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Transcript of Dullcorp Valuation Computations. load dullcorp_ga_data.xls local drive c:/program files/eval2...
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Dullcorp Valuation Dullcorp Valuation ComputationsComputations
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load dullcorp_ga_data.xlsload dullcorp_ga_data.xls
local drive c:/program files/eval2 local drive c:/program files/eval2 program files/thomson research saved program files/thomson research saved data/data/
set valuation date to 7/9/1998set valuation date to 7/9/1998 set cost of debt = 10%set cost of debt = 10% set forecast horizon = 5 yearsset forecast horizon = 5 years set terminal sales growth = 0%set terminal sales growth = 0% Price = $3000.38.Price = $3000.38.
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playing with eValplaying with eVal
reset default forecasts for dullcorp:reset default forecasts for dullcorp: put neg 10% in exord item to make ROE=10%. Examine put neg 10% in exord item to make ROE=10%. Examine
the RI model valuation. How does changing sales the RI model valuation. How does changing sales growth change value? growth change value?
increase cash balance to 100% in yr 1. Examine RI and increase cash balance to 100% in yr 1. Examine RI and FCF model valuations.FCF model valuations.
using the data center:using the data center: find a company with negative equity value (reset find a company with negative equity value (reset
valuation date and use default forecasts)valuation date and use default forecasts) find a company with a huge ROEfind a company with a huge ROE find an industry with high turnover/low marginfind an industry with high turnover/low margin find an industry with low turnover/high marginfind an industry with low turnover/high margin
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time adjustmentstime adjustments
1997 1998 1999 2000 2001historical forecasted
RI1999 RI2000 RI2001
valuation date
most current fiscal year end
• move RI flows ½ year earlier by multiplying valuation by (1+re/2)
• move to valuation date by multiplying valuation by (1+re(fraction of year))
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year 0 1 2 3 4 5 6 7
CE end 1000 1200 1400 1600 1800 2000 2100 2205
NI forecast 100 200 300 400 500 525 551.25
Div implied -100 0 100 200 300 425 446.25
RI implied 0 80 160 240 320 325 341.25
Div*1.05 315330.75
RI*1.05 336352.80
when can you start using the perpetuity when can you start using the perpetuity formula?formula?
r=10%, forecast g=5% after year 5 and beyond
?
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Common Errors in ValuationCommon Errors in Valuation
e.g. common error is to assume DT+1 = (1+g)DT .
DT+1 = NIT+1 – [CET+1 – CET] = (1+g)NIT – [(1+g)CET - CET]
(1+g)DT = (1+g)NIT – [(1+g)CET – (1+g)CET-1]
1. Starting the terminal value off with the wrong amount
2. Losing cash in the DCF model – its not operating but its not financing, its just GONE!
3. Inconsistent weighted average cost of capital in the DCF model
/ /
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=229445
Lundholm/Okeefe CAR 2001
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SalomonSmithBarneySalomonSmithBarney
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Screening for misvalued Screening for misvalued stocksstocks
accrual measuresaccrual measures surprise measuressurprise measures valuation measuresvaluation measures momentum measures (finance)momentum measures (finance) ““smartmoney” measures (not here)smartmoney” measures (not here)
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Operating AccrualsOperating Accruals Definition: Definition: Operating Accruals = Operating Accruals = Earnings - Cash from Earnings - Cash from
Operations, deflated by average total assetsOperations, deflated by average total assets
SCF Operating sectionSCF Operating section::EarningsEarnings 200200+ depreciation+ depreciation +50+50- Change in working capital- Change in working capital -30 -30+ non-cash special item charges+ non-cash special item charges
+10+10=Cash From Operations=Cash From Operations 230230op
erat
ing
accr
uals
Dechow and Ge (2005)
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Operating Accruals and Operating Accruals and Future Stock ReturnsFuture Stock Returns
Dech
ow
and G
e (
2005)
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Within the Operating Accrual Within the Operating Accrual portfolios, SI drive the resultsportfolios, SI drive the results
a SI if SI/TA > .02
Dechow and Ge (2005)
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The Earnings SurpriseThe Earnings Surprise
Surprise =Surprise = (un-split-adjusted IBES actual EPS(un-split-adjusted IBES actual EPStt – IBES forecast EPS – IBES forecast EPStt))
------------------------------------------------------------------------------------------------------------------------------------
price per shareprice per sharett
Sort into deciles in quarter t-1 and use the decile cutoffs to form Sort into deciles in quarter t-1 and use the decile cutoffs to form earnings surprise portfolios for quarter t.earnings surprise portfolios for quarter t.
