Equity Flashcards
Intrinsic Value
The value of an asset given a hypothetically complete understanding of the asset’s investment characteristics. Reflects the ‘true’ or ‘real’ value.
Rational Efficient Markets Formulation
Investors will not rationally incur the expenses of gathering information unless they expect to be rewarded by higher gross returns compared with the free alternative of accepting the market price.
The Valuation Process
1) Understanding the business
2) Forecasting company performance
3) Selecting the appropriate valuation model
4) Converting forecasts to a valuation
5) Applying the valuation conclusions
Porter’s Five Forces
1) Intra-industry rivalry
2) New entrants
3) Substitutes
4) Supplier Power
5) Buyer Power
Qualitative Factors
Includes the company’s ownership structure, it’s intellectual and physical property, the terms of its intangible assets such as licenses and franchise agreements, and the potential consequences of legal disputes or other contingent liabilities.
Absolute Valuation Models
A model that specifies an asset’s intrinsic value. Produces an estimate of value that can be compared with the asset’s market price.
Relative Valuation Models
Estimates and assets value relative to that of another asset. Similar assets should sell at similar prices.
Intrinsic Value (Formula)
Intrinsic value = year-ahead dividend/(required return - expected dividend growth rate)
Required Return Estimate
Required return estimate = (year-ahead dividend/market price) + expected dividend growth rate
Expected Equity Risk Premium
Expected equity risk premium =[ (1 + expected inflation)(1 + expected growth rate in real EPS)(1 + expected growth rate in P/E) - 1 + expected income component] - expected risk free rate
Unlevered Beta
Unlevered Beta = [1/(1 + D/E)] x Beta of Equity
Relevered Beta = (1 + D’/E’) x Unlevered Beta
Bond Yield Plus Risk Premium
Bond yield plus risk premium = YTM on the company’s long-term debt + risk premium
Industry Factors
1) Industry growth rate
2) Technology and Innovation
3) Government
4) Complementary Products and Services
Value of Growth
Also known as the Present Value of Growth Opportunities (PVGO). Sums the expected value today of opportunities to profitably reinvest future earnings.
No-Growth Value Per Share
The per-share value of assets in place because of the assumption that the company is not making any new investments because none are profitable.
V = E/r
E = EPS for the period r = required rate of return
Determining Present Value of Growth Opportunities (PVGO)
1) Value of the company’s options to invest, captured by the word ‘opportunities’
2) The flexibility to adapt investments to new circumstances and information is valuable
3) Value of the company’s option to time the start, adjust the scale, or even abandon future projects
Value of no-growth company = Dividend/r
P/E = 1/r + PVGO/E
P/E
Forward P/E = (D/E)/r - g = (1 - b)/r - g
Trailing P/E = [D(1 + g)/E]/r - g = [(1 - b)(1 + g)]/(r - g)
Return on Equity (ROE)
ROE = Net Income/Shareholder’s Equity
ROE = Net Income/Total Assets x Total Assets/Shareholder’s Equity
ROE = Net Income/Sales x Sales/Total Assets x Total Assets/ Shareholder’s Equity
Growth Rate (g)
g = Retention Rate x ROE
g = (net income - dividends)/net income x net income/sales x sales/total assets x total assets/ shareholder’s equity
PRAT Model
P = Profit Margin R = Retention Ratio A = Asset Turnover T = Leverage
g = PRAT
Free Cash Flow to the Firm
The cash flow available to the company’s suppliers of capital after all operating expenses (including taxes) have been paid and necessary investments in working capital (e.g.: inventory) and fixed capital (e.g.: equipment) have been made.
Free Cash Flow to Equity
The cash flow available to the company’s holders of common equity after all operating expenses, interest, and principal payments have been paid and necessary investments in working and fixed capital have been made.
Constant-Growth FFCF Model (Single Stage FFCF)
Firm Value = FFCF(1 + g)/(WACC - g)
FFCF Formula
FFCF = NI + Non cash charged + Int(1 - tax) - FCInv - WCInv
FFCF = CFO + Int(1 - tax) - FCInv
FCFE (Formula)
FFCE = FCFF - Int(1 - tax) + Net borrowing
FCFE = CFO - FCInv + Net borrowing
Normalized EPS
The EPS that the business could be expected to achieve under mid-cyclical conditions.
Calculated as the average EPS over the most recent full cycle (4 quarters) or
Average ROE from most recent full cycle, multiplied by the current book value per share.
