July 04, 2022.
Relative Rating
When we work with investments, it is normal to come across opportunities as varied as possible. One of the tools that helps us a lot and makes our “valuation” simpler is the relative evaluation . Here is an example of how it is used in everyday life:
Let's imagine that you want to put your beach house up for sale and you have no idea what price to sell for. In this case, how do you formulate the selling price? Simple, you check the price of similar properties for sale and try to draw a parallel. The relativization of one house in relation to the other makes the valuation work much simpler. You know it's going to be hard to sell your two-bedroom house for R$1 million when your neighbor is selling a four-bedroom house for R$900,000.
In investments we use a similar strategy , we use relative valuation to understand whether an investment is worthwhile or not.
How to evaluate an investment?
Suppose I told you I had an investment that would return you 10% a year for the next 10 years. Would you invest in my business? The answer to that question is: it depends. It depends on the alternative investments you have available. If you are a shareholder in an investment fund that has been losing money for a long time, my proposal is undeniable. However, if you own a venture that has a return on equity of 30% pa. my offer sounds almost like an insult. The interesting thing about investments is that the reality of an investor is very different from the reality of other investors, creating what we call a market.
A measuring tape for an architect, Treasury Direct for an investor
If you're looking to build an empire and don't have a tape measure, you might as well get one. In this case, the tape measure for an American investor living in the United States is the US government T-Bonds , while the tape measure for a Brazilian investor living in Brazil is the Brazilian government bonds .
Figure 1: Direct Treasury Card from July 4, 2022 at 4:30 pm
Government bonds are considered the safest investments in Brazil and, therefore, they are ideal for us to use as our benchmark, our “measuring tape”, within the universe of investments available on Brazilian soil.
As we see in Figure 1, my investment proposal yields 10% pa. , when compared to the prefixed direct treasury yielding 13.04% pa, is logically a bad deal. But you wouldn't know that if there wasn't a frame of reference that makes sense.
How to use Direct Treasury?
It is common for bank managers or Autonomous Investment Agents to offer us investment products over time. This is the ideal time to use our "measuring tape" to check how much the investments offered by them are yielding when compared to our benchmark.
This week I am discussing with my manager a possible investment in Eneva's first series debentures .
Source: BB/ Public Offers
Reading the issue prospectus, we discovered that Eneva's debentures mature on August 15, 2030. Technically, we would have to use papers with the same maturity date for comparison purposes, but as an effect of a first investigation we will use the IPCA+ bond 2032, which is the bond available with the closest possible maturity to Eneva's paper. As Warren Buffet says, it's better to be more or less right than precisely wrong.
We see that the Bookbuilding fee will possibly be I PCA + 6.05% . Is this renumbering enough for the investor?
Before proceeding with the study, we must remember that government bonds are deducted from income tax while this debenture is exempt from income tax (not all debentures are exempt from income tax) and therefore we must deduct tax from government bonds to comparison effects.
So that this article doesn't get too technical, I'm going to report the equivalent rate here and if you're interested in how to calculate it manually, I leave the link to another article here. Thus, we have that the government bond selected to be our basis for comparison, will yield something around IPCA + 4% , free of income tax.
We have the following scenario:
- Direct treasury yielding IPCA+ 4% pa .
- Eneva debentures yielding IPCA + 6.05%.
If we consider an inflation of 5% pa for the period of 10 years. This means that we will have approximately a yield of 9.2% pa. of our government bonds against 11.35% of our Eneva debentures.
With that, we are able to answer: Would you invest in Eneva's debentures yielding 11.35% per annum if, at this very moment, you have a “risk-free” investment yielding 9.2% per annum?
Conclusion
Therefore, the answer to this question varies according to the risk perception of each investor, some will find it safer to stay in government bonds, while others will find the risk/return of Eneva paper attractive. The trick here is to only invest in opportunities that have a prospect of yielding at least 20% more than the Brazilian government bond. Precisely to compensate for the greater degree of exposure to risk . However, this does not always happen, investments are often offered at rates equal to or even lower than government bonds , so be aware.
Therefore, we have that the minimum rate accepted would be 11.04% and therefore Eneva, offering 11.35%, deserves our attention and we must continue our investigation before investing.
To think about:
How to perform a credit analysis?