Take position 2 days after earnings announcement and hold for Take position 2 days after earnings announcement and hold for 1, 2 or 3 years.1, 2 or 3 years.
Focus (mostly) on extreme good and bad news portfoliosFocus (mostly) on extreme good and bad news portfolios can use total assets per share at t-1 and get very similar resultscan use total assets per share at t-1 and get very similar results
Doyle, Lundholm and Soliman 2005
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The Big ResultThe Big Result
Surprise Portfolio
N
Average Minimum in
Surprise Portfolio
Mean Surprise
Mean Ret1yr
Mean Ret2yr
Mean Ret3yr
1 16,254 -0.0397 -0.0458 -0.0496 -0.0943 2 15,830 -0.0120 -0.0062 -0.0195 -0.0537 -0.0581 3 15,618 -0.0042 -0.0023 -0.0441 -0.0781 -0.1181 4 8,050 -0.0016 -0.0013 0.0151 -0.0188 -0.0184 5 26,344 -0.0005 -0.0001 -0.0394 -0.0668 -0.1198 6 13,007 -0.0000 0.0002 0.0065 -0.0009 -0.0199 7 16,913 0.0004 0.0007 0.0197 0.0164 -0.0019 8 15,940 0.0011 0.0016 0.0344 0.0385 -0.0093 9 15,843 0.0023 0.0033 0.0588 0.0903 0.0641 10 15,990 0.0052 0.0126 0.0937 0.1493 0.1426
Hedge Return (Portfolio 10 – Portfolio 1) 0.1395 0.1989 0.2369
how big is a big surprise? Suppose P=$20, E=$1, or .25/qtr. ½ percent of 20 is 10 cents, so report 35 cents EPS when market was expecting 25 cents.
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Future returns controlling for risk Future returns controlling for risk (matched on size and book-to-(matched on size and book-to-
market)market)
Surprise Portfolio
N
Average Minimum in
Surprise Portfolio
Mean Surprise
Mean Ret1yr
Mean Ret2yr
Mean Ret3yr
1 14638 -0.0397 -0.0459 -0.0515 -0.0741 2 14562 -0.0120 -0.0062 -0.0260 -0.0220 0.0125 3 14242 -0.0042 -0.0023 -0.0288 -0.0200 -0.0076 4 7475 -0.0016 -0.0013 -0.0095 -0.0106 -0.0261 5 24960 -0.0005 -0.0001 0.0040 0.0258 0.0662 6 12273 0.0000 0.0002 -0.0015 0.0288 0.0218 7 15868 0.0004 0.0007 0.0231 0.0676 0.0925 8 14864 0.0011 0.0016 0.0465 0.0993 0.0933 9 14661 0.0023 0.0033 0.0532 0.1159 0.1216 10 14526 0.0052 0.0126 0.0868 0.1792 0.2095
Hedge Return (Portfolio 10 – Portfolio 1) 0.1327 0.2307 0.2836
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Future returns after controlling Future returns after controlling for risk and other market for risk and other market
anomaliesanomalies
All independent variables are sorted into ten portfolios based on prior quarter’s decile rank. Regressions estimated quarterly (mean coefficients reported). Fama McBeth t-statistics with the Newey-West correction for serial correlation.
