Pricing a Growth Stock

By Ramesh Akkineni
from an article in Business Standard
The huge demand from institutional investors for the DLF issue of issues underscores the tremendous international appetite for Indian stocks. The issue’s performance also highlights the fact that, though domestic retail investors may find the pricing aggressive, there are enough institutional takers for local issuances. If local investors are conscious of the risks involved in real estate prices levelling off, in the company’s rapid growth assumptions as also the history when it comes to corporate governance, the institutional investor who is supposed to be more rigorous before showing the money, has no doubts.
 
There is the question of understanding new and fast-growing industries in rapidly growing economies, and how to value them correctly. This is where global institutional investors seem to come out on top. Whether it was believing in the mobile penetration or the retail proliferation story, they have been the early adopters, and have made good money in Bharti and Pantaloon. Real estate is probably at the same level as was telecom and retail, three or four years ago. Understanding the sector and putting a fair value to the price is not an easy task. It is also relevant that with a market capitalisation of close to Rs 1 lakh crore, DLF’s listing would boost India’s market capitalisation by 2.5 per cent. Potentially, this could also increase India’s weight in the global equity indices.
 
The questions that have bothered domestic analysts are whether DLF has the financial strength to earn the valuations that it has sought and whether its pricing is purely based on a promise by the management to develop its 10,000-acre land bank profitably, and that too within a very short span of time. The intrinsic value of the company or the net asset value of the company for March 2007 is less than 5 per cent of the market capitalisation, while its profit for the last year was less than 2 per cent of the market value. There is a lot of discounting of the future in the current price.
 
Valuing a company with sales, earnings or assets which are going to be significantly higher in the future than what they are now requires faith in the management on keeping promises. In the case of DLF, there is lack of clarity on the value of the land holding, the titles and the rights to development of the land, and so on. For a sample, more than 60 per cent of company’s land is still agricultural land which needs government clearance to be used for any other purpose, the cost of which is indeterminable. As for real estate prices heading upward, which is a key selling point for DLF, its own aggressive development schedule could keep prices under check.

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