Book Review of ‘The Value Elephant’

Debashis Basu 26 June 2015

Who’s the typical reader of this book?

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There aren’t too many books on valuation, shareholder value or wealth creation, in the Indian context. The Value Elephant, by Sanjay Kulkarni, is, therefore, an important addition to this slim sub-genre. Kulkarni was the managing director and country head of Stern Stewart & Co, a consulting firm that brought the concept of economic value addition (EVA) that many Indian companies embraced in the 1990s. EVA separated businesses that create value, such as Nestlé or Marico, and those that don’t and, hence, need additional capital periodically to virtually stay where they are.

A company in the second category is Reliance Industries. Its core businesses—upstream and downstream petrochemicals—earn a low return on capital. About 16 years ago, it went into oil exploration, which not only requires a lot of capital but is a hit-or-miss business. Reliance has had more hits there than misses. Then, it went into brick-and-mortar retailing—just when e-tailing business took off in India. After nine years and thousands of crores of rupees of investments, Reliance Retail is barely profitable. And now Reliance is getting into the telecom business where competition is intense. Kulkarni had “mentored group businesses and investments at the office of Mukesh Ambani, chairman of Reliance Industries,” proudly mentions the book jacket.

The pages inside showcase better achievements by him. He claims to have netted fantastic returns using his model V-GRO which identifies stocks on the basis of value, growth, risk and operating performance. According to him, value is central to this framework. Valuation gets expressed in price/earnings ratio, EBIDTA/enterprise value and price/sales, etc. Kulkarni hastens to add that “these multiples may not provide you with complete information, yet they are useful for better assessment of value as seen on bourses... what you see on the bourses is price and not value. Price is decided by the market. Value is your estimate of the underlying worth of the company.”

While this is correct, unfortunately, anyone even with good grasp of finance will find it hard to move any further with this piece of knowledge. As I like to emphasise, a shareholder is an outsider. He really knows too little about the company. What estimate could he make, beyond extrapolating published information? By highlighting objective valuation ratios as a guide and immediately de-emphasising them and then shifting the focus to subjective estimates, the author gives confusing signals that will paralyse the average reader.

To calculate returns of V-GRO, go for trailing five years of operating performance. But, of course, like valuation, you need to have your own estimates—the past only provides some clues. Can an average person estimate future earnings? Would the author himself be able to do so without the analytical tools of a professional set up like Stewart & Stern? The other aspects of the model are harder still. Here is a partial list of the risks Kulkarni wants you consider: risks of size, diversity, capital deployed in different geographies, business segments as proportional a of total capital deployed, concentration of revenues from or capital in one geography, product, brand, etc.

Then the author wants you to assess ‘strategic risks’, such as volatility revenues, ‘economic profits’ and cash flows as well as risks of operating leverage such as fixed assets as a proportion to capital employed. “You could also consider variations in contributions margins, working capital and its individual constituents such as receivables, inventories and payables. You may consider the ‘newness’ of assets…trailing ratio of average gross assets and depreciation over five years.” Phew! And I have not even gone into ‘risk of financial leverage’ and ‘risk of investment’. Then, “beyond these quantifiable risk parameters, there can be lot more to risk and you must rely equally on qualitative assessments of risk.”

Finally, even if you can figure out how to handle this thicket of parameters breezily described, how do you apply them? Investing is a matter of choosing the best bets from a wide set of companies. Without the access to sort-able database of companies and their parameters, how will you even start this process? Start with any 50, or a sample of your choice, is Kulkarni’s advice. Also, there are two parts to the book. The first is for individual investors (how to find stocks to buy) and the second is for businessmen (how to become stocks that people want to buy). This is another cause of confusion: whom is this book meant for?

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