Dependent Variable
Intercept Surprise Beta Book
to Market
Size Accruals Momentum Pro Forma Exclusions
SUE
Ret1yr -0.020 (-0.44)
0.097 (7.36)
0.092 (1.34)
0.029 (0.54)
-0.067 (-1.15)
-0.089 (-8.18)
0.047 (1.63)
-0.041 (-4.01)
0.044 (0.72)
Ret2yr
-0.016 (-0.14)
0.163 (8.74)
0.221 (1.89)
0.013 (0.11)
-0.125 (-1.59)
-0.145 (-7.49)
-0.004 (-0.11)
-0.066 (-3.19)
0.034 (0.48)
Ret3yr
-0.050 (-0.37)
0.197 (8.00)
0.291 (3.11)
0.046 (0.30)
-0.120 (-0.30)
-0.197 (-9.27)
-0.023 (-0.75)
-0.101 (-7.32)
0.027 (0.31)
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one year returns beginning each quarter one year returns beginning each quarter (after risk controls) with non-overlapping (after risk controls) with non-overlapping
intervalsintervals
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year
Ab
no
rmal
Ret
urn
Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4
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Extreme firms continue to Extreme firms continue to SurpriseSurprise
-0.006000
-0.004000
-0.002000
0.000000
0.002000
0.004000
0.006000
0 1 2 3 4 5 6 7 8 9 10 11 12
Current and Future Quarters
Med
ian
Ea
rnin
gs S
urp
rise
Lowest SurpriseSurprise Portfolio 2Surprise Portfolio 3Surprise Portfolio 4Surprise Portfolio 5Surprise Portfolio 6Surprise Portfolio 7Surprise Portfolio 8Surprise Portfolio 9Highest Surprise
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1 2 3 4 5 6 7 8 9 101
3
5
7
9
-0.15
-0.10
-0.05
0.00
0.05
0.10
0.15
1 yr stock return
rank_acc
rank_surp
0.1-0.15
0.05-0.1
0-0.05
-0.05-0
-0.1--0.05
-0.15--0.1
earnings surprise/price >.005
(CFO-NI)/price > .05
if 6 month stock return > 30% then beat market by 24%!
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Price equals the current book value plus the discounted sum of expected future residual income (abnormal earnings).
1
0 )1(t
tt
ee RIrCEP
modeling residual income modeling residual income persistencepersistence
Define CEo as book value of Common Equity at time 0
RIt as residual income at time t, = (NIt – reCEt-1)
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persistence in RIpersistence in RI
need forecasts of future RIneed forecasts of future RI
Suppose RISuppose RItt = = RIRIt-1t-1 + + t t , , between between 0 and 1, so that0 and 1, so that
RIRI1 1 = = RIRI0, 0, RIRI2 2 = = 2 2 RIRI0 0 , etc., etc. Then Then
000 1RI
rCEP
Dechow and Sloan (1999 ?)
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Some models of persistenceSome models of persistence
If If =1 then=1 then
If If =0 then=0 then
or estimate or estimate =.62=.62
001
Err
P
000 3.1 RICEP
00 CEP
12. ,1 000
rRI
rCEP
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000 12.1RICEP
=
.62 model
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a better model of a better model of
RIRIt+1t+1=.62RI=.62RItt
RIRIt+1t+1=-.02+.61RI=-.02+.61RItt
- .37RI- .37RIt t * * |RI|RItt/CE/CEtt|| - 1.21RI - 1.21RIt t * * |special|specialtt/TA/TAtt||
so, if so, if |RI|RItt/CE/CEtt|| = .10 and = .10 and |special|specialtt/TA/TAtt|| = .01 = .01
then RIthen RIt+1t+1=-.02+.61-.37(.10) - 1.21(.01) = .541RI=-.02+.61-.37(.10) - 1.21(.01) = .541RItt
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the resultsthe results
Next Year’s Return
Conditional RI
Unconditional RI
Pure Earnings
Pure Book Value
1st decile .086 .111 .118 .118
10th decile .212 .210 .207 .191
Hedge return
.126 .099 .089 .073
buy dogs, sell glamour
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miscellaneous observationsmiscellaneous observations
notice that every time we add context notice that every time we add context to the analysis the performance to the analysis the performance improvesimproves returns to talent and hard work!returns to talent and hard work!
what about risk?what about risk?
other variables not discussedother variables not discussed P/B – is it risk?P/B – is it risk? 6 month stock return momentum6 month stock return momentum