Earnings Power Value (EPV)–Indian Stock Market

EPV is a methodology evangelized by Bruce Greenwald, Professor at Columbia Business School and one of the foremost experts in Value Investing.

A few readings on EPV –

a) Bruce Greenwald – http://www.scribd.com/doc/15987706/Greenwald-Earnings-Power-Value-EPV-lecture-slides

b) My Value Idea – http://myvalueidea.blogspot.com/2007/12/valuation-technique-earning-power-value.html

c) Jae Jun – http://www.oldschoolvalue.com/stock-analysis/earnings-power-value-epv-valuation-microsoft/

Earnings Power Value (EPV) is an estimate of the value of a company from its ongoing operations. One of the most attractive feature of this methodology is that the price of the share would be calculated using (assuming) no growth and the existing earnings would be sustainable. We would be only subtracting from earnings the amount of capital expenditure required to sustain the business. By using existing earnings we eliminate attempts to predict future growth (a.k.a DCF methodology) and as such arrive at a number which we can be fairly certain of. The only downside that is obvious in this methodology is that it uses Earnings and not cash flows in its calculations (if Sundry debtors don’t get converted into Cash, we might have a problem!)

There are certain steps to calculate EPV of a firm:

1) We will be using Earnings not just of the current/last year but we would normalize these earnings to the business cycle. This eliminates the effects on profitability of valuing the firm at different points in the business cycle. This means that we consider average EBIT margins over the past 5 years and apply it to current year sales (thereby, normalizing EBIT).

2) We use a tax rate of 30%, and find out the value of Earnings post tax.

3) We add back depreciation for the current year [I am not clear on this point yet – do we add back the entire depreciation or multiply depreciation by a certain percentage according to the industry – say, on average, 25%? I multiplied the depreciation by 25% in the example below]

4) We add back (subtract) the average non-recurring charges over the past 5 years to the figure obtained in Step 3.

5) Bruce Greenwald says that we need to add back 25% of SG&A expenses to Step 4, as a certain percentage of SG&A also contributes to Earnings power. [I am not yet convinced of this step, and shall skip it in my example below]

5) The next step is to calculate maintenance capex which we need to subtract from the figure obtained in Step 4.

6) The first step is to calculate the average percentage of PPE/Sales (in other words, Gross Block/Sales in our Indian Financial Statements]. We multiply this average PPE/Sales figure to the increase in Sales over the past year. This gives us the figure of capex that was responsible for the growth in sales (we’ll call it growth capex). We subtract the growth capex from the actual Capex to get the maintenance capex.

7) We subtract this maintenance capex from the figure obtained in Step 4, which gives us ‘Earnings of the Firm’

8) We assume a cost of capital, say, 12.5% (for the more mathematically inclined, you can calculate WACC – I am a little unsure of using Beta and hence wouldn’t use WACC)

9) EV of Business Operations = Earnings of the firm * 1/cost of capital

10) We add Cash and subtract debt from EV of Business Operations to get the EV of the firm.

11) We divide the EV of the firm by the number of shares, to get Price per share.

12) If this Price is greater than the Current price in the market, we ‘Buy’, else ‘Don’t Buy’

13) In fact, to account for the assumptions made (like cost of capital, growth capex etc.), we can account for a ‘margin of safety’ (say 30%) and check the Price per share according to EPV methodology and then compare it to the current price.

I have attached a EPV analysis for a stock, Z F Steering (India) and found that the methodology throws up a ‘BUY’.

Earning Power Value
Average EBIT margin 0.17
Current Year Sales 216.12
EBIT 35.81483
Tax Rate 30%
Normalized Earnings on average 25.07038
Add: Depreciation for current year 22.2625
Avg non-recurring charges 1.81
Avg PPE/Sales 0.56
Current Year increase in Sales 50.01
Actual Capex 28.08
Growth Capex 27.78821
Deduct Maintenance Capex 0.29
Normalized Earnings 48.85
Cost of Capital 12.50%
EV of Operations 390.8088
Cash 94.20
Debt 28.4
EV of Company 456.61
Value per Share 503.2611
Margin of Safety 30%
Share Price after MOS 352.2828
Current Share Price 333.85
Buy/Don’t Buy Buy


What do you think of this methodology? Is this a sound methodology? Sure – you need to use this methodology along with a whole host of parameters, but is this a good starting point?

The issues I am not yet clear about (and hope someone clears it for me – I am just tired of searching and searching) –

1) Do we need to use EBIT or EBT in Step 1? For a firm with substantial debt, the numbers would widely differ. Bruce Greenwald calls it Operating Earnings, but what exactly does it mean in the Indian context.?

2) Do we need to add back entire depreciation or multiply depreciation by a certain amount? If I add full depreciation to the Z F Steering example, the price is northwards of Rs. 700. Does the stock really have so much value? (Bruce Greenwald says, add back excess depreciation. How exactly do we calculate excess depreciation?)

3) Is my calculation of Maintenance Capex on target, or do I have to modify some line here?

Your thoughts would be immensely appreciated.


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  1. #1 by chinmay on February 10, 2011 - 12:48 AM

    Hi Kiran,

    Generally 5 years do not make a business cycle. In India itself, the last 7 years were pretty good and if you have to cover a business cycle, you will have to take a 15 year view. The real bear market in India lasted between 1996 and 2003 and ZF steering’s EBIT margin reached almost low single digits in 1998-1999 unlike the 17% it has averaged over the last 5 years. So 17% is quite optimistic. I wouldn’t consider its intrinsic value at 500. It would be more nearer to 300.


  2. #2 by Kiran on February 10, 2011 - 9:36 AM

    Hi Chinmay,

    I totally agree with you that I need to take a 10-15 year view to cover an entire business cycle. The problem I have is with the availability of information. Everywhere I look, I can only find 5 year information. Do you know any site which provides 10-15 year view? I can’t pay as much for Capitalline, but if it is reasonable, I am willing to look at it. Let me know.

    I had not known about the low single digit margins in the bear cycle. Thanks for pointing it out. The learning here is that I need to have a higher MOS if I am using a 5 year cycle (in case I don’t get to the 10-15 year info!). I agree with you now – if I use an average of 10% EBIT margin, we are looking at Rs. 300 intrinsic value.


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