Equity Valuation: Concepts and Basic Tools Flashcards
Market Value > Intrinsic Value
- stock is overvalued
Market Value = Intrinsic Value
- stock is fairly valued
Market Value < Intrinsic Value
- stock is undervalued
Three major categories of Equity Valuation Models
- present value
- multiplier models
- asset-based valuation models
Dividend payment chronology:
- declaration date
- ex-dividend date
- holder-of-record date
- payment date
Ex-dividend date
- cutoff date on or after which buyers are not eligible for the dividend
- ie need to own before this date
Holder-of-record date
- list of sh.h who are able to receive the dividend
- usually two days after the ex dividend date
r =
- cost of equity
- required rate of return on a share
CAPM model
r = rfr + B(MRP)
FCFE def
- the residual CF available to be distributed as dividends to common shareholders
FCFE model is used because
- FCFE is a measure of a firm’s dividend-paying capacity
- can be used for non-dividend paying stocks
- not all of the available cf is distributed
FCFE equation
FCFE = CFO - FCInv + net borrowing
FCFE Model equation
Vo = FCFE t / (1+r) ^t
Preferred stock valuation formula
Vo = Do / r
Do might = Par * dividend
- for non-callable, non-convertible perpetual pref shares
The Gordon Growth Model
- dividends grow indefinitely at a constant rate
- aka the constant-growth dividend discount model
The Gordon Growth Model formula
Vo = D1 / (r - g)
To estimate g (growth rate of dividend
- use historic growth rate of the firm
- use the industry median g rate
- estimate the sustainable growth rate: g = b * ROE
Sustainable growth rate formula (g)
g = b * ROE
b= retention rate b = (1 - dividend payout ratio)
Earnings retention rate formula
b = (1 - dividend payout ratio)
The higher the retention rate, the higher the _____
higher growth rate
- ie less dividends are paid out = higher g
Higher ROE = higher
g
Price-to-book ratio
P/B
= Price per share / book value per share
book value per share = A - L / shares outstanding
*evidence suggests that companies with low P/B tend to outperform stocks with high P/B
Book value per share formula
book value per share = A - L / shares outstanding
Price-to-earnings ratio
PE = price per share / trailing 12 months EPS
*can use for trailing or leading EPS
Price-to-sales ratio
P/S = price per share / sales per share
- can use for trailing or leading sales per share
- can never be negative unlike the PE ratio
Price-to-cash-flow ratio
P/CF = price per share / cash flow per share
*CFO, FCF, etc
Justified (Forward) P/E ratio
Justified PE = dividend payout / r-g
A higher payout ratio may mean a company is retaining less for reinvestment, which in turn means:
a slower growth rate
Enterprise Value
measures the market value of the whole company (debt and equity)
Enterprise Value formula
EV = market value of debt + market value of equity + market value of pref stock - cash and equivalents
EV = MVD + MVE + MVP - cash and equivalents
EBITDA
- earnings before interest taxes, depreciation, and amortization
- a proxy for cash flow
When is the EV/EBITDA ratio used?
- when earnings are negative
- for comparing companies with significant differences in capital structure
- to evaluate the cost of take over
*MVD can be difficult to obtain
Asset-based valuation
(A - L) / sh.o