Reading equity valuation: applications and processes
Transcript of Reading equity valuation: applications and processes
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Reading 24: equity valuation: applications and processes
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Different kinds of value & valuation
Ø intrinsic value (IV)• we are referring to the valuation of an asset or security by someone who has
complete understanding of the characteristics of the asset or issuing firm.
Ø Fair market value• the price at which a hypothetical willing, informed, and able seller would trade
an asset to a willing, informed, and able buyer.Ø Investment value• the value of a stock to a particular buyer. depending on the buyer’s specific
needs and expectations, and perceived synergies with existing buyer assets.Ø Liquidation value• the estimate of what the assets of the firm would bring if sold separately, net
of the company’s liabilities. 2
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applications of equity valuation.
Ø Objectives• Stock selection:Check if this security is fairly priced, overpriced, or underpriced
relative to its current estimated intrinsic vaule and relative to the prices ofcomparable securities.
• Inferring(extracting)market expections:Market prices reflect the expectations ofinvestors about the future performance of companies.
• Evaluating corporate events:Investment bankers, corporate analysts, and investmentanalysts use valuation tools to assess the impact of such corporate events as mergers,acquisition, divestitures, spin-offs, and going private transactions.
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applications of equity valuation.
Ø Objectives• Fairness opinions:The parties to a merger may be required to seek a fairness
opinion on the terms of the merger from a third party, such as an investment bank.• Evaluating business strategies and models: Companies concerned with maximizing
shareholder value evaluate the effect of alternative strategies on share value.• Communicating with analysts and shareholders:Valuation concepts faciliate
communication and discussion among company management, shareholders, andanalysts on a range of corporate issues affecting company value.
• Appraising private businesses:Valuation of the equity of private businesses isimportant for transactional purposes and tax reporting purposes among others.
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applications of equity valuation.
• Porefolio mangementü Planning, execution and feedback 3 steps in the portfolio management
process(valuation is not closely associated with the planning andexecution steps).
ü PlanninguIdentification and specification the investment objectives and constraints
writing detail on the investment strategy of securities selection.uValuation on individual security is not apply to Indexing strategy but active
management.ü ExecutionuPortfolio selection;uPortfolio implementation.ü Feedback
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Quantitative and qualitative factors in valuation
Ø Quantitative factors• Key source from company's accounting information and financial disclosures.• Including balance sheet, income statement, cash flow statement, as well as the
footnotes.Ø Quantitative factors• Purpose:to measure industry performance, such as legal and regulatory envirnment.• Includingü Quality of the firm's management team;ü The transparency of its performance;ü The analyst's confidence in the firm's;ü Industry's accounting practices.
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quality of input
Ø quality of financial statement information
• investigating the issues associated with the accuracy and detail of a firm’sdisclosures
• The basic building blocks of equity valuation come from accountinginformation contained in the firm’s reports and releases.
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Alpha
Ø Alpha,an excess risk-adjusted return, also called an abnormal return.Ø Formula• Ex ante alpha=expected holding period return-required return• Ex post alpha=actual holding period return-contemporaneous required
returnØ The difference between intrinsic value(V)and market value(P) perceive
mispricing becomes part of the manger's forecast of expecte returninfluence the total return on the asset namely influence alpha.
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going concern assumption
Ø Going concern assumption
• the assumption that a company will continue to operate as a business, asopposed to going out of business.
• The valuation models we will cover are all based on the going concernassumption.
Ø Non-going-concern assumption
• The assumption that the company will finish operating and all assets will besold out
Ø Going concern value > Liquidation value9
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Types of valuation models
Ø Absolute valuation models
• Discounted cash flow model
ü DDM
ü FCF model
ü Residual income model
Ø Relative valuation models (price multiple model)
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sum-of-the-parts valuation
Ø Sum-of-the-parts value
• Rather than valuing a company as a single entity, an analyst can valueindividual parts of the firm and add them up to determine the value for thecompany as a whole. The value obtained is called the sum-of-the-parts value ,or sometimes breakup value or private market value .
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Conglomerate discount
Ø Conglomerate discount
• The market applies a discount to the stock of a company operating in multiple,unrelated businesses compared to the stock of companies with narrower focus
Ø Three explanations for conglomerate discounts are:
• Internal capital inefficiency: The company’s allocation of capital to differentdivisions may not have been based on sound decisions.
• Endogenous (internal) factors: For example, the company may have pursuedunrelated business acquisitions to hide poor operating performance.
• Research measurement errors: Some hypothesize that conglomeratediscounts do not exist, but rather are a result of incorrect measurement. 12
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Reading 25: Return concepts
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framework
Ø Return concept
Ø Equity risk premium
Ø Required return on equity
Ø International consideration
Ø WACC
Ø Discount rate selection in relation to cash flow
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Return concept
Ø Holding Period
• Holding period return is the increase in price of an asset plus any cash flowreceived from that asset, divided by the initial price of the asset.
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Return concept
Ø Annualized holding period returns
• For example, if the return for one month is 1% (0.01), then the annualizedholding period return of (1 + 0.01) 12 − 1 = 0.1268 or 12.68%.
Ø Realized & Expected Holding Period Return
• A realized return is a historical return based on past observed prices and cashflows.
• An expected return is based on forecasts of future prices and cash flows.
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Return concept
Ø Required Return (opportunity cost )
• An asset’s required return is the minimum return an investor requires giventhe asset’s risk.
• A more risky asset will have a higher required return.
• If expected return is greater than required return, the asset is undervalued.
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• The discount rate is the rate used to find the present value of an investment.
Ø Internal Rate of Return
• It is the rate that equates the value of the discounted cash flows to the currentprice of the security.
• If markets are efficient, then the IRR represents the required return.
