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The Equitymaster Research Digest

The Art of Conservatism, Exorbitant Valuations, and More...
Dec 11, 2015

Is it possible to value a company the way a housing loan company checks out a borrower's eligibility? This thought crossed my mind as I sat in the office of a home loan firm last week. I had accompanied a friend who wanted to get his loan eligibility figured out. And as he got busy with one of the sales reps, I this idea that struck me out of the blue, and I decided to explore it further.

So going back to the question, can the process that determines the eligibility of a borrower for a housing loan also help determine the value of a company?

The way home loan assessment is done, especially in India, has conservatism written all over it. The standard process works something like this. The annual income a person earns is verified, his capacity to pay EMI is determined, and lastly, he loaned a maximum of 80-85% of the total value of the house he intends to buy.

Here's an example to illustrate: A person whose net income is Rs 50,000 per month is believed to be able to afford an EMI of roughly 60% of their income (i.e. Rs 30,000). Therefore, if the EMI per lakh comes to Rs 1,000 per month for a 20-year loan, the borrower can take out a loan worth Rs 30 lakh. With this, he can buy a property with a value of at least Rs 35.3 lakh.

The Math Behind the Process

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