Equity valuation: Aplications and processes

Question 1

Intrinsic value

Answer 1

Valuation of an asset with complete understanding of the asset’s characteristics

Question 2

Mispricing percieved by analyst

Answer 2

IV(analyst)-Price=(IV actual-Price)+(IVanalyst-IVactual)

Question 3

Fair market value

Answer 3

Price at which a hypotheticall, able and willing seller would trade an asset with a hypothetical, able and willing buyer

Question 4

Investment value

Answer 4

Value of a stock to a particular buyer

Question 5

Most relevant valuation metric for an analyst

Answer 5

For investment decision - Intrinsic value

For acquisition decision - Investment value

Question 6

Applications of equity valuation

Answer 6

1. Valuation
2. Stock selection
3. Reading the market
4. Projecting the value of corporate actions
5. Fairness opinion
6. Planning and consulting
7. Communication with analysts and investors
8. Valuation of privated business
9. Portfolio management

Question 7

Equity valuation process

Answer 7

1. Understand the business
2. Forecast company performance
3. Select appropriate valuation model
4. Convert forecast into valuation
5. Apply valuation conclusions

Question 8

Stock Selection

Answer 8

By comparing the intrinsic value of the stock with its market price and comparing the price with comparable stocks

Question 9

Reading the market

Answer 9

Current market prices include future market expectations of the variables that influence the stock market
Estimate the variables by comparing the intrinsic value to the stock market

Question 10

Proyecting the value of a corporate action

Answer 10

Determine the value of a proposed corporate merger, acquisition, divestiture, management buyout…

Question 11

Fairness opinion

Answer 11

Support professional opinion about the fairness of a price to be recieved by a minority in a merger of acquisition

Question 12

Planning and consulting

Answer 12

Evaluate effects of proposed corporate strategies on firm’s stock price

Question 13

Communicating with analysts and investors

Answer 13

Common basis to discuss and evaluate company’s performance, current state and future plans

Question 14

Valuation of private business

Answer 14

Determine the valua of a firm’s holdings in a non publicly traded company (determine the value of their position or proposed position)

Question 15

Portfolio management and steps

Answer 15

Determine the value and risk of a portfolio of investments
Steps: planning, execution and evaluation of results
Planning: defining investment objectives and constraints and articulating investment strategy
Executing: valuation of potential investment

Question 16

Porter’s five forces

Answer 16

1. Threat of new entrants in the industry
2. Threat of substitutes
3. Bargaining power of buyers
4. Bargaining power of suppliers
5. Rivalry among existing competitors

Question 17

Profit generating strategies

Answer 17

1. Cost leadership: lowest-cost producer of the good
2. Product differentiation: adding new featues or services to make the product more attractive and charge a premium for it
3. Focus: applying either strategy to a specifi segment of the industry

Question 18

Quality of earnings issues

Answer 18

1. Accelerating or premature recognition of income: obscures declines in operating performance or boosts recorded revenue
2. Reclassifying gains and nonoperating income as operating income: hides underperformance or declining sales
3. Delaying recognition of expenses, capitalising expenses or classifying operating expenses as non operating expenses: increases operating income
4. Amortization, depreciation and discount rates: reduce current recognition of expenses, deferring recognition to later periods
5. Off-blance sheet issues: SPEs obscuring nature of assets and libilities or structuring operating leases as financial leases reducing total liabilities reported in BS

Question 19

Absolute vs relative valuation models

Answer 19

Absolut valuation model: estimates asset’s intrinsic value (ex: discounted cash flow)
Relative valuation: estimates an asset’s investment characteristics compared to the value of other firms (ex: ratios)

Question 20

Sum of the parts valuation

Answer 20

Valuing the individual components of a company and adding them all together to obtain the value of the whole company

Question 21

Broad criteria of choosing appropriate approach

Answer 21

1. If model fits the characteristics of the company
2. If appropriate based on quality and availability of data
3. Suitable given the purpose of the analysis