Return concept
Ø Discount Rate
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Equity risk premium
Ø Equity risk premium
• The equity risk premium is the return in excess of the risk-free rate thatinvestors require for holding equity securities.
• equity risk premium = required return on equity index − risk-free rate
Ø CAPM
• required return for stock j= risk-free return + β j× (equity risk premium)
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Equity risk premium
Ø There are two types of estimates of the equity risk premium
•
•
historical estimates
forward-looking estimates
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Equity risk premium——historical estimates
Ø A historical estimate of the equity risk premium consists of the difference between thehistorical mean return for a broad-based equity-market index and a risk-free rate over a giventime period.
• strength : objectivity and simplicity
• Issues in historical estimates
ü Selected an appropriate index (stationary)
ü Time period. The longer the period used , the more precise the setimate
ü Arithmetic mean or geometric mean in estimating the return; ERP will be lower if geometricmean is used.
ü Long term bond or short term bill is a proxy for risk-free assets; the use of longer-term bondsrather than shorter-term bonds to estimate the risk-free rate will cause the estimated riskpremium to be smaller.
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Equity risk premium
Ø A historical estimate of the equity risk premium consists of the difference between thehistorical mean return for a broad-based equity-market index and a risk-free rate over a giventime period.
• strength : objectivity and simplicity
• Issues in historical estimates
ü survivorship bias: The historical estimate can also be upward biased if only firms that havesurvived during the period of measurement are included in the sample.
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Equity risk premium
Ø Forward-looking estimates:use current information and expectationsconcerning economic and financial variables.
• The strength of this method :
ü it does not rely on an assumption of stationarity
ü less subject to problems like survivorship bias
• There are three main categories
ü Gordon growth model
ü Supply-side models
ü Estimates from surveys.
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Equity risk premium
Ø GGM• GGM equity risk premium estimate=Dividend yield on the index based on year-ahead
aggregate forecasted dividends and aggregate market value +Consensus long-termearnings growth rate—Long term government bond yield.
• A simple way to understand the equation
ERP r-RFR g-RFR
• The above equation assumes growth rate is constant.• An analyst may make adjustment to reflect P/E boom or bust.Ø Another method to solve these problems
Equity Index Price PVrapid (r) PVtransition(r) PVmature(r)
0
1
PD
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1YTM of 20-yearT-bonds1
Equity risk premium
Ø Supply-Sied Estimates (Macroeconomic Model)
TIPS:Treasury Inflation Protected Securities• Expected real growth in GDP
Expected growth in real earing per share=real GDP growth=labor productivity growth rate+labor supply growth rate
Ø Survey estimates• Use the consensus of the opinions from a sample of people.
• Exected inflation
1YTM of 20-yearTIPS
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Estimates Strength WeaknessHistoricalEstimates
•Afamiliarandpopularchoice(ifreliable long-termrecordsareavailacle)
•Unbiasedestimate(ifnosystematicerrorshasbeenmade)
•Objectivequality(groundedindata)
•Precisionissues(duetothereduced/dividedlengthofdata)•Difficult-to-maintainstarionaryassumption(iftheseriesstartingpointextededtothedistantpast)•Empiricallycountercylicalexpctedequityriskpremiun•Survivorshipbiasandpositive/negativesuprises
Forward-lookingEstimates
•Available(directbasedoncurrentinfo.Andexceptationsconcerningsuchvariables)•Notsubjecttotheissueofnon-stationarityordatabiases
•Oftensubjecttootherpotentialerrorsrelatedtofinancial/economicmodelsandbehavioralbiasesinforcasting.•Subjective
Equity risk premium
Ø Comparison
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Estimates Strength Weakness
GGM •Popularmethod;•Reasonablewhenappliedtodevelopedeconomiesandmarkets;•Typicallysamplesourxes.
•Changethroughtimeandneedtobeunpdated;•Assumptionofastablegrowthrate.
Supplu-SideEstimates
•Provenmodels;•Currentinformation;
•Onlyappropriatefordevelopedcountries;
SurveyEstimates
•Easytoobtain •Widedisparityfromdifferentgroups
Equity risk premium
Ø Comparison
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Required return equity
Ø To estimate the required return on equity, the analyst can choose followingmodels
• CAPM• Multi-factor Modelsü Fama-French Model(FFM)ü Pattor-Stambaugh model(PSM)ü Marcroeconomic Multifactor models• Build-up methodü Bond Yield Plus Risk Premium Method
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Required return equity
Ø Capital Asset Pricing Model
• required return on stock j = risk-free rate + (equity risk premium × beta of j)
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Required return equity
Ø Capital Asset Pricing Model
Ø Beta Estimates for Public Companies
• For a public company, an analyst can compute beta by regressing the returnsof the company’s stock on the returns of the overall market.
Ø Adjusted Beta for Public Companies
• adjusted beta = (2/3 × regression beta) + (1/3 × 1.0)
• Beta drift refers to the observed tendency of an estimated beta to revert to avalue of 1.0 over time.
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Required return equity
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companies
Required return equity
Ø Capital Asset Pricing Model
Ø Estimating Beta for tiny trraded stock or nonpublic companies
● Step 1:Selecting benchmark company(comparable);
√ Use the public companies' information in the same industry;
● Step 2:Estimate the benchmark's beta(similar with previous section);
● Step 3:Unlevered enchmark's beta
● Step 4:Lever up the unlevered beta for tiny traded stock or nonpublic
E 1D/ Eu
�
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Required return equity
Ø Multifactor Model
• Multifactor models can have greater explanatory power than the CAPM, whichis a single-factor model. The general form of an n-factor multifactor model is:
• Factor sensitivity or factor beta is the asset's sensitivity to a particularfactor(holding all other factors constant),and zero sensitivity to all otherfactors.
