In this post, let's analyse the basic parameters of ITC Limited. We will be analysing the company using three different methods which can get us clarity about the company.
The first method will be to check the financial strength and other key parameters of the company. We named this ‘Graham Method’. These criteria have been derived from the great Benjamin Graham, the author of Intelligent Investor. These criteria can give clarity whether it is fruitful for us to consider the stock for valuation.
Graham Checklist:
In the first of the Graham’s method, which is called Net-Net by him, we won’t mostly find many companies. The method that suits today’s world will be the second one. Below are these parameters for ITC Limited.
| Graham Stock pick method | Values | Check | |
| Method 1 | |||
| One check pick | 1. Current market price less than 67% of the Net current assets 2. Net current assets = (Current assets – Total Liabilities) / Number of outstanding shares |
||
| Current Price | 194.65 | NO | |
| Fixed Assets | 37,861 | ||
| Current Assets | 39,505 | ||
| Fixed Liabilities | 2,156 | ||
| Current Liabilities | 9,559 | ||
| Total number of shares | 1,225.00 | ||
| Check Value | 15.20 | ||
| Method 2 | |||
| 1. Size of the company | Sales at least more than 200 crores. | ||
| Latest Annual Sales | 50,968 | YES | |
| 2. Strong financial stability | 1. Current assets must be at least twice current liabilities 2. Long term or Fixed liabilities must be less than net current assets (Current assets – current liabilities) |
||
| Fixed Assets | 37,861 | ||
| Current Assets | 39,505 | 1. YES | |
| Current Liabilities | 9,559 | ||
| Fixed Liabilities | 2,156 | 2. YES | |
| 3. Earnings Stability | Should have positive earnings for past 10 years at least. May be we can reduce this to 5 years for Indian market | YES | |
| 4. Dividend record | Should have paid dividend for last 10 years uninterrupted. May be we can reduce this to 5 years for Indian market | YES | |
| 5. Earnings Growth | Average earnings should have increased by at least 30%. We can increase it to 100% to be on safe side | ||
| Current Earnings | 10.66 | NO | |
| Earnings before 10 years | 6.19 | ||
| Check Value | 72.12% | ||
| Financial Ratios | |||
| 6. Moderate Price/Earnings Ratio | PE ratio should be at least less than 14 (which means at least 7% return) | 18.26 | |
| 7. Moderate Ratio of Price to Assets | PB ratio should be less than 1.5 or may be 2 | 3.63 | |
| 9. Moderate Ratio of Debt to Equity | Debt to Equity ratio should be less than 1 | 0.18 | |
| 10. Moderate Return on Equity | At least 20 % | 19.89% | |
| 11. Moderate Return on Total Assets | At least 15 % | 16.88% | |
| 12. Moderate Earnings growth rate | At least 15 % | 5.58% | |
Asset Based calculation method:
Next is called the Asset based calculation. In this we consider the last four financial year earnings to average them and arrive at a reasonable earning capacity of the company. Then we calculate how much is needed to earn that cash flow at a nominal 7% interest rate. This forms one part. The next is net cash in hand. That is calculated by subtracting the total liabilities from financials assets in hand because they are the highly liquid form of asset. The same is given below for ITC Limited.
| 2019 | 2020 | ||
| Earnings calculation | |||
| Income from operations | 52,836 | 51,812 | |
| - Expenses | 37,910 | 35,933 | |
| Income before tax | 14,925 | 15,879 | |
| - Tax | 5,075 | 5,399 | |
| Income after tax | 9,851 | 10,480 | |
| + Depreciation and Amortization | |||
| + Profit from associates and Joint ventures | |||
| - Maintanence Capital expenditure | |||
| Distributable cash flow | 9,851 | 10,480 | |
| 2019 | 2020 | ||
| Excess Cash Calculation | |||
| + Fixed financial assets | |||
| Investments | 0 | 0 | |
| Other financial assets | 11,416 | 10,448 | |
| + Current financial assets | |||
| Investments | 13,347 | 17,948 | |
| Cash and Cash eq | 317 | 650 | |
| Bank balance | 3,834 | 6,626 | |
| Other financial assets | 1,499 | 1,818 | |
| - Total debt | |||
| Fixed liabilities | 2,302 | 2,156 | |
| Current liabilities | 10,011 | 9,559 | |
| Total | 18,100 | 25,775 | |
| Borrowings | 8 | 5 | |
| Investment needed @ | Per Share Value | Per share value | |
| 7.50% | 121.99 | 135.11 |
Buffet method:
The last method is called the Buffet Method. We named this method as such because we consider how the great Warren Buffett assesses a company before buying. We calculate the free cash flow by starting at the net income, adding the depreciation, subtracting the borrowings (spanned across 10 years) and the average capital expense over last four years. With this when we estimate the future cash flow for the company for next 10 years and find out the current value for it, we can attain an intrinsic value using this method. For ITC, it is as given below.
| ITC Limited | ||
| 2019 | 2020 | |
| Current Market Price | 194.65 | 194.65 |
| 4 year average profit | 8.04 | 8.56 |
| 4 year average D&A | 0.99 | 1.11 |
| 4 year average capital expense | 2.35 | 2.37 |
| Borrowings deduction | 0.00 | 0.00 |
| Free cash flow every year | 6.68 | 7.29 |
| Earnings in first 3 years | 4.20 | 5.14 |
| Earnings in recent 3 years | 9.29 | 10.66 |
| Earnings growth in 10 years | 2.21 | 2.07 |
| Profit after 10 years | 17.78 | 17.75 |
| Value after 10 years | 248.95 | 248.44 |
| Year | Current value of money | Current value of money |
| 1 | 6.21 | 6.78 |
| 2 | 5.78 | 6.31 |
| 3 | 5.38 | 5.87 |
| 4 | 5.00 | 5.46 |
| 5 | 4.65 | 5.07 |
| 6 | 4.32 | 4.72 |
| 7 | 4.02 | 4.39 |
| 8 | 3.74 | 4.08 |
| 9 | 3.48 | 3.80 |
| 10 | 123.72 | 123.77 |
| Current Value: | 166.30 | 170.24 |
| Price discount: | -17.05% | -14.34% |
To check the intrinsic value and complete fundamental analysis, please see the video below
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