P/E to Growth Ratio (PEG)
A calculation of a stock’s P/E per percentage point of expected growth.
PEG Ratio = (P/E)/Expected earnings growth in %
Stocks with lower ratios are more attractive. Some say a number under 1 is an indicator of value.
Adjustments to Book Value
Some adjustments to book value:
1) Tangible book value - subtract reported intangible assets from shareholders’ equity
2) Adjusting LIFO to FIFO
3) Adjust for off-balance sheet assets and liabilities
Price to Book Ratio
P/B = (ROE -g)/r - g
P/B = 1 + present value of expected future residual earnings/B
Price-to-Sales
P/S = price per share/annual net sales per share
P/S = [(Profit Margin)(Payout Ratio)(1 + g)]/(r - g)
P/S = P/E x Net profit margin
Sales x Net profit margin = Net income
Annual net sales per share = total sales - returns and customer discounts
Dividend Displacement of Earnings
Holding return on equity constant, dividends paid now displace earnings in all future periods.
Dividend Yield
D/P = (r - g)/(1 + g)
Enterprise Value
Total company value (market value of debt, common equity and preferred stock) minus cash and short term investments.
Return on Invested Capital (ROIC)
ROIC = operating profit after-tax/total invested capital
Is relevant measure of profitability because EBITDA flows to all providers if capital.
Total Invested Capital (TIC)
A measure of total firm value, sometimes also known as market value of invested capital - includes the market value of equity and debt, but does not deduct cash and investments.
Unexpected Earnings (Earnings Surprise)
UE = EPS - E(EPS)
Method of Average ROE P/E
EPS = Avg ROE x Est. BV
P/E = Price/EPS
Earnings Yield
The inverse of P/E, the Earnings Yield helps compare companies with negative earnings. The lower the ratio, the richer the valuation.
Residual Income
Net income less a charge for common shareholders’ opportunity cost in generating net income. It is the residual remaining income after considering the costs of all of a company’s capital. The residual income modem analyzes the intrinsic value of equity as the sum of 1) current book value of equity 2) the present value of expected future residual income.
Capital Charge
Takes the perspective of all providers of capital.
Equity capital x after-tax cost of debt + equity capital x cost of equity
Economic Value Add (EVA)
EVA = NOPAT - (C% x TC)
C% = cost of capital TC = Total Capital
Tobin’s Q
Tobin’s q = market value of debt and equity/replacement cost of total assets
Continuing Residual Income
Residual income after the forecast horizon. Should be based on the ability to explicitly forecast inputs in the model.
Private Company Valuation Approaches
1) Income Approach
2) Market Approach
3) Asset-Based Approach
Capitalized Income Method
Values a private company by using a single representative estimate of economic benefits and dividing that by an appropriate capitalization rate to derive an indication of value.
Excess Earnings Method (EEM)
Involves estimating the earnings remaining after deducting amounts that reflect the required returns to working capital and fixed assets.
Discount for Lack of Control
DLOC = 1 - [1/(1 + Control Premium)]
Fama French Model
The idea that small-cap stocks might generate higher returns in the long run. The Fama French model addresses perceived weaknesses in the CAPM with multifactors in the model. Excess return on the market, excess return small cap stocks, and excess return on low book to market stocks.
Fama French Model
The idea that small-cap stocks might generate higher returns in the long run. The Fama French model addresses perceived weaknesses in the CAPM with multifactors in the model. Excess return on the market, excess return small cap stocks, and excess return on low book to market stocks.
Fama French Model
The idea that small-cap stocks might generate higher returns in the long run. The Fama French model addresses perceived weaknesses in the CAPM with multifactors in the model. Excess return on the market, excess return small cap stocks, and excess return on low book to market stocks.
Justified Price Multiple
The estimated fair value of that multiple, which can be justified on the basis of the method of comparables or the method of forecasted fundamentals.
Look-Ahead Bias
The use of information that was not contemporaneously available in computing a quantity.
Justified Price Multiple
The estimated fair value of that multiple, which can be justified on the basis of the method of comparables or the method of forecasted fundamentals.
Look-Ahead Bias
The use of information that was not contemporaneously available in computing a quantity.
Persistence Factor
High Persistence is associated with low dividend payments.
Low Persistence is associated with significant levels of nonrecurring items.
Confidence Risk
Represents the unexpected change in the difference between the return of risky corporate bonds and corporate bonds.
Business Cycle Risk
Represents the unexpected change in the level of real business activity.