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Required return equity
Ø Multifactor Model• Fama-French Model V.S. Pastor-Stambaugh Model(PSM)
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FactorSensitivityRiskPermium(%)
MarketFacor 1.20 4.5
SizeFactor -0.50 2.7
ValueFactor -0.15 4.3
Required return equity
Ø The estimated factor sensitivites of TerraNova Energy to Fama-French factors andthe risk premium associated with those factors are given in the table below.
1. Based on the Fama-french model,calculate the required return for TerraNovaEnergy using theses estimates.Assume that the Treasure bill rate is 4.7 percent.
2. Describe the expected style characteristics of TerraNova based on its factorsensitivites.
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Required return equity
2. TerraNova Energy appears to be a large-cap, growth-oriented, high ,market riskstock as indicated by its negative size beta, negative value beta, and market betaabove 1.0.
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Required return equity
Ø Macroeconomic Multifactor Models(了解)
• The Burmeister, Roll, and Ross model incorporates the following five factors:
1. Confidence risk: unexpected change in the difference between the return ofrisky corporate bonds and government bonds.
2. Time horizon risk: unexpected change in the difference between the returnof long-term government bonds and Treasury bills.
3. Inflation risk: unexpected change in the inflation rate.
4. Business cycle risk: unexpected change in the level of real business activity.
5. Market timing risk: the equity market return that is not explained by theother four factors.
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Required return equity
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Required return equity
Ø Build-Up Method
• The build-up method is similar to the risk premium approach. It is usuallyapplied to closely held companies where betas are not readily obtainable.
• required return = RF + equity risk premium + size premium + specific-companypremium
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Estimates Strength WeaknessCAPM •Verysimpleinthatitusesonlyone
fator•Choosingtheappropriatefactor.•Lowexplanatorypowerinsomecases
Multifactor •Higherexplanatorypower(notassued)
•Morecomplexityandexpensive
Build-up •Simple•Canapplytocloselyheldcompanies.
•Historicalvaluesmaynotberelevanttocurrentmarketconditions
Required return equity
Ø Comparison
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International consideration
Ø Country risk
1. CAPM model
2. Country Spread Model
3. Country Risk Rating Model
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WACC
Ø The cost of capital is most commonly estimated using the company's after-taxweighted average cost of capital, or weighted average cost of capital (WACC)forshort.
• A weighted average of required rates of return of the component sources ofcapital
rceMVCE
MVDMVCEMVD
MVDMVCEWACC rd1Taxrate
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Discount rate selection in relation to cash flow
Ø Being used as discount rates in valuation,required returns need to be definedappropriately relative to the cash flows to be discounted.
• Cash flow to equity the required return on equity• Cash flow to the firm the firm's cost of capital(after-tax weighted average
cost of capital)Ø When cash flows are stated in real terms,amounts reflect offsets made for
actual or anticipated changes in the purchasing powers of money.• Nominal cash flows nominal discount rates• Real cash flows real discount rates
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Reading 26: INDUSTRY AND COMPANY ANALYSIS
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approaches for developing inputs to equity valuation models
Ø Bottom-up analysis starts with analysis of an individual company or its reportable
segments. Revenue projections based on historical revenue growth or a
company’s new product introductions over the forecast horizon are considered
bottom-up approaches.
Ø Top-down analysis begins with expectations about a macroeconomic variable,
often the expected growth rate of nominal GDP. Revenue projections that are
derived from an estimate of GDP growth and an expected relationship between
GDP growth and company sales are an example of a top-down approach.
Ø Hybrid analysis incorporates elements of both top-down and bottom-up analysis.
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Long term VS short term forcast
Ø Long term forecasting
• 基于growth rate (g) , 粗略估计
Ø Short term forecasting
• 预测每一年的B/S I/S,对应得到FCF
Ø 先预测利润表,基于利润表结果,预测资产负债表
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Forecasting items
Ø Forecasting items (利润表)
• Revenue
• COGS
• SG&A
• Interest
• Tax
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Forecasting items
Ø Forecasting items (资产负债表)
• A/R
• Inventory
• F.A
• I.A
• A/P
• Note payable
• Long-term debt
• Capital
• R/E• Cash 48
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Reading 27: Discounted Dividend Valuation
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framwork
1. The Gordon Growth model
2. Discount cash flow model
3. Multistage dividend discount model
4. Growth phase, transitional phase, and maturity phase
5. Equity analysis
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The Gordon Growth model
Ø Assumption
1. The firm expects to pay a dividend, D 1, in one year.
2. Dividends grow indefinitely at a constant rate, g (which may be less than zero).
3. The growth rate, g, is less than the required return, r.
Ø Formula
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The Gordon Growth model
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The Gordon Growth model
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The Gordon Growth model
Ø The value of a firm's equity has two components• The present value of a perpetual cash flow of equity;• The present value of its present value of growth opportunities(PVGO).
v0 E1 /r PVGOwhere:E1 earnings at t=1
r=required return on equity
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The Gordon Growth model
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The Gordon Growth model
Ø Justified P/E• Leading P/E P 0 / E1 1b/r g• Trailing P/E P 0 / E0 1b*1 g/r g
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The Gordon Growth model
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D D
1r 1r 1r
Discounted cash flow models
Ø Valuing perferred stock• The preferred stock holders are promised to receive a stated dividend for an
infinite period;• Preferred stock is perpetuity since it has no maturity;• Valuation model of a preferred stock.
