Equity Flashcards
Porters 5 forces
- Understand the business
- Forecast performance - quality of earnings
- Select valuation model - Use of CAPM etc
- Estimate intrinsic value
- Make investment reccomendation
Dividend discount model
D1 / r-g
Mispricing
mispricing = estimated value - market price
Equity Risk Premium
r
ERP = r - rf
r = (D1 / P0) + g
Blume adjusted Beta
1/3 + (2/3 x unadjsuted raw beta)
Unlevered beta of xyz
Relevered beta / estimated Beta of ABC
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.
Debt to Equity ration:
if Debt = 40%
If Debt to equity ratio is 50%
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
CAPM
Fama-French Multi factor Model CAPM
Pastor Stambough Model CAPM
Market factor Market beta High =
Size beta High =
Value beta Positive =
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
5 Factor BIRR Model ways to enhance CAPM
- Confidence Risk
- Time Horizon Risk
- Inflation Risk
- Business cycle risk
- Market timing risk
Build up Method for r =
Equity Risk Premium
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
Bond Yield Plus Risk Premium
WACC =
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)
Holding period return =
Ibbotsen and Chen ERP =
HPR = Dividend yield + price appreciation
(1 + Expected Inflation) x (1 + Expected EPS growth) x (1+ Expected PE growth) - 1 + income - gov bond yield
Return on invested capital ROIC =
ROCE =
ROIC = NOPAT / Invested capital
ROCE = basically ROIC before tax is taken away
NOPAT - Net operating profit less adjusted tax
Inflation effect on inelastic products =
Selling to a country with high inflation =
What happens to margins as you pass on price increases?
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
Porters 5 forces of profitability =
- threat of substitutes
- Rivalry
- Bargaining power of suppliers
- bargaining power of buyers
- threat of new entrants.
Organic growth =
Organic growth = (1 + price/mix growth rate) x (1 + volume growth) - 1
When to use which valuation method:
Dividends
FCFF and FCFE
Residual Income
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
Valuing a share
Gordons growth model dividends
Preference shares
Present Value Growth Opportunites PVGO
Dividend given payout ratio
growth
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)
Two stage H Model =
H model =
(D1/r-glong) + (D0 x H x (gshort - glong ) / r - glong)
H = Half life of growth period = 2H = linear decline to growth
Leading Justified P/E =
Trailing Justified P/E =
1-b =
Leading PE > Trailing PE =
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
Price to sales ratio =
Profit margin =
Price to sales = (e/s x (1-b) x (1+g)) / r-g
profit margine = Earnings/sales
EPS =
Share price =
Terminal value using PE =
Dividend / payout ratio
Share price = PE x EPS
Terminal value = (D0 x (1+g)^n / (1-b)) x PE
Firm value using WACC ie cash available to all investors?
How do you find equity value?
Equity value
Firm value = FCFF / (1+WACC)^t
Firm value = debt + equity (you would subtract one from the other)
FCFE / (1+rce)^t
FCFF =
FCFF =
FCFF1 = (Using WACC)
FCFF =
FCFE =
FCFE =
FCFE =
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
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
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
Leading PE =
Trailing PE =
Fundamental Justified PE (passthrough rate) =
Higher inflation on PE?
Leading PE = P0 / E1
Trailing PE = P0/E0
P0/E1 = 1 / (real r + (1- pass-through rate) x Inflation)
Higher inflation = lower PE
Earnings Yield
PEG ratio
P/B value
P/B given ROE
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
Molodovsky approach
Default approach
PEs change according to cyclicality
Next 4 quarters to calculate leading PE ratio
Price to Sales
Positives
Disadvantages
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.
Price to Cash Flow =
Cash flow =
Advantages
Disadvantages
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.
EV =
EV/EBITDA
Adv
Disadv
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
Standardised Unexpected Earnings
SUE = (EPSactual - EPSforecast) / SD(EPSactual - EPS forecast)
Terminal value of a stock
Adjusted CFO =
TV stock = P/EPS x future EPS estimate
Adjusted CFO = CFO + net interest charge
Residual income given B0 Price =
RI =
BV0 =
Assumptions of RI
Equity value given PVRI
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
RI Value =
No continuing residual income persistence factor =
Residual income continues in perpetuity =
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
RI given NOPAT =
NOPAT =
RI = NOPAT - WACC
NOPAT = EBIT (1-t)
Market Value Added (MVA) =
Economic Value Added (EVA) =
MVA = Market value of company (debt + equity) - Total adjusted capital
EVA = NOPAT - (WACC x capital)
What causes a higher persistance factor in residual income?
Extreme levels of accruals, low dividend payout & high non-recurring items.
TV of a stock in Y4 with persistance factor =
RI in Y5 / 1 + r - w
w = persistence factor
Market Value =
Fair value =
Investment value =
Intrinsic value =
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
Lack of control discount given - control premium 30%=
Two stage discounts method
Control premium 40%
Marketability discount 15%
Single stage = 1 - (1 / 1.30) = 23%
Two stage:
1 - (1/1.4) = 28.5%
1 - (1- 0.285) x (1- 0.15) = 40%
Ex ante alpha =
Required return =
Ex ante alpha = Expected return - required return
Required return = (1 + r^n) - 1
