Session 6- Valuationpeople.stern.nyu.edu/adamodar/pdfiles/invphilslides/session5.pdf · PT Indosat...
Transcript of Session 6- Valuationpeople.stern.nyu.edu/adamodar/pdfiles/invphilslides/session5.pdf · PT Indosat...
Valua%on: The Basics
Aswath Damodaran www.damodaran.com
DCF Choices: Equity Valua%on versus Firm Valua%on
Assets Liabilities
Assets in Place Debt
Equity
Fixed Claim on cash flowsLittle or No role in managementFixed MaturityTax Deductible
Residual Claim on cash flowsSignificant Role in managementPerpetual Lives
Growth Assets
Existing InvestmentsGenerate cashflows todayIncludes long lived (fixed) and
short-lived(working capital) assets
Expected Value that will be created by future investments
Equity valuation: Value just the equity claim in the business
Firm Valuation: Value the entire business
More generally… The value of any business is a func%on of..
Cashflows from existing assetsCashflows before debt payments, but after taxes and reinvestment to maintain exising assets
Expected Growth during high growth period
Growth from new investmentsGrowth created by making new investments; function of amount and quality of investments
Efficiency GrowthGrowth generated by using existing assets better
Length of the high growth periodSince value creating growth requires excess returns, this is a function of- Magnitude of competitive advantages- Sustainability of competitive advantages
Stable growth firm, with no or very limited excess returns
Cost of capital to apply to discounting cashflowsDetermined by- Operating risk of the company- Default risk of the company- Mix of debt and equity used in financing
Determinants of Firm Value
How well do you manage your existing investments/assets?
Are you investing optimally forfuture growth? Is there scope for more
efficient utilization of exsting assets?
Are you building on your competitive advantages?
Are you using the right amount and kind of debt for your firm?
Es%ma%ng cash flows to a business
Cash flows can be measured to
All claimholders in the firm
EBIT (1- tax rate) - ( Capital Expenditures - Depreciation)- Change in non-cash working capital= Free Cash Flow to Firm (FCFF)
Just Equity Investors
Net Income- (Capital Expenditures - Depreciation)- Change in non-cash Working Capital- (Principal Repaid - New Debt Issues)- Preferred Dividend
Dividends+ Stock Buybacks
And discount rates…
Cost of Equity = Riskfree Rate + Beta X (Risk Premium)
Has to be default free, in the same currency as cash flows, and defined in same terms (real or nominal) as thecash flows
Historical Premium1. Mature Equity Market Premium:Average premium earned bystocks over T.Bonds in U.S.2. Country risk premium =Country Default Spread* (σEquity/σCountry bond)
Implied PremiumBased on how equity is priced todayand a simple valuationmodel
or
Cost of Capital = Cost of Equity (Equity/(Debt + Equity)) + Cost of Borrowing (1-t) (Debt/(Debt + Equity))
Cost of borrowing should be based upon(1) synthetic or actual bond rating(2) default spreadCost of Borrowing = Riskfree rate + Default spread
Marginal tax rate, reflectingtax benefits of debt
Weights should be market value weightsCost of equitybased upon bottom-upbeta
Cost of Capital: Weighted rate of return demanded by all investors
Cost of Equity: Rate of Return demanded by equity investors
Let’s do some valua%on…
• You have been asked to value a business. The business expects to $ 120 million in aNer-‐tax earnings (and cash flow) next year and to con%nue genera%ng these earnings in perpetuity. The firm is all equity funded and the cost of equity is 10%.
• What is the value of the business?
• What is the value of equity in this business?
• If there were 100 million shares outstanding, what is the value of equity per share?
• What would happen to the value of equity per share if the firm has
granted op%ons to its managers over %me? (Assume that there are 20 million op%ons outstanding)
Now, let’s try some growth
• Assume now that you were told that the firm can grow earnings at 2% a year forever. Es%mate the value of the business.
• Now what if you were told that the firm can grow its earnings at 4% a year forever?
• What if the growth rate were 6% a year forever?
Where does growth come from?
• To grow, a company has to reinvest. How much it will have to reinvest depends in large part on how fast it wants to grow and what type of return it expects to earn on the reinvestment. – Reinvestment rate = Growth Rate/ Return on Capital
• Assume in the previous example that you were told that the return on capital was 10%. Es%mate the reinvestment rate and the value of the business (with a 2% growth rate).
