LM 8: Equity Valuation: Concepts & Basic Tools Flashcards

1
Q

What is the difference between market value and intrinsic value?

A

market value determined by market quotes and transactions

intrinsic value objective true value investors would get if they had all relevant quantitative and qualitative information

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2
Q

Will the intrinsic value be less than the market value or more than the market value for undervalued and overvalued securities?

A

undervalued = intrinsic value > market price

overvalued = intrinsic value < market price

fairly valued = intrinsic value = market price

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3
Q

What are the 3 major categories of equity valuation models? PMA

A
  1. Present Value Models (Discounted Cash Flow Models) (FCFE)
  2. Multiplier Models (Market Multiple Models)
  3. Asset-based Valuation Models
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4
Q

What is the difference between present value models and asset based valuation models?

A

present value models = intrinsic value is the present value of future benefits from the security.

asset based valuation models = intrinsic value is estimated as the market value of assets minus the estimated value of liabilities and preferred stock.

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5
Q

What are multiplier models?

A

Relative valuation of stock based on some fundamental multiplier of value like price to earnings, price to sales, etc.

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6
Q

What is the formula for asset based valuation models?

A

ABV intrinsic value = estimated value of assets - estimated value of liabilities - preferred shares

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7
Q

What is forward basis vs trailing basis?

A

forward basis = projected earnings per share next year

trailing basis = earnings per share for the past year

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8
Q

What is enterprise value formula?

A

EV = total market value of a company - cash and short-term investments

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9
Q

What is declaration date?

A

This is the day that the dividend’s authorization is announced.

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10
Q

What is ex-dividend date?

A

Starting this day, new owners will not be eligible to receive the previously declared dividend.

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11
Q

What is holder of record date?

A

On this day, the company records the list of owners who held shares at the close of trading on the day before the ex-dividend date.

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12
Q

What is payment date for dividends?

A

This is when the dividend is actually paid

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13
Q

What is extra special dividends vs liquidating dividend?

A

extra special = may be paid at any time outside the regular schedule, often when companies does well

liquidating dividend = paid to return capital to shareholders when a company goes out of business.

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14
Q

What are stock dividends?

A

grant extra shares to investors rather than cash

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15
Q

What is stock split vs reverse stock split?

A

Stock splits = increase the number of shares outstanding,

Reverse stock splits = reduce the number of shares outstanding

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16
Q

What is share repurchase?

A

Management can choose to repurchase shares if they believe that they are trading below their intrinsic value.

17
Q

What is the basis of the dividend discount model?

A

intrinsic value of a share of stock = PV of expected future dividends

18
Q

What is the formula for the dividend discount model?

A

v0 = (Dt / (1+r)^t) + (Pn / (1+r)^n)

v0 = intrinsic value of 1 share of stock
Dt = expected dividend in year t
r = require rate of return
Pn = expected selling price at end of investment horizon

19
Q

How is free cash flow to equity valuation model different than dividend discount model?

A

FCFE = focuses on how much they can pay dividends

dividend discount model = focuses on expected dividends

20
Q

What is FCFE formula?

A

FCFE = CFO - FCInv + Net Borrowing

CFO = cash flows from operations
FCInv = fixed capital investments

21
Q

What is the intrinsic value of stock using the FCFE?

A

v0 = (FCFEt / (1+r)^t)

22
Q

What is one method investors use to estimate R?

A

using CAPM

23
Q

What is CAPM formula?

A

E (Ri) = Rf + Bi [E(Rm) - Rf)]

E (Ri) = expected return
Rf = risk free rate
Bi = beta, stock sensitivity to equity market
E(Rm) - Rf = market risk premium
E(Rm) = expected return of market

24
Q

What is the preferred stock valuation formula, and the preferred stock valuation formula with a known maturity date?

A

preferred stock valuation = V0 = D0 /r

preferred stock valuation formula with a known maturity date = V0 = (Dt / (1+r)^t) + (F / (1+r)^n)

D0 & Dt = dividend
r = required rate of return
F = preferred stocks par value

25
Q

What is a retraction option of preferred stock?

A

essentially a put option, allow investor to sell preferred stock back to issuer at a set price on a set date

26
Q

What is the gordon growth model?

A

Gordon constant growth model (GGM) estimates future dividend payments by assuming a constant dividend growth rate (g
) and the required return on equity.

27
Q

What is the formula for the gordon growth model, and the simplified formula?

A

v0 = D0 (1+g)^t / (1+r)^t

V0 = D0 (1+g)^t / (r-g)

D1 = dividend in next period
D0 = dividend now
r = required rate of return
g = growth rate

28
Q

What is sustainable growth rate, and formula, and how is it used in the gordon growth model?

A

the maximum rate of growth that a company or social enterprise can sustain without having to finance growth with additional equity or debt

G = b (earnings retention rate) * ROE

used as the growth rate for gordon growth model

29
Q

What is the formula for retention rate and return on equity for the gordon growth model?

A

retention rate = 1 - dividend payout ratio

ROE = net income / average total equity

30
Q

What are price multiples?

A

ratios of the share price to some other value related to the relative worth of the company’s stock. eg. Price-to-earnings (P/E),
Price-to-book (P/B)

31
Q

What is enterprise value formula?

A

EV=Market capitalization (common stock)+MV of preferred stock+MV of debt−(Cash+Short-term investments)

short term investments doesn’t include inventory or accounts receivable

32
Q

What is asset base valuation?

A

uses difference between estimates of a company’s market value (fair value) of current assets & current liabilities

33
Q

What is the law of one price and what equity model does it apply too?

A

states that identical assets should sell for the same price. In theory, a company trading at 14 times earnings is attractively priced compared to a similar company with a P/E ratio of 20.

applies to multiplier models or fundamental models

34
Q

What is formula for intrinsic value of preferred share given issue rate, par value, and required rate of return?

A

Issue rate * par value for = annual dividend

Annual dividend/ required rate of return = stock price intrinsic value

35
Q

What is EV/EBITDA?

A

enterprise value / EBITDA

used to determine fair market value of a company

36
Q

When is it most appropriate to use Gordon growth vs two stage dividend discount model vs three stage dividend discount model?

A

Gordon growth: suited for mature companies

Two stage: companies transitioning from growth to mature stage

Three stage: young companies entering the growth phase

37
Q

What is the ratio used to get P/E forward P/E from retention ratio, and growth rate?

A

D1/EPS / R-G

D1/EPS = payout ratio (1- earnings retention)
R = required rate of return
G = growth