D
rD
N V ...2
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Discounted cash flow models
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V0 n D01 gSt D0 1 gSn 1 gL1r 1rn r gL
Multistage dividend discount model
Ø Two-Stage DDM
• two-stage DDM we assume the company grows at a high rate for a relativelyshort period of time (the first stage) and then reverts to a long-run perpetualgrowth rate (the second stage).
t t1
where:
gs=short-term growth rate
gL=long-term growth rate
r=required retunrn
n=length of high growth period 60
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Multistage dividend discount model
Ø Carl Zeiss Meditec AG(Deutsche BÖrse XETRA:AFX),65 percent pwned bythe Carl Zeiss Group, provides screening,diagnostic, and therapeuticsystems for the treatment of ophtalmologic(vision) problems.Reviewingthe issue as of mid-August 2013,when it is trading for €23.37.
• Hans Mattern, a buy-side analyst covering Meditec, forecasts that thecurrent dividend of €0.40 will grow by 9 percent per year during the next10 years.Thereafter,Mattern believes that growth rate will decline to 5percent and remain at that level indefinitely.
• Mattern estimates Meditec's required return on equity as 7.1 percentbased on a beta of 0.90 against the DAX, a 2.4 percent risk-free rate, andhis equity risk premium estimate of 5.2 percent.
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Time Value Calculation DtorVt PV
1 D1 $0.401.09 $0.4360 $0.4071
2 D2 $0.401.09 $0.4752 $0.4143
3 D3 3
$0.401.09$0.5180 $0.4217
4 D4 4
$0.401.09$0.5646 $0.4291
5 D5 5
$0.401.09$0.6154 $0.4368
6 D6 6
$0.401.09$0.6708 $0.4445
7 D7 7
$0.401.09$0.7312 $0.4524
8 D8 8
$0.401.09$0.7970 $0.4604
9 D9 9
$0.401.09$0.8688 $0.4686
10 D10 10
$0.401.09$0.9469 $0.4769
Multistage dividend discount model
Ø Correct Answer:
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Multistage dividend discount model
Ø Three-stage DDM:the growth rate fits the three growth stages.
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Multistage dividend discount model
Ø IBM(as of early 2013)pays a dividend of $3.30 per year. A current price is$194.98.An analyst makes the following estimates.
• The current required return on equity for IBM is 9 percent, and• Dividends will grow at 14 percent for the next two years,12 pecent for the
following five years,and 6.75 percent thereafter.• Based only on the information given,estimate the value of IBM using a three-
stage DDM approach.
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Time Value Calculation DtorVt PresentValue
1 D1 3.301.14 $3.7620 $3.4514
2 D22
3.301.14$4.2887 $3.6097
3 D32
3.301.141.12$4.8033 $3.7090
4 D422
3.301.141.12$5.3797 $3.8111
5 D523
3.301.141.12$6.0253 $3.9160
6 D624
3.301.141.12$6.7483 $4.0238
7 D725
3.301.141.12$7.5581 $4.1346
7 D725
3.301.141.121.0675/0.090.0675
$358.59 $196.161
Multistage dividend discount model
Ø Correct Answer
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Multistage dividend discount model
Ø Correct Answer(cont):Given these assumptions, the three-stage model indicates that a fair priceshould be $222.82, which is above the current market price by over 14percent. Characteristically, the present value of the terminal value of$196.16 constitutes the overwhelming portion(here, about 88 percent)oftotal estimated value.
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Multistage dividend discount model
Ø H-Model
• The growth rate starts out high, and then declines linearly until it reach thelong-term growth rate
t2
V0
H
D0 1gLD0 Hgs gLr gL
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Multistage dividend discount model
Ø Vinci SA (NYSE Eouronext:DG).Through 2003, DG paid a single regular cashdividend per fiscal year.Since 2004 it has paid two dividends per (fiscal) year, aninterim dividend in December and a final dividend in May.Although during thepast five years total annual dividends grew at less than 3 percent peryear,Delacour foresees faster future growth. Having decided to compute the H-model value estimate for DG,analyst gathers the following facts and forecasts:
• The share price as of mid-August 2013 was €41.70.• The current divided is €1.77.• The intial divided growth rate is 7 percent, declining linearly during a 10-year
period to a final and perpetual growth rate of 4 percent.• DG's required rate of return on equity will be 9.5 percent.
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Multistage dividend discount model
Ø Correct Answer:
V0
0.0950.04 0.0950.04
33.474.8338.30
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Multistage dividend discount model
Ø Spreadsheet modeling(只掌握概念)
l 优点:
1. Flexibility
2. Computational accuracy
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phase Initialgrowth(初创期)
Growthphasetransition
(成长期)
Maturity(成熟期)
model Three-stage Two-stage Gordongrowth
3 phase
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Calculating SGR
Ø The sustainable growth rate (SGR)
• the rate at which earnings (and dividends) can continue to grow indefinitely
• 公式:
SGR = b × ROE
b = earnings retention rate = 1 − dividend payout rate
ROE = return on equity
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Calculating SGR
Ø The sustainable growth rate (SGR)
• Expansion (PRAT model)
• Dupont model
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• 例题
Company A has an equity multiplier of 1.5, ROA of 10 percent, it retains two-thirds ofearnings . What are the sustainable dividend growth rates for Company A
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Reading 28: FREE CASH FLOW VALUATION
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framework
1. 计算FCF的公式
2. 计算公式中的item
3. 根据财务报表计算FCF
4. 用FCF折现(模型与DDM中相同)
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Introduction to FCF
Ø Why we use FCF (FCFF/FCFE)
•
•
•
•
some companies do not pay dividends;
the dividends paid differ significantly from the company’s capacity to paydividends;
Free cash flows align with profitability within a reasonable forecast periodwith which the analyst is comfortable;
FCF valuation takes a "control” perspective; DDM takes a “minority”perspective
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Introduction to FCF
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Introduction to FCF
Ø FCF 选择的问题 (FCFF or FCFE)
•
•
•
FCFE is easier and more straightforward
If a company has negative FCFE, we use FCFF, which is usually positive
Equity value = Firm value - Market value of debt
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Introduction to FCF
Ø FCF 选择的问题 (FCFF or FCFE)
•
•
The value of the firm is the present value of the expected future FCFFdiscounted at the WACC
firm value = FCFF discounted at the WACC
ü FCFFt= FCFFt-1× (1+g)
ü Firm Value=FCFF1/ (WACC-g) = FCFF0(1+g) /(WACC-g)
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Introduction to FCF
Ø FCF 选择的问题 (FCFF or FCFE)
•
•
The value of equity : the present value of the expected future FCFEdiscounted at the required return on equity(r).
