Lecture 5 Flashcards
Why carying about prospective analysis? (forecasting & valuation)
Because you want to know how expected changes in performance drivers affect future performance
Where is Market capitalization based on?
Market capitalization is based on assumptions about future:
- Macro-economic and industry-wide changes, and growth of companies
- Any changes in these assumptions will affect share prices / market value of companies
Forecasting involves a three-step process:
Step 1: Predict change in environmental and firm-specific factors
Macro-economic analysis:
Industry and business strategy analysis:
Accounting analysis
Step 2: Assess relationship between step 1 factors and performance
How much has Ford’s past performance responded to economic conditions? What has been the impact of industry-wide trends on sales, R&D, investments?
Step 3: Forecast condensed financial statements
‘Condensed’ entails a focus on key items, rather than on details.
E.g.: Ford and automotive industry:
Translate expectations about economy, industry, strategy into forecasts of Ford’s future performance.
Sensitivity Analysis
Two most likely alternative scenarios;
- Upside scenario
- Downside scenario
At some point ‘superior’ companies will return to ‘normal’ performance, due to the following factors:
Saturated markets
Size-growth relationship
Increased competition
Industry-wide developments
Why did Few companies have been able to sustain a competitive advantage?
due to the strength of their product
or by ‘reinventing’ themselves.
Why do Pharmaceutical companies have consistently high performance?
This is mainly due to their main economic assets (R&D) not being shown on the balance sheet.
What means a high or a low ROE/profitability?
High profitability attracts competition.
Low profitability means either ‘bankruptcy’ or capital moving away.
As what can Statistical properties of key measures be used?
can be used to analyze trends and provide benchmarks for forecasts
Firm value
represents the present value of the cash payoffs that an equity investor can expect to receive
What are the four different methods to derive Firm value?
Discounted dividends
Discounted cash flows
Discounted abnormal earnings
Price multiples
What is the present value of future cashflows to shareholders?
Equity Value0 = Dividend/(1+Re)
How is the cost of equity determined?
By a risk-free rate plus a risk premium
Equity value perpetuity
Equity value = dividends/(r-g)
What are two assumptions of the gordon growth model?
- Model assumes constant growth in dividends.
- Model is very sensitive to assumed growth rate, so can only be used for companies with stable dividend growth rates
Terminal Value
((1+g)Free Cash Flows)/((Re-g)(1+Re)^t)
The present value of either abnormal profits or free cash flows occuring beyond the terminal year.
Terminal growth rate
Terminal growth rate is usually assumed to be around the long-term economic growth rate (2-3%).
Price multiple relation and Steps
A price multiple relates a firm’s share price to a per-share accounting-based metric and provides an easy-to-use valuation benchmark.
Price multiples valuation employs three steps:
1. Select base measure.
- For example: Price-to-earnings (P/E) ratio.
2. Calculate price multiples for comparable firms or compute industry averages.
3. Apply comparable firm multiple to firm analyzed.
Areas of difficulty for price multiples valuation:
How to select comparable firms, especially for private companies?
- If no comparable firm is found, industry averages may be used.
How to treat loss-making firms?
- Exclude ‘non-recurring’ items or use forecasts
Compute the price‐to‐expected‐earnings ratio for the three companies. What do you conclude based on this comparison? ABI’s multiple is lower than the ones of Heineken and Carlsberg
This suggests that the company may be somewhat undervalued.
SUMMARY & OUTLOOK
Where do Forecasted financials serve for?
Forecasted financials serve as inputs to valuation models that seek to determine a company’s equity value.
- We focused on one-period models that yield a simplified valuation.
- Also, our approach was to impute the growth rate implied by a firm’s current share price
