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CFA 2 > Equity > Flashcards

Equity Flashcards

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CFA flashcards
1
Q

Porters 5 forces

A
  1. Understand the business
  2. Forecast performance - quality of earnings
  3. Select valuation model - Use of CAPM etc
  4. Estimate intrinsic value
  5. Make investment reccomendation
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2
Q

Dividend discount model

A

D1 / r-g

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3
Q

Mispricing

A

mispricing = estimated value - market price

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4
Q

Equity Risk Premium

r

A

ERP = r - rf

r = (D1 / P0) + g

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5
Q

Blume adjusted Beta

A

1/3 + (2/3 x unadjsuted raw beta)

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6
Q

Unlevered beta of xyz

Relevered beta / estimated Beta of ABC

A

UB = (1 / 1 +D/E) x B

Be and D/E of a comparable stock!

RB = 1 + (D/E) x UB

D/E of own company! UB from comparable part 1 of question.

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7
Q

Debt to Equity ration:

if Debt = 40%

If Debt to equity ratio is 50%

A 
Debt = 40%
Equity = 60%
Total = 100%

D/E = 40/60 = 0.667

50% debt
50% equity
100% total
D/E = 1

30% debt
70% equity
total 100%

D/E = 0.429

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8
Q

CAPM

Fama-French Multi factor Model CAPM

Pastor Stambough Model CAPM

Market factor Market beta High =
Size beta High =
Value beta Positive =

A

r = rf + B(Rm-Rf)

r = rf + B(Rm-Rf) + bSMB + bHML

bSMB = small minus big cap premium x beta
bHML = High minus Low value premium x beta

r = rf + B(Rm-Rf) + bSMB + bHML + bLIQ

bLIQ = Liquidity premium x beta

Market factor beta positive shows above average market risk
Size positive Beta shows SMALL cap stock
Value positive beta shows Value stock

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9
Q

5 Factor BIRR Model ways to enhance CAPM

A
  1. Confidence Risk
  2. Time Horizon Risk
  3. Inflation Risk
  4. Business cycle risk
  5. Market timing risk
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10
Q

Build up Method for r =

Equity Risk Premium

A

r = rf + Equity risk premium +/- company specific risk premia

ERP = Rm-Rf (portion of CAPM)

ERP = Year ahead dividend Yield + g - Long term bond yield

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11
Q

Bond Yield Plus Risk Premium

WACC =

A

BYPRP cost of equity = YTM of long term debt + risk premium

WACC = (W x Debt (1-t)) + (W x Return Common Equity) + (W X Return Preference shares)

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12
Q

Holding period return =

Ibbotsen and Chen ERP =

A

HPR = Dividend yield + price appreciation

(1 + Expected Inflation) x (1 + Expected EPS growth) x (1+ Expected PE growth) - 1 + income - gov bond yield

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13
Q

Return on invested capital ROIC =

ROCE =

A

ROIC = NOPAT / Invested capital

ROCE = basically ROIC before tax is taken away

NOPAT - Net operating profit less adjusted tax

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14
Q

Inflation effect on inelastic products =

Selling to a country with high inflation =

What happens to margins as you pass on price increases?

A

Inelastic products benefit from inflation as they can pass on costs.

High inflation countries create currency losses due to money owed on credit now being worth less.

Margins fall as you now have the same profit but smaller relative to the COGS

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15
Q

Porters 5 forces of profitability =

A
  1. threat of substitutes
  2. Rivalry
  3. Bargaining power of suppliers
  4. bargaining power of buyers
  5. threat of new entrants.
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16
Q

Organic growth =

A

Organic growth = (1 + price/mix growth rate) x (1 + volume growth) - 1

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17
Q

When to use which valuation method:

Dividends

FCFF and FCFE

Residual Income

A

Dividends = mature stable companies

FCFF or FCFE = Non dividend paying companies FCF positive companies
FCFF = useful when you have high unstable leverage
FCFE = useful when there is a controlling interest or takeover likely

Residual income model = FCF negative companies and no dividends

18
Q

Valuing a share

Gordons growth model dividends

Preference shares

Present Value Growth Opportunites PVGO

Dividend given payout ratio

growth

A

D1 / r-g

D/r

Value = (E1 / r) + PVGO

D1 = dividend and can be found from payout ratio

g = RR x ROE

E = EPS 
RR = Retention ratio (inverse of payout ratio)
19
Q

Two stage H Model =

H model =

A

(D1/r-glong) + (D0 x H x (gshort - glong ) / r - glong)

H = Half life of growth period = 2H = linear decline to growth

20
Q

Leading Justified P/E =

Trailing Justified P/E =

1-b =

Leading PE > Trailing PE =

A

Leading Justified P/E = 1-b / r-g = Trailing PE / 1+g

Trailing Justified P/E = (1-b) x (1+g) / r-g

1-b = Payout ratio

Leading PE > Trailing PE = Overvalued

21
Q

Price to sales ratio =

Profit margin =

A

Price to sales = (e/s x (1-b) x (1+g)) / r-g

profit margine = Earnings/sales

22
Q

EPS =

Share price =

Terminal value using PE =

A

Dividend / payout ratio

Share price = PE x EPS

Terminal value = (D0 x (1+g)^n / (1-b)) x PE

23
Q

Firm value using WACC ie cash available to all investors?
How do you find equity value?

