CFA 50: Equity Valuation: Concepts and Basic Tools Flashcards
present value models (discounted cash flow models)
Major Categories of Equity Valuation Models
Estimate the intrinisc value of a securty as the present value of the future benefits expected to be received from the security.
divident discount models (PV)
Major Categories of Equity Valuation Models
A present value model that estimates the intrinsic value of an equity share based on the present value of its expected future dividends.
multiplier models (PV) Major Categories of Equity Valuation Models
Valuation models based on share price multiples or enterprise value multiples.
free-cash-flow-to-equity models
Major Categories of Equity Valuation Models
Valuation models based on discounting expected future free cash flow to equity.
enterprise value
Major Categories of Equity Valuation Models
A measure of a company’s total market value from which the value of cash and short-term investments have been subtracted (because an acuierer could use those assets to pay for acquiring the company). EV multiples have the form (enterprise value) / (value of a fundamental variable). Two common denominators are EBITDA and total revenue. Also, common share value can be calculated indirectly from the EV multiple; the value of liabilities and preferred shares can be subtracted from the EV to arrive at the value of common equity.
asset-based valuation models
Major Categories of Equity Valuation Models
These models estimate intrinsic value of a common share from the estimated value of the assets of a corporation minus the estimated value of its liabilities and preferred shares. The estimated market value of teh assets is often determined by making adjustments to the book value (also called carrying value) of assets and liabilities. The theory underlying the asset-based approach is that the value of a business is equal to the sum of the value of the business’s assets.
book value (carrying value) Major Categories of Equity Valuation Models
The net amount shown for an asset or liability on the balance sheet; book value may also refer to the company’s excess of total assets overtotal liabilities.
terminal stock value (terminal value)
Present Value Models: The Dividend Discount Model
The expected value of a share at the end of the investment horizon - the expected selling price.
The Gordon Gowth Model
Present Value Models: The Dividend Discount Model
Circumvents the discounting problem of th dividend discount model’s estimate of an infinite series of expected dividends. To simplify this process, analysts frequently make assumptions about how dividends will grow or change over time. The Gordown Growth Model assumes dividends grow indefinitely at a constant rate. For that reason, the Grodon growth model is particularly appropriate for valuing the equity of dividend-paying companies that are relatively INSENSITIVE to the business cycle and are in a mature growth phase.
Gordon Growth Model Assumptions
Present Value Models: The Dividend Discount Model
Dividends are the correct metric to use for valuation purposes.
The dividend growth rate is forever: It is perpetual and never changes.
The required rate of return is also constant over time.
The dividend growth rate is strictly less than the required rate of return.
Multistage Dividend Discount Models
Present Value Models: The Dividend Discount Model
Can have as many “stages” as necessary. The two-stage DDM assumes that at some point the company will begin to pay dividends that grow at a constant rate, but prior to that time the company will pay dividends that are growing at a higher rate than can be sustained in the long run. The two-stage DDM makes use of two growth rates: a high growth rate for an initial, finite period followed by a lower, sustainable growth rate into perpetuity. The Gordon growth model is used to estimate a terminal value at time n that reflects the present value at time n of the dividends received furing the sustainable growth period.
price multiple
Multiplier Models
A ratio that compares the share price with some sort of monetary flow or value to allow evaluation of the relative worth of a company’s stock. A common criticism of all of these kinds of multiples (P/E, P/B, P/S, P/CF, etc) is that they do not consider the future.
law of one price
Present Value Models: The Dividend Discount Model
Identical assets should sell for the same price. This methodology of evaluation involves using a price multiple to evaluate whether an asset is fairly valued, undervalued, or overvalued in relation to a benchmark value of the multiple. Choices for the benchmark multiple include the multiple of a closely matched invdivdual stock or the average or median value of the multiple for the stock’s industry.
