equity Flashcards
What is going concern value, and why is it important?
Going concern value is the value of a company given it keeps operating as it was. It is important in valuing a company wanting to hold it longer term in the portfolio.
What is Liquidation Value and why is it important?
Liquidation Value is the value of a firm given that you sell everything immediately.
Investment Value, what is it?
Investment value gives certain stocks more value. Why? Because they might complement your portfolio very well, meaning you might want to pay more.
What are the 5 Forces important for valuing the competitive landscape surrounding a firm?
Porter’s five forces are:
- Competition in the industry
- Potential of new entrants into the industry
- Power of suppliers
- Power of customers
- Threat of substitute products
What are the 2 types of valuation mechanisms?
Top down and Bottom Up
What is pairs trading?
Pairs trading is going SHORT an overvalued firm, and going LONG an undervalued firm. Great for firms operating in the same sort of competitive landscape.
What is a CONGLOMERATE DISCOUNT?
Since a firm might be MASSIVE, think like Franklin Templeton - since the firm might be a tad unfocused on a certain stream of income, you might want to actually discount the value you come to in your valuation.
If you were to RETIRE DEBT early, what might that do to your net income? What might be the knock on effects?
Keep it high - analysts have to remember to really scrutinize financial statements to suss out what firms might be doing to distort their earnings. EPS will be heightened
What is alpha?
Return IN EXCESS OF the benchmark. So the it is the holding period return MINUS the holding period return of the benchmark.
What is the HOLDING PERIOD RETURN?
(1+r/n)^n
Explain the FAMA FRECH MODEL in detail please.
The FAMA FRENCH MODEL. It is a 3 Factor Approach for one to get a return. Factor 1: you have to be in the market. Factor 2: The size factor. Factor 3: The price factor.
Risk Free + Market Risk (basically CAPM) + beta 2 (Small Minus Big) {this means the market pays more for small cap stocks, so the higher the beta here, the smaller the stock} + Beta 3 (High Minus Low) {Basically Value firms are better for returns, higher beta means the firm is more a value firm}.
Small Value is where you win.
Large and growth companies just don’t give as good of returns.
Risk Free+β1(RMRF-risk free)+β2SMBt+β3HMLt
Bond Yield + Equity Premium Model. Bond yield is the Short or Long term YTM?
Long
ROIC (Return on Invested Capital) What is this
ROIC is the Net Income - Divs / Equity + Debt.
Equity and Debt are basically all the cash going INTO a firm, the numerator is the return - you would obviously want that to be HIGH
Gross Profit is
Rev - COGS
Gross Margin is
Gross Profit / Rev
There are 3 established ways to value a firm. DDM, Residual Value and FCFE/FCFF. Why might each one be good? In what situations?
DDM is good for dividend paying companies, and if dividends have a, more or less, relationship with earnings.
Residual Income Model is Book Value per share / residual income. Residual income is : Net Income - (Required Return * Monies invested). This method is great for non-dividend paying stocks OR companies with negative earnings.
FCFF/FCFE is good for non dividend paying firms. FCFF is good for levered firms or firms with a negative FCFE.
How is Gordon’s Growth model different from DDM?
DDM is just discounting future cash flows. It does NOT take dividend growth into consideration. The Gordon Growth model solves this.
How might you perhaps model growth?
GDP, Inflation Expectations, Prior dividend growth, industry growth, technology expansion, market growth, etc.
What is the perpetuity formula
D/r
PVOG - Present Value of Growth. What is this and explain the formula behind it? Hint: Think E1
it is like a premium one might pay based on how well a firm might capitalise on growth opportunities. The formula is : V = E1/r + PVOG. You can determine the premium folks but on the growth capitalision through this formula.
What is the sustainable growth rate?
