Equity Flashcards
Gordan growth model equity risk premium
1 yr forecasted div yield on market index + consensus long term earnings growth rate - long term government bond yield
Paster-Stambaugh model
adds liquidy factor to the fama-french model
Blume Adjustments
adjusted beta = (2/3 x raw beta) + (1/3 x 1)
Use DCF modles when
- Firm has dividend history
- Dividend policy is related to earnings
- Minority shareholder perspective
Use FCF models when
- Firm lacks table dividend policy
- Dividend policy not related to earnings
- FCF is related to profitability
Use RI model when
- Firm lacks dividend history
- Expected FCF is negative
- Firm has transparent financial reporting and high quality earnings
GGM
Assumes perpetutal D growth rate
Vo= D1/(r-g)
Limitations to GGM
Very sensitive to estimates of r and g
difficult with non dividend stocks
difficult with unpredictable growth patterns (use multi-stage)
Present Value of Growth Opportunities
Vo= E1/r + PVGO
H - Model
Vo= [Do *( 1+gl)]/(r-gl) + [Do * H *(gs-gl)]/( r-gl)
SGR
SGR= earnings retention rate x ROE
Solving for required return
r = D1/Po + g
FCFF -NI - Assuming depreciation is the only NCC
FCFF= NI + Dep + Int *(1-tax) - FCinv - WCinv
FCFF -EBIT - Assuming depreciation is the only NCC
FCFF= EBIT *(1-tax rate) + Dep - FCinv - WCinv
FCFF -EBITDA - Assuming depreciation is the only NCC
FCFF= EBITDA (1-tax rate) + Deptax rate - FCinv - WCinv
FCFF -CFO - Assuming depreciation is the only NCC
FCFF = CFO + [int * (1-tax)] - FCInv
FCFE - from FCFF
FCFE = FCFF - Int *(1-tax) + Net borrowing
FCFE - from NI
FCFE = NI + Dep - FCInv - WCInv + Net borrwing
Single State FCFF
Vo= FCFF1/ (wacc - g)
Single stage FCFE
Vo = FCFE1/ (r-g)
Problems with P/E
- if earnings are less than 0 PE is meaningless
- volatile, transitory portion of earnings makes interpretation difficult
- Management discretion over accounting choices
Justified leading P/E
= payout ratio/(r-g)
= (D1/E1) / (r- g)
= P0/E1
Justified trailing P/E
=payout ratio * (1+g)/ (r-g)
= (D1/E0) / (r- g)
= P0/E0
Price to Book - advantages
- BV almost always greater than 0
- BV more stable than EPS
- Measures NAV for FIs
Price to Book - disadvantages
- Size differences cause misleading comparisons
- Influences by accounting choices
- BV cannot equal market value due to inflation/tech
justified PB
= (ROE - g)/(r-g)
DuPont
ROE = NI/S * Sales/TA * TA/E
Price to cash flows - Advantages
- cash flow harder to manipulate than EPS
- More stable than PE
- Mitigates earnings quality concerns
Price to cash flows - disadvantages
- difficult to estimate true CFO
FCFE better but more volatile
RI Models
RI = Et - (r x Bt-1) = (ROE - r) * Bt-1 t-1 Et = expected EPS for year t Bt-1 = book value per share in the year t-1
Single Stage RI
Vo = Bo +[(ROE - r) * Bo/ (r-g)]
Economic Value added
EVA = NOPAT - $WACC NOPAT = EBIT(1-t)
Private Equity valuation - DLOC
DLOC = 1 - [1/(1 + control)]
Residual Income
NI - stock holders opportunity cost.
Required return * total equity
MVA market value added
MVA= market value - total capital
How to calculate value of equity using ccm capitalized cash flow method
Value of equity = FCFE1/(r-g)
Calculate Justified price to BV
(Roe - g)/ (r - g)
Clean surplus
ending book value = beginning book value + net income - dividends
may not hold when items bypass the income statement and affect equity directly. Foreign currency gains and losses under the current rate method bypass income statement and are reported under shareholders equity as CTA
Relative-strength indicators
The belief that there are patterns of persistence or reversals in returns provides the rationale for valuation using relative strength indicators. There has been a considerable amount of empirical research in this area. Research suggests that the investment horizon is also an important determining factor in the appearance of these patterns.
how to unlever and lever a beta
= beta x 1/ (1 + debt/equity)
to lever = unlevered beta x (1 + debt/equity)
PRAT
Profit margin
Retention ratio
Asset Turnover
T - leverage
The guideline transactions method
he guideline public company method
The prior transaction method
The guideline transactions method (GTM) generates a value estimate based on pricing multiples associated with the acquisition of control of entire companies. The guideline public company method (GPCM) generates an estimate of value based on the multiples from trading activity in the shares of public companies that are similar to the private company in question. The prior transaction method (PTM) uses actual transactions in the stock of the subject private company.
an example of a transaction-related valuation for a private company
Venture capital financing, initial public offering (IPO), bankruptcy proceeding, performance-based managerial compensation, and sale in an acquisition are all examples of transaction-related valuations for a private company.
Tax burden ratio
Tax burden = NI/EBT or 1 - the effective tax rate.
Equity risk premium formula
Equity risk premium = forecasted dividend yield + consensus long term earnings growth rate - long-term government bond yield.
Excess Earnings
The excess earnings method values tangible and intangible assets separately; this method is useful for small firms and when there are intangible assets to value. In the free cash flow method, a firm is valued by discounting a series of discrete cash flows plus a terminal value. In the capitalized cash flow method, a firm is valued by discounting a single cash flow by the capitalization rate.
Asset-based approach
The asset-based approach is usually not used for most going concerns, but is appropriate for troubled firms, finance firms, investment companies, firms with few intangible assets, and natural resource firms. It values equity as the asset value of a firm minus the debt value of the firm.
