpose of writing is targeted towards investors that are new to the concept of return. So taking into that consideration, I choose to brush through most of the things and keep it simple, and as always, when you keep things on a high level, you will miss out a lot of 'what ifs'. And I do so to avoid overwhelm readers. And any reader like you that is familiar with this concept will definitely find me oversimplify and generalize things

Posted by Dolly_Chai2 > 2017-04-19 15:22 | Report Abuse

ricky/JT is a very good fundamental sifu, same like KC Chong sifu.. those who condemned him do no really understand why ricky is trying to say... i feel sorry for these ppl...