ROE * (1-Divident Payout Ratio)
V = (EPS (1) / r ) + PVOG. what is this formula telling us
This is valuing the PVOG (present value of growth. The v is the value of the stock, and the EPS and r should be given, therefore, simple algebra should take us to what PVOG is. This is how much the market thinks the firm can capitalise on growth opportunities
What does the H Model Assume and what is the formula and what does the H mean in the formula
V_0=(D_0 (1+g_L )^ +D_0H(g_S-g_L))/(r-g_L )
The H Stands for Half, or half the life of the assumed longevity of the short term growth rate. The H model assumes that the growth is going to decline linearly until it hits the long term growth rate.
Cagr formula
(P1/P0)^1/n
What is the required rate of return formula using the Dividend Yield? And what is the dividend yield?
Div Yield is Dividend/Price. The formula is
r = D Yield (1+gL) + H (gS-gL)+gL, Think of it sort of like 3 premiums to make r. There is the dividend yeild, then there is the H model bit in the middle, then there is just the long term growth rate.
Constant Growth Rate. Else can it be called?
The Capital Gains Rate
Trailing and Forward PE
Today’s market price divided by the trailing 12 months’ earnings per share
Today’s market price divided by a forecast of the next 12 months’ earnings per share
DDM vs Free Cash Flow. What is a major difference?
DDM is cash PAID to shareholders. FCF measures cash AVALIABLE to shareholders.
FCFE and FCFF Formulas - from start to finish - Firm Value, Equity Value and Equity Value per share
Firm value is just the gordon growth model, but the the FCFF, FCFE numerator. FCFF uses WACC as the denominator, FCFE uses required rate of return.
Equity Value is the firm value minus debt.
Then divide by total shares outstanding for value per share.
What is the formula for r using the H Model
r = D Yield (1+gL) + H (gS-gL)+gL
What are the 3 growth stages, and what do they mean?
Growth = High Dividend Growth Maturity = Low Dividend Growth Transition = Growth Slows
What is spreadsheet modelling and why is it so great?
It can accommodate a wide variety of assumptions. This is the same with multistage DDM
What is the DuPont formula for calculating the growth rate
Growth = ROE x 1 - Dividend Payout.
What is the dividend payout ratio
The dividend payout ratio is the amount PAID OUT from net income to shareholders.
Why do we Add back interest expense to calculate FCFF?
Remember, FCFF is the cash available to creditors (including bondholders). At the time of the financial statement being created (from which one is gathering this information) the interest expense IS available to the creditors, and thus should be included in FCFF.
What is the formula for FCFF? From Net Income
FCFF = Net Income + Non Cash Charges + Interest (1*t) - Fixed Capital Investment - Increases Working Capital Investment
What are fixed capital expenses?
Buying trucks, equipment and other long term assets. These aren’t recorded on the income statement SO they are deducted.
Working Capital, what is it? Give an example
Current Assets - Current Liabilities. Something like inventory for currents and accounts payable for current L
What is the CFO formula for FCFF. Explain how this is the same as the Net income formula.
CFO + Interest (1-t) - Fixed Capital. The changes in working capital are already captured by the CFO.
Explain FCFF. The process through Net Income, NCC, Interest, Fixed Capital and Changes in working capital
FCFF is trying to find cash available TO CREDITORS. So we need cash money on hand that can be spent for the creditor. We take Net Income (there are some non cash items included in Net Income) so we add those Non cash charges back on. This takes us closer to the cash amount available. Then Interest. If we pay back creditors, we need not include Interest expense. Next, the other 2 are non income statement items, and the cash flows would have come from NON CFO items - working out these BALANCE SHEET items gives us insight on other cash movements, which will take us to the current cash available.
Should infrequent items be included in longer term analysis and why
No, because they are not predictable.
If you buy an asset (truck) for 60,000 and sell it later for 100,000, how does this effect FCFF?
This 40,000 difference will be included in net income, but must be removed prior to calculating the Net Income for FCFF. This discrepency will be addressed when you take a look at the investments in fixed capital.
An increase in Working Capital will do what to FCFE
Decrease FCFF.
Compute FCFE from FCFF
FCFE = FCFF - I(1-t) + Net Borrowing
Firm Value is taken from FCFF, while EQUITY Value is from FCFE - true or false?