The methods to estimate r
1. CAPM
2. Multifactor model
3. Build up method
• Constant Growth Valuation Model
1. Equity Value=FCFE1I (r-g)
2. FCFE (1+g) I (r-g) 81
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FCF计算公式
Ø 10 个公式
•
•
•
计算 FCFF 有 4 个公式
计算 FCFE 有6个公式
记住2个核心公式,推导其余8个公式
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FCF计算公式
Ø 计算FCFF
• From EBIT : FCFF=EB1T× (1-T)+ NCC – FCINV – WCINV(核心公式)
• From NI: FCFF=( Nl+ NCC – Wcinv) + Int×(1-T) – FCINV
•
•
From EBITDA: FCFF=EBITDA× (1-T)+ NCC×T – FCINV – WCINV
From CFO: FCFF= CFO + lnt× (1-T) – FCINV
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FCFE=NI+NCC-WCINV-FCINV+NBl From NI :
l From DR :
FCF计算公式
Ø 计算FCFE (以计算FCFF公式为基础)
l 核心公式:FCFE = FCFF − Int(1 − tax rate) + net borrowing
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NoncashItem adjustmentDepreciation +Amortization +impairmentofintangibles +Restructuringcharges(expense) +Restructuringcharges(incomeresultingfromreversal)
-
公司处置F.A的Losses +公司处置F.A的Gains -Amortizationoflong-termbonddiscount +Amortizationoflong-termbondpremiums -Deferredtaxes
NCC(Non-cash charges) adjustments
Ø NCC(Non-cash charges) adjustments for FCFF calculation
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Ø 例题
Meyer Henderson, CFA, is analyzing the financials of Roth Department Stores. He intends to use afree cash flow to the firm (FCFF) model to value Roth’s common stock. In the 2016 financialstatements and footnotes he has identified the following items:Item #1: Roth reported depreciation and software amortization of $23 million in 2016.
Item #2: The deferred tax liability increased by $17 million in 2016.
Item #3: Roth reported income of $6 million in 2016 from the reversal of previous restructuringcharges related to store closings in 2015.
Item #4: Net income totaled $173 million in 2016.
Item #5: The net increase in noncash net working capital accounts was $47 million in 2016.
Item #6: Net capital spending totaled $86 million in 2016.
Item #7: Roth reported interest expense of $19 million. 86
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Ø 例题
Henderson estimated Roth’s marginal tax rate to be 35%. He also expects Roth tobe profitable for the foreseeable future, so he does not expect the deferred taxliability to reverse. As the base-year projection for his FCFF valuation, Hendersoncalculates FCFF for 2016 as:
FCFF2016= $173 + $23 - $6 + $17 + [$19(1 − 0.35)] − $86 − $47= $86.35 million
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WCINV 计算
Ø WCINV 计算
•
•
•
The investment in net working capital is equal to the change in workingcapital
excluding cash, cash equivalents, notes payable, and the current portion oflong-term debt.
公式:WCINV=WCt -WCt-1
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FCINV 计算
Ø FCINV 计算
•
•
Fixed capital investment is a net amount: it is equal to the difference betweencapital expenditures (investments in long-term fixed assets) and the proceedsfrom the sale of long-term assets:
公式:FCInv = capital expenditures − proceeds from sales of long-term assets
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FCINV 计算
Ø If no long-term assets were sold during the year:
• 公式1:基于GV
FCInv = ending gross PP&E − beginning gross PP&E
• 公式2:基于BV
FCInv = ending net PP&E − beginning net PP&E + depreciation
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FCINV 计算
Ø If long-term assets were sold during the year
•
•
Calculate FCInv = capital expenditures − proceeds from sale of long-termassets.
公式1:基于GV
FCInv = = ending gross PP&E − beginning gross PP&E + disposal gross PP&E –disposal G/L - disposal net PP&E
• 公式2:基于BV
FCInv = ending net PP&E − beginning net PP&E + depreciation − gain on sale.
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NB 计算
Ø NB计算
• 定义式
ü net borrowing = long- and short-term new debt issues − long- and short-termdebt repayments
• 计算式
ü net borrowing=debt末- debt初
ü 注意debt包含long and short-term(short-term debt : note payable)
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Free Cash Flow With Preferred Stock
Ø 特殊情况: Free Cash Flow With Preferred Stock
•
•
•
•
Remember to treat preferred stock just like debt, except preferred dividendsare not tax deductible.
If the company has preferred stock
FCFF=NI + Int * (1-T) + NCC – WCINV- FCINV
FCFE=NI + NCC – WCINV– FCINV +NB
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Ø The current FCFF for Barlow Energy is closest to
A. $36.
B. $62.
C. $86.
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Target debt ratio
计算FCFE
From NI : FCFE=NI+NCC-WCINV-FCINV+NB
NB = (WCINV + FCINV - Depr) * DR
公式6: FCFE=NI+NCC-WCINV-FCINV +(WCINV + FCINV - Dep) * DR
FCFE = NI − [(1 − DR) × (FCInv − Dep)] − [(1 − DR) × WCInv]
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Single-Stage FCFF Model
Ø Single-Stage FCFF Model
• it’s the Gordon growth model with FCFF replacing dividends and WACC
replacing required return on equity.
