Equity - Chp. 27: Equity Valuation

Question 1

• Steps in equity valuation

Answer 1

• Understand the business
• Forecast company performance
• Select appropriate valuation model
• Convert forecast into valuation
• Apply valuation conclusions

Question 2

Difference b/t analyst value and IV value

Answer 2

• part mispricing and part analyst error:
  
  • IV_analyst – price = (IV_actual – price) + (IV_analyst – IV_actual)

Question 3

Going concern assumption

Answer 3

• assumption that a company will continue to operate rather than going out of business

Question 4

Liquidation value

Answer 4

estimates what firms assets would bring net of liabilities

Question 5

Investment value

Answer 5

• value of a stock to a particular buyer, depends on buyer
  
  • May be more relevant for acquisitions

Question 6

• Valuation definitions

Answer 6

• estimating the value of an asset by (1) using a model based on the variables the analyst believes influence the fundamental value of the asset
• (2) Comparing it to the observable market value of “similar” assets.

Question 7

• Objectives of equity valuation (8)

Answer 7

• Stock selection – comparing intrinsic value to market price
• Reading the market - Current market prices implicitly contain investors’ expectations about the future value of the variables that influence the stock’s price, can be read from comparing to IV
• Projecting the value of corporate actions – value proposed corporate action
• Fairness opinions – to support price to be received by minority shareholders in M&A
• Planning and consulting – evaluating corporate strategy
• Communication with analyst and investors – common basis to discuss company performance
• Valuation of private business –
• Portfolio management
  
  • Planning –
  • Executing plan

Question 8

• Elements of industry structure

Answer 8

• Threat of new entrants
• Threat of substitutes
• Bargaining power of buyers
• Bargaining power suppliers
• Rivalry among existing competitors

Question 9

• Generic strategies

Answer 9

• Cost leadership – lowest cost producer of the good
• Product differentiation – command premium price in market

Focus – employing one of these strategies in a particular area to gain competitive advantage

Question 10

Quality of earnings issues

Answer 10

• Accelerating/premature recognition of income
• Reclassifying gains and nonoperaing income
• Expense recognition and losses
• Amortization, deprecation, and discount rates
• Off balance sheet issues

Question 11

• Absolute valuation models – estimates assets intrinsic value

Answer 11

• One method is to value based on discounted value of future cash flows
• Dividend discount model – value a share based on present value of all expected dividend discounted at opportunity cost of capital
• Others include all cash flow to the firm not payable to senior claims
• Asset based model – values firm based on sum of market value of assets

Question 12

• Relative valuation models

Answer 12

• Price to earnings ratio
• Just tells if it is under/overvalued relative to other firms, not to intrinsic value

Question 13

Conglomerate

Answer 13

• – conglomerates marked down compared to single industry companies
  
  • Internal capital inefficiency
  • Endogenous factors – pursued unrelated business acquisitions to hide poor operating
  • Research measurement error