Chapter 9 Flashcards
2 Investment Styles
- Growth share or earnings momentum investing
- Value investing
Growth Share investing
Supports the premise: good companies are good investments.
Value investing
Undervalued shares are good investments.
Looks for a “margin of safety” reflected by the discount below intrinsic value at which a share is priced.
8 Type of companies in value investing
- Growth companies
- Growth shares
- Defensive companies
- Defensive shares
- Cyclical companies
- Cyclical shares
- Speculative companies
- Speculative shares
Growth companies
Companies with the management capability and the opportunity to undertake investment projects that produce rates of return greater than their weighted average cost of capital.
Growth shares
Shares with above-average expected rates of return given their risk.
Generally undervalued shares with a reasonable prospect of becoming properly valued in the near term
Defensive companies
Not likely to react sharply to a decline in the general level of economic activity.
Defensive shares
Shares with low betas, regardless of the nature of the company.
Cyclical companies
Companies whose sales and earnings tend to rise and fall sharply with fluctuations in the business cycle.
Cyclical shares
High-beta shares whose returns rise and fall sharply in bull and bear markets.
Speculative companies
Forms whose business involves great risk.
Speculative shares
Overpriced shares whose returns might be abnormally low because of their overvaluation.
Added value
Profit in excess of the firm’s cost of capital (economic profit).
Economic value added (EVA)
EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. By taking all capital costs into account, including the cost of equity, EVA shows the dollar amount of wealth a business has created or destroyed in each reporting period.
Cash Value Added
Net present value model that uses the net present value approach to calculate company value.
CVA: 2 Investment categories
- Strategic investments
- Non-strategic investments
CVA Index
Operating cash flow/ Operating cash flow demand.
Market Value Added
Difference between the firm’s total value and the total capital that investors have committed to it.
MVA = Total Value - Total Capital
Total Value (MVA)
Market value of debt and equity
Total Capital (MVA)
Adjusted total assets from the statement of financial position (according to EVA).
Sources of Value added
- Economies of scale
- Economies of scope
- Cost advantages
- Product differentiation
- Access to distribution channels
- Government policy
4 Techniques
- 2-stage dividend discount model
- H-model
- 3-stage dividend discount model
- Growth duration model
Disadvantages to the Dividend Discount Model
- Models only apply to dividend paying shares, or to shares that may not pay a dividend currently, but a dividend stream can be projected in the future.
- Risk is not an explicit variable of the models.
- Analyst’s estimates of g and rs (cost of equity capital) may be in error.
- Small changes in rs and g produce large differences in valuation.
- Models don’t reflect the value of under-utilised assets.
- Model tends to orient investors towards high yielding shares.
5 Major Value Drivers of CVA
- Operating Surplus
- Working capital movement
- Non-strategic investments
- Operating cash flow demand
- Sales