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Single-Stage FCFE Model
Ø Single-Stage FCFE Model
• The single-stage constant-growth FCFE valuation model is analogous
to the single-stage FCFF model, with FCFE instead of FCFF and
required return on equity instead of WACC:
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Two-Stage Model
Ø Two-Stage FCFF Model
• The company value is the present value of the first stage‘ FCFF plus the
present value of the terminal value of the FCFF.
Ø Two-Stage FCFE Model
• The equity value is the present value of the first stage’ FCFE plus the present
value of the terminal value of the FCFE.
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Three-Stage Model
Ø Three -Stage FCFF Model
• The company value is the present value of the high-growth and transitional
period’ FCFF plus the present value of the terminal value of the FCFF.
Ø Three -Stage FCFE Model
• The equity value is the present value of the high-growth and transitional
period’ FCFE plus the present value of the terminal value of the FCFE.
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sensitivity analysis in FCFF and FCFE valuations
• Sensitivity analysis shows how sensitive an analyst’s valuation results are to
changes in each of a model’s inputs.
• Some variables have a greater impact on valuation results than others. The
importance of various forecasting errors can be assessed through
comprehensive sensitivity analysis.
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Reading 29: MARKET-BASED VALUATION:PRICE AND ENTERPRISE VALUE MULTIPLES
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framework
Ø Price multiple
• P/E
• P/B
• P/S
• P/CF
• EV/EBITDA
• Dividend yield
Ø Momentum valuation indicators
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Introduction
Ø The method of comparables values a stock based on the average price multiple of
the stock of similar companies.
• The economic rationale for the method of comparables is the Law of One Price.
Ø The method of forecasted fundamentals values a stock based on the ratio of its
value from a discounted cash flow (DCF) model to some fundamental variable
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P/E
Ø P/E
• Advantage
• Earnings power, as measured by earnings per share (EPS), is the primary
determinant of investment value .
• The P/E ratio is popular in the investment community.
• Empirical research shows that P/E differences are significantly related to long-run
average stock returns.
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P/E
Ø P/E
• Disadvantage
ü Earnings can be negative, which produces a meaningless P/E ratio.
ü The volatile, transitory portion of earnings makes the interpretation of P/Es
difficult for analysts .
ü Management discretion within allowed accounting practices can distort reported
earnings, and thereby lessen the comparability of P/Es across firms.
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P/E
Ø P/E
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Methods of normalizing EPS
Ø The following two methods are used to normalize earnings:
1. Under the method of historical average EPS,.
ü the normalized EPS is estimated as the average EPS over some recent period,
usually the most recent business cycle.
ü The method of historical average EPS ignores size effects
2. Under the method of average return on equity
ü normalized EPS is estimated as the average return on equity (ROE) multiplied by
the current book value per share (BVPS). average ROE is often measured over the
most recent business cycle.
ü The reliance on BVPS reflects the effect of firm size changes 111
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P/E-to-growth ratio (PEG)
Ø The relationship between earnings growth and P/E is captured by the P/E-to-
growth (PEG) ratio:
• 公式:
• The implied valuation rule is that stocks with lower PEGs are more attractive than
stocks with higher PEGs, assuming that risk is similar.
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P/E-to-growth ratio (PEG)
Ø The drawbacks to using the PEG ratio:
• The relationship between P/E and g is not linear, which makes comparisons
difficult .
• The PEG ratio still doesn’t account for risk .
• The PEG ratio doesn’t reflect the duration of the high-growth period for a
multistage valuation model, especially if the analyst uses a short-term high-
growth forecast.
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P/B
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P/B
Ø Rationales for using price-to-book (P/B) ratio in valuation:
• Book value is a cumulative amount that is usually positive, even when the firm
reports a loss and EPS is negative. Thus, a P/B can typically be used when P/E
cannot.
• Book value is more stable than EPS
• Book value is an appropriate measure of net asset value for firms that primarily
hold liquid assets. Examples include finance, investment, insurance, and banking
firms.
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P/B
Ø Disadvantages of using the price-to-book ratio include:
• P/Bs can mislead when there are significant size differences.
• Different accounting conventions can obscure the true investment in the firm
made by shareholders .
• Inflation and technological change can cause the book and market value of assets
to differ significantly.
• P/Bs do not recognize the value of nonphysical assets(无形资产).
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P/B calculation
Ø Justified P/B(用 RI valuation 计算)
• 公式:P/B0=(ROE-g) I (r-g)
• The P/B increases as ROE increases.
• It also increases as the spread between ROE and r increases.
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P/S
Ø Rationales for using price-to-sales (P/S) ratio in valuation :
• P/S is meaningful even for distressed firms .
• Sales revenue is not as easy to manipulate or distort as EPS and book value .
• P/S ratios are not as volatile as P/E multiples .
• P/S ratios are particularly appropriate for valuing stocks in mature or cyclical
industries and start-up companies with no record of earnings .
• Empirical research finds that differences in P/S are significantly related to
differences in long-run average stock returns.
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P/S
Ø Disadvantages of using the price-to-sales ratio include :
• Higher sales do not necessarily indicate higher operating profits .
• P/S ratios do not capture differences in cost structures across companies .
• While less subject to distortion than earnings, revenue recognition practices can
distort sales forecasts.
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P/S calculation
Ø Justified P/S (结合P/E ratio)
• 公式:
• 变形: IV/Sales=EPS/Sales * IV/EPS
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P/CF
Ø Advantages of using the price-to-cash flow (P/CF) ratio include :
• Cash flow is harder for managers to manipulate than earnings .
