Equity Valuations Flashcards
Goal of Equity Valuations
Goal of Equity valuations is to identify mispriced assets / securities
Three Methods of Valuations
Asset Value is drived from
- Liquidity Value (If the asset is forced to sell)
- Similar Assets
- Future Investement Returns.
Price Vs Value
Price = Observable = Market Price
Intrinsic Value = (Unobservable) = Value of an Asset given a hypothetically complete understanding of the assets investment characteristic
What do valuation assume
- Mispricing Exists: (Price is not equal to value) and (markets are not efficient) -
- Price and Value will converge within a certain Investment Horizon - (What will cause the convergence) (It is important to note that the prices will only converage if there is a catalyst forcing them to converge)
Grossman - Stiglitz Paradox
If markets were informationally efficient, no rational person would incur the cost of valuation.
What are the rewards for market efficiencies
Abrnomal Returns and Excess Risk Adjusted Returns.
Difference between Estimated Value and Market Price is
Also what is the eqation for the difference.
True Mispricing (Alpha) + Error in forcasts / model
Ve-P = (V-P)+(Ve-V)
where V = Correct Value
and Ve = Estimated Value
Alpha = (V-P)
Key Elements of a forcast are
- It should be different from consensus
2. it should be correct.
Going Concern Assumption
The company will continue its activities
Some assets have value only if the company is a going conecern.
If a compay is a retalier which leases its retail shop then what economic assuption must be true for the assets to have any value
Going Concern.
Liquidation Value
Immediate sale of assets (Financial Distress)
This is unlike orderly liqudation of
Defination of Intrinsic Value
Relevant concept of value for valuing public equities
Defination of Fair Market Value
Value at which an asset or liability would change hands between a willing buyer and a seller when they are in no compulsion to buy / sell
We assume that both are informed of all material aspects
Defination of an Investment Value
an asset may be more to a particular buyer (i.e Synergies)
What is the application of valuation
- Selecting Stocks
- Inferring Market Expectations: We assume that price reflects consensus expectations of investors about future performance
- Evaluating Corporate Events. (M&A, Spin-off )
- Rendering Fairness Opinions
- Evaluating Business Strategies
- Communicating with Analysts and Shareholders
- Appraise Private Businesses
- Evaluating Share based Compensation
What is a spin-off
one of the divisions of the company is formed into another company and the shareholder of the principal company also own the new company.
Valuation Process
- Understand the Business
- Forcast Company’s Performance
- Selecting Appropriate Valuation Models
- Converting Forcasts to Valuations
- Applying Valuation Conclusions
What needs to be done to Understand the Company Business
- Industry and Competitive Analysis
- Identify the Economic Drivers of the Business
- Threats and Opportunities
Industry and Competative Analysis
- Industry Attractiveness for sustained profitablity.
- The company’s relative Competative Position within the industry and its competative Strategy. (Cost Leadership / Differenciation and Focused Niche.)Business Model (How it turns its strategy into model)
- How well has the company executed its strategy and what are its prospects for future execution)
What are Portors 5 forces model
- Intra-industry rivalry
- Threat of New Entrants
- Buying Power
- Supplier Power
- Availability of Substitutes
Absolute Valuation Model Vs Relative Valuation Models
Abs Valutation Models = Specifies an Assets intrinsic Value (PV / Discounted CFs or Asset Based Valuations)
Relative Valuations Models = Metods of comparables. Relies on the law of one price. (i.e Similar Assets should sell for same price) (Ex Price Multiples and Enterprise Multiples)
Important to note is that Relative Valuation provides relative measure of over / under valued securties.
Cash Flow for Shareholders Vs Cash Flow for Company Level
CFs can be discounted to arrive at the value of the firm.
At Shareholder Level - Use Dividends
A Company Level - Use Free Cash Flows or Residual Income
Formula for Free Cash Flows
FCF = CFO - Capex - Change in WCs
Asset Based Valuation (part of Absolute Valaution
Uses Market Value of Assets / Resources it controls (such as REITs)