True
WACC Formula (extended version)
WACC = MV Debt / MV DEBT*MV EQUITY) *r (1-t) + MV Equity / MV Equity + MV DEBT) * r
EBIT FCFF Formula please
EBIT * 1-t + NCC - Fixed - Working Capital
Remember, you DONT add back interest again, because it is included in EBIT
How do you get to Net income from EBIT?
Take away TAX and Interest Expense
FCFE Formula and meaning
It is when a company has met ALL its financial obligations - this is why we subtract Interest - that is something you gotta pay mate. Also, remember to not include cash in working capital
FCFE = Net Income+Depreciation−FCInv−WCInv+Net borrowing
FCFF and FCFE - why do we not include Interest, and why do we add Net Borrowing to FCFE
FCFF is Free Cash Flow to FIRM, while the alternate is to equity. FCFE is to equity shareholders, and interest expense is owed to creditors, NOT equity holders, thus that cash flow is not available to them
When calculating FCFF, Fixed asset investment is derived from where?
the Begining value of the asset at each period. DO NOT Take depreciation into consideration
Notes Payable and Long Term debt are included in what in FCFE?
Net Borrowing
Pastor–Stambaugh model (PSM) adds what addition/premium to Fama French?
Liquidity
Restructuring costs and its effect on FCFE. Please describe.
Restructuring costs should be REMOVED from FCFE
Do Share purchases or Issuances effect FCFE and FCFF ? And how? And does leverage effect them?
No they don’t. FCFF and FCFE are FREE CASH FLOWS AVALAIBLE, those cash flows are already included. Leverage does effect the outcomes of FCFE because it is not taken into consideration in the calculation of it.
EBITDA - is it a good proxy for fcfe or fcff
Its a shit proxy. It doesn’t take a lot of things into consideration
Book Value per share times ROE =
EPS
Normalized EPS - what is is
Average of trailing eps scores
EVA means what? And what is the formula?
Economic Value Added. Net Operating Profit After Tax * (Cost of Capital * Total Capital). If this is positive, the company is making money
Eps / BVPS = ?
ROE
What is the RI formula
V_0=B_0+RI/(1+r^n )
RI=〖EPS〗_1 (end period)-(r*〖BVPS〗_0-this is the BVPS at beginning of period)
Or
ROE - r * BVPSt-1 / 1+*r
Residual income is calculated as net income minus a deduction for the cost of equity capital. The deduction, called the equity charge, is equal to equity capital multiplied by the required rate of return on equity (the cost of equity capital in percent).
Strengths and Weaknesses of RI model
Strengths and weaknesses of RI model:
- Uses readily available accounting data
- Accounting data can be altered
- Model can be used on unpredictable cash flows
- Model focuses on economic profitability
EPS * Div Payout = what
Dividend paid, / to be paid
Earnings - Dividends = ?
Book Value
What is ROCE
return on capital employed (ROCE) is a pre-tax return measure that can be useful in the peer comparison of companies in countries with different tax structures. Archway’s two main competitors are located in different countries with significantly different tax structures, and therefore, a pre-tax measure of return on capital is better than an after-tax measure. EBIT/equity
Financial Leverage Formula
Assets / Equity
ROA * Financial Leverage
ROE
Why do analysts prefer to use DILUTED Eps in calculating forward and trailing P/E Multiples?
It puts all firms on level ground - some firms may owe significant amounts in dilutive securities, so the diluted EPS is what you use to common the ground
EPS = ?
Net income - Divs / av shares outstanding
Restructuring Costs in calculating EPS, do we add or subtract the costs from EPS and why?
Add - remember that EPS is Net income / av shares etc. - net income is significantly effected by restructuring costs, so it is reduced, therefore at the back end, we have to ADD IT BACK to get the Core EPS.
ROE * BVPS
EPS
Why do we normalise EPS in P/E ratios?
To average it out across different stages in the business cycle.
Earnings Yield is the reciprocal fraction of which commonly used multiple?