• Price to cash flow is more stable than price to earnings .
• Reliance on cash flow rather than earnings handles the problem of differences in
the quality of reported earnings, which is a problem for P/E .
• Empirical evidence indicates that differences in price to cash flow are significantly
related to differences in long-run average stock returns.
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P/CF
Ø Disadvantages of using the price to cash flow include:
• Items affecting actual cash flow from operations are ignored when the EPS plus
noncash charges estimate is used. For example, noncash revenue and net changes
in working capital are ignored .
• From a theoretical perspective, free cash flow to equity (FCFE) is preferable to
operating cash flow. However, FCFE is more volatile than operating cash flow, so it
is not necessarily more informative.
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EV/EBITDA
Ø Enterprise value (EV) is total company value:
• 公式:EV = market value of common stock + market value of preferred equity +
market value of debt + minority interest – cash and investments
• EBITDA = recurring earnings from continuing operations + interest + taxes +
depreciation + amortization
• 公式:
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EV/EBITDA
Ø EV/EBITDA is useful in a number of situations :
• The ratio may be more useful than P/E when comparing firms with different
degrees of financial leverage.
• EBITDA is useful for valuing capital-intensive businesses with high levels of
depreciation and amortization.
• EBITDA is usually positive even when EPS is not.
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Dividend Yield
Ø Dividend yield (D/P) is the ratio of trailing or leading dividend divided by current
market price per share:
• 公式:
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Compare price multiple with benchmark
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momentum indicators
Ø Momentum indicators
• Unexpected earnings or earnings surprise is the difference between reported
earnings and expected earnings:
• earnings surprise = reported EPS − expected EPS
• 存在问题:只考虑收益(EPS),没有考虑风险(标准差)
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momentum indicators
Ø Momentum indicators
• the standardized unexpected earnings (SUE) measure is defined as:
• 2
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Momentum indicators
Ø Relative strength indicator (RSTR)
• Relative strength indicators compare a stock’s price or return performance during
a given time period with benchmark
ü its own historical performance
ü some group of peer stocks.
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计算 portfolio P/E
Ø the portfolio or index P/E is best calculated as the weighted harmonic mean P/E.
• 公式:
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Reading 30: RESIDUAL INCOME VALUATION
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framework
1. Residual income是什么,怎么算
2. Residual income single-stage model
3. Residual income two-stage model
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Concept of residual income
Ø Residual income (RI), or economic profit, is the net income of a firm less a
charge that measures stockholders’ opportunity cost of capital.
• 公式:RI = NI – Equity capital * cost of equity
Ø Economic value added (EVA ) measures the value added for shareholders by
management during a given year.
• 公式:
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Concept of residual income
Ø Market value added (MVA) is the difference between the market value of a
firm’s long-term debt and equity and the book value of invested capital
supplied by investors.
• 公式:MVA = market value − total capita
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Residual income computation
Ø 定义式:RI = NI – Equity0* re
Ø 计算式:RI = Equity0* (ROE - re)
Ø RI 的递推计算公式 (基于 clean surplus relation)
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Residual income valuation model
Ø The residual income valuation model breaks the intrinsic value of a stock into
two elements:
•
•
(1) current book value of equity
(2) present value of expected future residual income:
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Residual income valuation model
Ø Difference with DDM & FCFE
• with a dividend discount model (DDM) or free cash flow to equity (FCFE)
model, a large portion of the estimated intrinsic value comes from the present
value of the expected terminal value.
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Residual income valuation model
Ø Single – stage valuation
• 公式:
Ø the relation with justified price-to-book ratio(考点)
• If ROE is greater than the required return on equity, the second term (the
present value of residual income) will be positive, the market value will be
greater than book value, and the justified P/B ratio will be greater than one.
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Residual income valuation model
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Residual income valuation model
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Residual income valuation model
Ø Continuing residual income (Two-stage model)
• In the residual income model, intrinsic value is the sum of three components:
• V 0= B 0+ (PV of interim high-growth RI) + (PV of continuing residual income)
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• Step 1: Calculate the current book value per share.
• Step 2: Calculate residual income in each year 1 to T − 1 during the interim
high-growth period and discount them back to today at the required return on
equity.
• Step 3: Calculate continuing residual income that begins at the end of the
high-growth period starting in year T, and then calculate the present value of
continuing residual income as of the end of year T − 1146
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Residual income valuation model
#4: Residual Income Declines to Long-Run Level in Mature Industry
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Residual income valuation model
• Assumption #4: Residual Income Declines to Long-Run Level in Mature Industry
ü PVT-1= BT-1* P/BT-1–BT-1
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Issues in applying residual income models.
Ø Issues in applying residual income models.
• Clean Surplus Violations
ü Foreign currency translation gains and losses that flow directly to retained
earnings under the current rate method.
ü Certain pension adjustments.
ü Gains/losses on certain hedging instruments.
ü Changes in revaluation surplus (IFRS only) for long-lived assets.
ü Changes in the value of certain liabilities due to changes in the liability’s credit risk
(IFRS only).
ü Changes in the market value of debt and equity securities classified as availablefor-sale. 149
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Issues in applying residual income models.
Ø Issues in applying residual income models.
• Variations from Fair Value
ü Operating leases
ü Special purpose entities (SPEs)
ü Inventory
ü Deferred tax liabilities
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Reading 31: PRIVATE COMPANY VALUATION
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Compare public and private company valuation
Ø Company-Specific Factors
• Stage of lifecycle : Private companies are typically less mature than public firms.
• Size: Private firms typically have less capital, fewer assets, and fewer employees
than public firms and, as such, can be riskier.
• Quality and depth of management: Smaller private firms may not be able to
attract as many qualified applicants as public firms.
• Management/shareholder overlap: In most private firms, management has a
substantial ownership position.
