Ch 7: corp & stock valuation Flashcards
proxy
proxy fight
- document giving one person authority to act for another, typically the power to vote shares of common stock
- attempt to take over a company in which an outside group solicits existing shareholders’ proxies in an effort to overthrow management and take control of business.
preemptive right
allows current common stockholders to purchase any additional shares sold by the firm. it allows the current to maintain control and prevents transfer of wealth from current stockholders to new stockholders. if not for this, management could issue additional shares at a low price and purchase the shares themselves.
classified stock
founders shares
- created by a firm to meet special needs and circumstances (dividend and voting rights)
dual class shares if there's 2 classes. New shares in IPO sometimes have voting restrictions but may have full dividend rights.
- stock owned by firm’s founders that have sole voting rights but restricted dividends for a specific # of years. Standard & Poor’s no longer allows new additions to its indices to have classified stock.
free cash flow (FCF) valuation model
shows the connection between managerial choices and firm value. defines the value of a company’s operations as the present value of its expected FCF when discounted at the WACC.
importance of FCF model
managerial choices that change operating profitability, asset utilization, or growth also change FCF, hence, the value of operations. Managerial choices that affect risk, such as implementing riskier strategies or changing the amount of debt financing also affect the WACC, which affects the company’s value.
entity value
total value of a company. 2 primary sources of value- value of ops and nonoperating assets. 3 major types of claims on this value are debt, preferred stock and common stock.
value of operations (Vop)
present value of all expected future FCF when discounted at the WACC
primary source of value for companies
value of operations. second source is from nonoperating assets. (financial assets) 2 major types: 1) ST investments that are very marketable securities (t bills) and temporarily held for future needs rather than to support current ops. and 2) other nonoperating assets which are investments
tracking stock/target stock
The dividends of tracking stock are tied to a particular division, rather than the company as a whole.
Investors can separately value the divisions.
Its easier to compensate division managers with the tracking stock.
But tracking stock usually has no voting rights, and the financial disclosure for the division is not as regulated as for the company.
Very few companies have tracking stock anymore
different approaches of valuing common stock
Free cash flow model: Constant growth and Non-constant growth
Dividend growth model: Constant growth and Non-constant growth
Using the multiples of comparable firms or industries
Claims on Corporate Value
Debtholders have first claim.
Preferred stockholders have the next claim.
Any remaining value belongs to stockholders.
entity valuation model
estimates the total value of a corporation rather than just the values of debt or stock
What happens to 〖 [(1+g_L)/(1+WACC)]〗^t as t gets large?
If gL < WACC: Then 〖 [(1+g_L)/(1+WACC)]〗^t < 1.
If gL ≥ WACC: Then 〖 [(1+g_L)/(1+WACC)]〗^t ≥ 1.
g can’t be greater than or equal to WACC
constant growth model
formula for the present value of an infinite stream of constantly growing cash flows.
- only applies if the expected growth is constant and less than the WACC
- calculates PV of cash flows from t=1 not t-0
multistage valuation model
used to find the PV of cash flows that grow at a nonconstant rate for multiple period before eventually growing at a constant growth rate for infinity. sum of PV of all cash flows during the forecast period + PV of the horizon value.
steps in multistage valuation model
- forecast expected free cash flows and calculate the annual growth rate for each year in the forecast - continue doing until the growth rate in FCF is expected to be constant. the last year in the forecast is the forecast horizon/horizon date/terminal date.
- bc expected growth is constant after the horizon date, you can apply the constant growth model to estimate the value of ops at the horizon year.
- create a TL with the FCF for each year up to the horizon date. includes horizon value and date. there will be 2 cash flows on the horizon date.
- discount the cash flows in the TL using the WACC. the result is the estimated value of ops as of t=0
horizon value/terminal value/continuing value
value of all FCF beyond the horizon discounted back to the horizon
how much the operations would be worth if they were sold right after receiving the FCF at the horizon date.
are stock values more affected by short term or long term cash flows
long term, company probably increased its R&D expenditures.
key inputs to the FCF valuation model
- most recent level of sales
- most recent level of net operating capital
- projected sales growth rates
- projected operating profitability ratios
- projected capital requirement ratios
- WACC
changes to these will cause intrinsic value of ops to change
value drivers
subset of inputs that managers are able to influence through strategic choices and execution of the resulting business plans. bc managers can’t change the past, the most recent level of sales and operating capital aren’t value drivers but the others are.
value based management
systematic use of the FCF valuation model to identify value drivers and guide managerial and strategic decisions
effect of value drivers on horizon value
- an increase in the ROIC has positive effect on horizon value because it increases the numerator.
- reduction in the cost of capital increases numerator and decreases the denominator –> positive effect on the horizon value and current value of ops
- increase in growth rate can have + or - effect on horizon value. if numerator is negative then then bracket term is less than 1 causing the intrinsic value of ops at the horizon to be less than the amount invested in op capital. basically earning a return that isn’t enough to compensate investors for the cost of using their capital.
what causes stocks to be so volatile?
readily available information (initial sales of a new product, results for an R&D program, etc) causes stock prices to be volatile
if a stock is stable, its not gettin new information
constant dividend growth model / Gordon model
formula for the PV of an infinite steam of constantly growing dividends.
if growth rate is not less than rate of return, the company is not in its constant growth phase. \
market multiple method
some analysts use to target company’s value.
Steps:
1. identify a group of comparable firms.
2. calculate each comparable firm the ratio of its observed market value to a particular metric, which can be net income, earnings per share, sales, book value, # of subscribers, or any other metric that applies to the target firm and comparable firms. this ratio is called market multiple.
to estimate the target firm’s market value, the analyst would multiply the target metric by the comparable firms’ average market multiple.
entity multiple
for a group of comparable firms, the avg ratio of the observed market entity value to a particular metric that applies to a whole firm (any metric that applies to the entity values of the target firm and comparable firms)
which model should you use
free cash flow valuation model - apply for high growth companies even if they are paying dividends because you would need to project future financial statements before you could make a reasonable estimate of future dividends –> then apply either corp valuation or dividend growth. useful when considering the sale or purchase of a division.
corporate valuation model- trying to estimate the value of a company that has never paid a dividend or a private company.
dividend growth model- financial analyst estimating the value of a mature company whose dividends are expected to grow steadily in the future.
preferred stock
hybrid. similar to bonds in some respects and to common stock in others. fixed amount and must be paid before common stock dividends can be paid.
