41. Equity valuation: Concepts and basic tools

Question 1

Present Value Models (Discounted Cash Flow Models)

Answer 1

The intrinsic value is the present value of future benefits from the security. Benefits could be viewed as dividends or free cash flows.

Question 2

Multiplier Models (Market Multiple Models)

Answer 2

Usually, these are based on share price multiples or enterprise value multiples. Examples of share price multiples include price to earnings and price to sales. The fundamental variable can be on a forward or trailing basis. This is commonly used to compare relative values.

Question 3

Asset-based Valuation Models

Answer 3

The intrinsic value is estimated as the market value of assets minus the estimated value of liabilities and preferred stock.

Question 4

Regular dividends

Answer 4

are paid at known intervals, which tend to vary by region (e.g., quarterly in North America, semiannually in Europe, annually in China). Directors may authorize an annual dividend that is paid in quarterly or semiannual installments. There are four important milestones in the standard chronology of dividend payments: Declaration date, Ex-dividend date, Holder-of-record date, Payment date

Question 5

Extra (special) dividends

Answer 5

may be paid at any time outside the regular schedule. Often, companies in cyclical industries choose to supplement their regular dividends with a special dividend. A liquidating dividend is paid to return capital to shareholders when a company goes out of business.

Question 6

Stock dividends

Answer 6

grant extra shares to investors rather than cash. Stock splits increase the number of shares outstanding, while reverse stock splits reduce the number of shares outstanding. These three types of transactions also have no effect on a company’s valuation.

Question 7

Share repurchases

Answer 7

can be used as an alternative to paying cash dividends. Management can choose to repurchase shares if they believe that they are trading below their intrinsic value.

Question 8

Price multiples

Answer 8

are ratios of the share price to some other value related to the relative worth of the company’s stock

Question 9

Enterprise value

Answer 9

calculated as the sum of the market values of all forms of capital (e.g., common stock, preferred stock, debt) net of cash and short-term investments