Equity value

A

Firm value = FCFF / (1+WACC)^t

Firm value = debt + equity (you would subtract one from the other)

FCFE / (1+rce)^t

24
Q

FCFF =

FCFF =

FCFF1 = (Using WACC)

FCFF =

FCFE =

FCFE =

FCFE =

A

FCFF = CFO + INT(1-t) - FC Inv

FCFF = NI + NCC + INT(1-t) - FC Inv - WC Inv + Pref shares

FCFF1 = FCFFo x 1+g / WACC - g

FCFF = EBIT (1-t) + NCC - FCInv - WCInv

FCFF = EBITDA (1-t) + Depr + NCC -FC FCinc - WC Inv

FCFE = NI + NCC - FCInv - WCInv + Net borrowing

FCFE = CFO - FC Inv + Net borrowing

FCFE = FCFF - INT (1-t) + Net borrowing

25
Q

FCInvestment:

Increase in accounts receivable:
Increase in accounts payable:
Increase in inventory:
Decrease in inventory:

Non Cash Charges (NCC):

Gains
Losses

WC Inv

Gain on disposal

A

FCInvestment:

*Increase in accounts receivable: add
Increase in accounts payable: subtract
*Increase in inventory: add
Decrease in inventory: subtract

Non Cash Charges (NCC):

Gains - Subtract
Losses - add

WCInv gain on dispoal = subtract

26
Q

Leading PE =

Trailing PE =

Fundamental Justified PE (passthrough rate) =

Higher inflation on PE?

A

Leading PE = P0 / E1

Trailing PE = P0/E0

P0/E1 = 1 / (real r + (1- pass-through rate) x Inflation)

Higher inflation = lower PE

27
Q

Earnings Yield

PEG ratio

P/B value

P/B given ROE

A

E/P (opposite of PE)

PE / g
assumes a linnear relationship of PE and growth.

P/B value = Price / Equity BV per share = MV equity / BV equity

P/B = ROE1 - g / r - g

28
Q

Molodovsky approach

Default approach

A

PEs change according to cyclicality

Next 4 quarters to calculate leading PE ratio

29
Q

Price to Sales

Positives

Disadvantages

A

P/S = Price per share / Sales per share = MV Equity / Total sales

P/S = E/S x (1-b) x (1+g) / r-g

Positives: sales usually positive, difficult to manipulate but still possible, Less volatile than PE.
Disadvantage = growth in sales does not mean growth in profits.

30
Q

Price to Cash Flow =

Cash flow =

Advantages
Disadvantages

A

P/CF = Price per share / Cashflow per share = MV Equity / Total cash flow

CF = NI + depreciation + amortisation

Adv = Difficult to maniplulate, more stable than PE,
Disadv = Non specified ie you dont know if to use CFO, CFI or CFF.
31
Q

EV =

EV/EBITDA

Adv
Disadv

A

EV = MV common stock + MV of debt - cash & Investments

Adv: useful for valuing firms with differnt financial leverage.
Disadv = FCFF a better measure than EBITDA, a higher WACC gives a lower enterprise value ratio

32
Q

Standardised Unexpected Earnings

A

SUE = (EPSactual - EPSforecast) / SD(EPSactual - EPS forecast)

33
Q

Terminal value of a stock

Adjusted CFO =

A

TV stock = P/EPS x future EPS estimate

Adjusted CFO = CFO + net interest charge

34
Q

Residual income given B0 Price =

RI =
BV0 =

Assumptions of RI

Equity value given PVRI

A

P0 = B0 + (ROE - r / r - g ) x B0

RI = (ROE - r ) x B0
B0 = NI - cost of capital

Assumptions = It will revert to zero, remain constant

Eq0 = BV0 + PVRI / 1+r

35
Q

RI Value =

No continuing residual income persistence factor =

Residual income continues in perpetuity =

A

V0 = B0 + (sum ROE-r / 1+r^t) + (Pt - Bt / 1+ r ^t)

No continuing residual income persistence factor = zero

Residual income continues in perpetuity = one

36
Q

RI given NOPAT =

NOPAT =

A

RI = NOPAT - WACC

NOPAT = EBIT (1-t)

37
Q

Market Value Added (MVA) =

Economic Value Added (EVA) =

A

MVA = Market value of company (debt + equity) - Total adjusted capital

EVA = NOPAT - (WACC x capital)

38
Q

What causes a higher persistance factor in residual income?

A

Extreme levels of accruals, low dividend payout & high non-recurring items.

39
Q

TV of a stock in Y4 with persistance factor =

A

RI in Y5 / 1 + r - w

w = persistence factor

40
Q

Market Value =

Fair value =

Investment value =

Intrinsic value =

A

Market Value = Definition under International Valuation Standard Committee (IVSC) and similar to Fair value

Fair value = Used in financial reporting and litigation

Investment value = Value to the investor ie some people may see more value in a company than others.

Intrinsic value = Value based on models such s GGM and DDM

41
Q

Lack of control discount given - control premium 30%=

Two stage discounts method
Control premium 40%
Marketability discount 15%

A

Single stage = 1 - (1 / 1.30) = 23%

Two stage:

1 - (1/1.4) = 28.5%

1 - (1- 0.285) x (1- 0.15) = 40%

42
Q

Ex ante alpha =

Required return =

A

Ex ante alpha = Expected return - required return

Required return = (1 + r^n) - 1

CFA 2 (10 decks)

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