P/E . Earnings Yield can be used to determine how much in EPS will be generated for every $ of price.
You can use this on negative earning companies
With trailing P/E ratio, if we are trying to find the normalised eps, what need we do with the data on roe and BVPS
Get the average roe across the periods and multiply it by the current or most recent bvps. This will give you a normalised eps for P/E ratio
What is PEG and what are the adv, disadv
PEG = P/E / growth rate. The lower the better. It pretty much treats the PE as a perpetuity to value it. Less than 1 is the best.
Negatives - it assumes a linear relationship between PE and growth, it does not take growth horizons into consideration and it does not take risk levels into consideration.
When comparing PE to the indsutry, benchmark, sector, etc. which score do you compare your focal company’s PE to?
The median - it removes outliers.
BVPS Formula
BVPS = Total Equity – Other Comprehensive Income – Preferred Shares / Shares outstanding
Firm Value minus debt = ?
Equity Value
Why would you use EV/EBITDA over P/E
EV/EBITDA is usually more appropriate than P/E alone for comparing companies with different financial leverage (debt), because EBITDA is a pre-interest earnings figure, in contrast to EPS, which is postinterest.
Why is Price / Sales such a good measure
It is not as subject to accounting scrutiny
EV = ?
EV = Market Cap + Market Value Stock + Market Value Debt - Cash
What is PRAT
P – Profit margin
R – Retention rate
A – Asset turnover
T – Financial leverage
What is the discount for lack of control
Discountforlackofcontrol = 1−[1/(1+Controlpremium)]
How do you calculate P/B ratio from ROE and growth rate and required return. What does this ratio tell us
ROE - g / r-g
Price to book is the market value of the firm vs the book value (so assets minus liabilities). Its pretty miuch what the firm is worth through assets.
Capitalisation Rate, what is it?
Its basically the denominator on a Gordon Growth Model when valuing a private company
P0 is the forward price to earning PE ratio, how do you calculate it, if given perpetuity growth
D0 / r - use that perpetuity formula to get P0, then incorporate EPS one period in future
Do we subtract preferred shares from Shareholder equity to get book value
Yes
Normalised EPS
So, normalized EPS is calculated as
Average ROE × BVPS = 0.131 × €22.58 = €2.96.
How to calcualte book value?
Shareholder equity minus preferred shares. This is per COMMON Share, this is why we subtract preferred shares, they are a different class.
As risk goes up, does P/E go up or down and why
Down. Remember, the formula for price is D/r. If price goes up, P goes down
What is P/S
Price to Sales PER SHARE
Dividend divided by EPS = ?
Payout ratio
Differences between Equity method and Consolidated method on balance sheet
Equity method does one line on the balance sheet in NON CURRENT ASSETS. Whereas the consolidated statement keeps everything on the same line (cash added together, accounts receivable etc.) so the liquidity ratios will be higher
What makes up net borrowing in FCFE
Notes payable and debts
Explain residual income formula
Residual income is income minus required rate of return on net assets. So the eps in the formula is nopat, and r* bvps is the net assets
Explain earnings yield
Earnings yield = E/P, the inverse of the p/e ratio. The closer this number is to 1, the better. It stipulates how much in EPS the firm gets for every dollar in price.
Is a higher or lower PEG better? What is PEG
The lower the PEG, the better. PEG is P/E ratio divided by dividend growth rate. The lower the PEG, the more undervalued the fund may be because the growth rate is high! Thats what you want
Should you add or minus upstream sales from the income statement of an equity method associate?
Minus it. It is an unrealized gain (you get the cash in balance sheet, but it is unverified so unrealized).
What is each section of the CAMEL
- Capital Adequacy: capital that a bank can access
- Asset Quality:
- Management Quality: How good is the management
- Earnings: How stable are earnings?
a. ROIC vs Required rate of return - Liquidity
- Sensitivity to market risk
With regards to liquidity, what are the ratios you need to know.