• Short-term investors : management may take a shorter-term view compared to
private firms where managers are long-term holders of significant equity interests.152
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Compare public and private company valuation
Ø Company-Specific Factors
• Quality of financial and other information: Public firms are required to make
timely, indepth financial disclosures. A potential creditor or equity investor in a
private firm will have less information than is available for a public firm. This leads
to greater uncertainty, higher risk, and reduces private firm valuations.
• Taxes: Private firms may be more concerned with taxes than public firms due to
the impact of taxes on private equity owners/managers.
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Compare public and private company valuation
Ø Stock-Specific Factors
• Liquidity: Private company equity typically has fewer potential owners and is less
liquid than publicly traded equity.
• Restrictions on marketability: Private companies often have agreements that
prevent shareholders from selling, reducing the marketability of shares.
• Concentration of control: The control of private firms is usually concentrated in
the hands of a few shareholders.
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Definitions of Value
Ø Definitions of Value
• Fair market value
• Fair value for financial reporting
• Fair value for litigation
• Market value:
• Investment value
• Intrinsic value
• Liquidation value
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Issues for financial statement adjustments
Ø Issues for financial statement adjustments
• Estimating Normalized Earnings
• Strategic and Nonstrategic Buyers
• Estimating Cash Flow
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Estimating Normalized Earnings
Ø Estimating Normalized Earnings
• Normalized earnings should exclude nonrecurring and unusual items.
• Artificially low earnings may also be the result of excessively high owner
compensation or of personal expenses charged to the firm.
• Any real estate owned by the firm may merit treatment separate from that of firm
operations.
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Strategic and Nonstrategic Buyers
Ø Strategic and Nonstrategic Buyers
• A transaction may be either strategic or financial (nonstrategic).
• In a strategic transaction, valuation of the firm is based in part on the perceived
synergies with the acquirer’s other assets.
• A financial transaction assumes no synergies, as when one firm buys another in a
dissimilar industry.
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Estimating Cash Flow
Ø Estimating Cash Flow
• FCFF is usually more appropriate when the significant changes in the firm’s capital
structure are anticipated.
• The reasoning is that the discount rate used for FCFF valuation, the weighted
average cost of capital (WACC), is less sensitive to leverage changes than the cost
of equity, the discount rate used for FCFE valuation.
• the FCFF valuation is less sensitive to the degree of financial leverage assumed in
the analysis than the FCFE valuation.
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the Income Approach
Ø The Income Approach
• The Free Cash Flow Method ( a two-stage model )
• The Capitalized Cash Flow Method (single-stage model )
ü Under this method, a single measure of economic benefit is divided by a
capitalization rate to arrive at firm value, where the capitalization rate is the
required rate of return minus a growth rate.
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the Income Approach
Ø The Excess Earnings Method
• Excess earnings are firm earnings minus the earnings required to provide the
required rate of return on working capital and fixed assets.
• The value of intangible assets can be estimated as the present value of the stream
of excess earnings
• This value for the intangible assets is added to the values of working capital and
fixed assets to arrive at firm value.
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3 models used to estimate the required rate of return
• CAPM: Typically, beta is estimated from public firm data, and this may not be
appropriate for private firms that have little chance of going public or being
acquired by a public firm.
• Expanded CAPM: This version of the CAPM includes additional premiums for size
and firm-specific (unsystematic) risk.
• Build-up method: When it is not possible to find comparable public firms for beta
estimation, the build-up method can be used.
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factors that require adjustment
Ø factors that require adjustment when estimating the discount rate for private
companies.
• Size premiums: Size premiums are often added to the discount rates for small
private companies.
• Availability and cost of debt: A private firm may have less access to debt financing
than a public firm.
• Projection risk : Because of the lower availability of information from private firms
and managers who are inexperienced at forecasting, that analyst should increase
the discount rate used.163
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factors that require adjustment
Ø factors that require adjustment when estimating the discount rate for private
companies.
• Lifecycle stage: It is particularly difficult to estimate the discount rate for firms in
an early stage of development.
• Acquirer versus target : When acquiring a private firm, some acquirers will
incorrectly use their own (lower) cost of capital, rather than the higher rate
appropriate for the target, and arrive at a value for the target company that is too
high.
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Market-based valuation
Ø Market multiple
• large private firm valuation is usually based on EBIT or EBITDA multiples.
• For small private companies with limited assets, net income multiples might be
used instead of EBITDA multiples.
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Market-based valuation
Ø The three methods
• guideline public company method (GPCM) : 要考虑control premium
• the guideline transactions method (GTM) :不考虑control premium
• the prior transaction method (PTM)
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Asset-based approach
Ø Asset-based approach
• The asset-based approach estimates the value of firm equity as the fair value of its
assets minus the fair value of its liabilities.
• It is generally not used for going concerns. Of the three approaches, the asset-
based approach generally results in the lowest valuation
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Asset-based approach
Ø The asset-based approach might be appropriate in the following circumstances:
• Firms with minimal profits and little hope for better prospects.
• Finance firms such as banks, where their asset and liability values (loan and
security values) can be based on market prices and factors.
• Investment companies such as real estate investment trusts (REITs) and closedend
investment companies (CEICs) where the underlying assets values are determined
using the market or income approaches.
• Small companies or early stage companies with few intangible assets.
• Natural resource firms where assets can be valued using comparables sales.168
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Valuation discounts
Ø The Discount for Lack of Control
• 公式:
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Valuation discounts
Ø The Discount for Lack of Marketability(题目中直接给)
• If an interest in a firm cannot be easily sold, discounts for lack of marketability
(DLOM) would be applied (sometimes termed a discount for lack of liquidity).
Ø Total discount
• 公式:
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THANKS!
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