• What about with a 4% growth rate?
The Determinants of Growth: How investment decisions affect value
• Quality growth is rare requires that a firm be able to reinvest a lot and reinvest well (earnings more than your cost of capital) at the same %me.
• The larger you get, the more difficult it becomes to maintain quality growth.
• You can grow while destroying value at the same %me.
Expected Growth
Net Income Operating Income
Retention Ratio=1 - Dividends/Net Income
Return on EquityNet Income/Book Value of Equity
XReinvestment Rate = (Net Cap Ex + Chg in WC/EBIT(1-t)
Return on Capital =EBIT(1-t)/Book Value of Capital
X
Rela%ve Valua%on
• What is it?: The value of any asset can be es%mated by looking at how the market prices “similar” or ‘comparable” assets.
• Philosophical Basis: The intrinsic value of an asset is impossible (or close to impossible) to es%mate. The value of an asset is whatever the market is willing to pay for it (based upon its characteris%cs)
• Informa%on Needed: To do a rela%ve valua%on, you need – an iden%cal asset, or a group of comparable or similar assets – a standardized measure of value (in equity, this is obtained by dividing
the price by a common variable, such as earnings or book value) – and if the assets are not perfectly comparable, variables to control for
the differences • Market Inefficiency: Pricing errors made across similar or
comparable assets are easier to spot, easier to exploit and are much more quickly corrected.
Let’s do some rela%ve valua%on..
Company Name PEPT Indosat ADR 7.8Telebras ADR 8.9Telecom Corporation of New Zealand ADR 11.2Telecom Argentina Stet - France Telecom SA ADR B 12.5Hellenic Telecommunication Organization SA ADR 12.8Telecomunicaciones de Chile ADR 16.6Swisscom AG ADR 18.3Asia Satellite Telecom Holdings ADR 19.6Portugal Telecom SA ADR 20.8Telefonos de Mexico ADR L 21.1Matav RT ADR 21.5Telstra ADR 21.7Gilat Communications 22.7Deutsche Telekom AG ADR 24.6British Telecommunications PLC ADR 25.7Tele Danmark AS ADR 27Telekomunikasi Indonesia ADR 28.4Cable & Wireless PLC ADR 29.8APT Satellite Holdings ADR 31Telefonica SA ADR 32.5Royal KPN NV ADR 35.7Telecom Italia SPA ADR 42.2Nippon Telegraph & Telephone ADR 44.3France Telecom SA ADR 45.2Korea Telecom ADR 71.3
The first missing component…
Company Name PE Expected Growth in EPS - Next 5 yearsPT Indosat ADR 7.8 6.00%Telebras ADR 8.9 7.50%Telecom Corporation of New Zealand ADR 11.2 11.00%Telecom Argentina Stet - France Telecom SA ADR B 12.5 8.00%Hellenic Telecommunication Organization SA ADR 12.8 12.00%Telecomunicaciones de Chile ADR 16.6 8.00%Swisscom AG ADR 18.3 11.00%Asia Satellite Telecom Holdings ADR 19.6 16.00%Portugal Telecom SA ADR 20.8 13.00%Telefonos de Mexico ADR L 21.1 14.00%Matav RT ADR 21.5 22.00%Telstra ADR 21.7 12.00%Gilat Communications 22.7 31.00%Deutsche Telekom AG ADR 24.6 11.00%British Telecommunications PLC ADR 25.7 7.00%Tele Danmark AS ADR 27 9.00%Telekomunikasi Indonesia ADR 28.4 32.00%Cable & Wireless PLC ADR 29.8 14.00%APT Satellite Holdings ADR 31 33.00%Telefonica SA ADR 32.5 18.00%Royal KPN NV ADR 35.7 13.00%Telecom Italia SPA ADR 42.2 14.00%Nippon Telegraph & Telephone ADR 44.3 20.00%France Telecom SA ADR 45.2 19.00%Korea Telecom ADR 71.3 44.00%
Closing Thoughts on Valua%on
• Valua%on is simple. We choose to make it complex.
• The biggest enemies of good valua%ons are biases and preconcep%ons that you bring into the valua%ons.
• You cannot value equity precisely. Be ready to be wrong and do not take it personally.
• Making a model bigger will not necessarily make it beeer.