- LCR (Liquidity Coverage Ratio) = All highly liquid assets / expected outflows
- NSFR (Net stable funding ratio) = available stable funding / required funding
- The HIGHER the BETTER. 100% is sort of the minimum for good liquidity
Why doesnt leverage effect FCFF?
because you add back interest payments in FCFF, therefore it is NOT included in the cash flows avalable.
What is CAGR formula
Value End / Value Start ) ^ (1/n) -1
How to calculate forecast BVPS (for RI formula)
Forecast ending book value per share (Bt–1 + Et – Dt)
ROE formula
ROE = Net income/Shareholders’ equity
Wc formula
WCInv=Increase in accounts receivable+Increase in inventory−Increase in accounts payable−Increase in accrued liabilities
a stable capital structure means which of FCFF and FCFE should be used and why?
FCFE - simple capital means that there is relativley stable leverage. FCFE is a simpler means of calcualting leverage.
ROE Acronym?
NP FLAT
Net Profit, Financial Leverage, Asset Turnover
Implied growth rate formula
r = D1 / P0 + g
Which balance sheet items are EXCLUDED from the Working capital componenet of FCFF and FCFE
Cash, Cash equivilents, notes payable and current portion of long term debt. Why?? Because they are included in FCFE’s net borrowing, and cash is NOT necessarily generated from CFO
Which balance sheet items are EXCLUDED from the Working capital componenet of FCFF and FCFE
Cash, Cash equivilents, notes payable and current portion of long term debt. Why?? Because they are included in FCFE’s net borrowing, and cash is NOT necessarily generated from CFO
Justified Trailing P/E Multiple
Trailing P/E = P0/E0 = [ D0 * (1+g) / E0 ] / (r - g) = (1 - b) * (1 + g) / (r - g)
Justified Leading P/E Multiple
Leading P/E = P0/E1 = D1/E1 / (r - g) = (1-b) / (r-g)
Justified P/B Multiple
P/B = ( ROE - g ) / ( r - g )
Justified P/S Multiple
P/S = P0/S0 = [ (E0/S0) * (1-b) * (1+g) ] / (r - g)
FED Model, What is it, what is the formula
Fed model is a formula for determining if you should buy stocks or bonds. It is all about the EARNINGS YIELD relative to the 10 year treasury. If earning yields is bigger, buy bonds (because the price in the E/P formula is too big).
Formula
E/P > 10 Year -> Bonds
E/P < 10 Year -> Stocks
Earnings Yield Formula
E/P - good for negative earners.
Yardeni Model
Similar to FED model. Earnings yield against the Yardeni model.
Yardeni = A Rated Bond Yield - (multiplier * Growth Rate)
If the E/P is bigger, they are UNDERPRICED, and you should buy stocks.
And vise versa
P/E times equity = ?
Price. This is used with benchmark values of PE to compare to a focal stock
3 times you would use the RI model?
No divs, or no predictability if divs. Inability to forecast terminal value, negative FCFE
3 types of private company valuation
Income, Multiple, Asset Based
When might you use an asset based approach
Natural resource companies
Do you use asset based approaches for valuing late stage companies
No
What is the total discount formula for lack of marketability and control
1-(1- Discount Marketability)*(1-Discount Control)
What is the persistence factor, which model do we use it in
Residual income for how long a firm can sustain a level of residual income into the future. This is only for multistage analysis
What is a clean surplus
BV0-1 + Net Income - Divs = BV1
There is nothing funky in OCI
Macro models, which environments can you NOT use it in
Developing economies
Residual income formula
BVPS + BVPS (roe-r) / r-g
Enterprise value formula
Enterprise value = Market Cap + debt + Pref shares - cash.
When doing multiple questions, what must you remember to do?
Round everything to the per share value
When calculating BVPS, what do you do with shareholder equity and preferred share
subtract prefrred shares from shareholder equity
if you have the goal of owning a company (major shareholder) do you wanna use a FCF or DCF value and why
FCF is good for majority shareholders cos you get to control the cashflows, DCF is good for a minority shareholder
