McKinsey valuation Flashcards
How do companies create value?
Companies create value by investing capital at rates of return that exceed their cost of capital. The more capital they can invest at attractive rates of return, the more value they will create, and as long as returns on capital exceed the cost of that capital, faster growth will create more value.
What is the average return on US Equities?
U.S. equities over the past 200 years have on average returned about 61/2 percent cent annually, adjusted for inflation. (Share price increase of 3-3.5% + dividend)
What is a normal P/E-ratio?
After adjusting ing for inflation, median price-to-earnings ratios (P/E) tend to revert to a normal level of about 15, suggesting that the typical investor’s risk-return trade-offs haven’t changed much over the past 100 years.
What caused the 20 year bull market from 1980 1999?
In our analysis, we identified three elements that were responsible for nearly all the change in the broad market ket index. The first two, growth in earnings and declines in interest rates and inflation, were precisely the factors one would expect to influence share prices. The third was the temporary emergence of what we call megacapitalization capitalization stocks associated with the Internet bubble of the late 1990s.
Are deviations from fundamental values mostly global?
NO.
Deviations from fundamental values tend to be concentrated in a small number of stocks.
(e.g. DotCom bubble)
What is value management?
Value managers are a special breed:
- They focus on long-term cash flow rather than on quarter-to-quarter earnings.
- They judge businesses by returns above opportunity costs, not by size, prestige, and other emotional issues.
- Most important, they recognize that managing for value means instilling the philosophy of value creation throughout the organization.
How to express economic profit?
Economic profit can be expressed as the spread between ROIC and the cost of capital, multiplied by the amount of invested capital. In Fred’s case, economic profit was $800,000. If he closed down his low-returning store, average erage ROIC would increase, but economic profit would decline. Even though the store earned a lower ROIC than the other stores, it still earned more than its cost of capital. The objective is to maximize economic profit over the long term, not ROIC.
How do you create value in the real market?
In the real market, you create value by earning a return on your invested vested capital greater than the opportunity cost of capital.
Free cash flow perpetuity formula
Value = Cash flow t = 1 / Cost of capital -g
NOPLAT
NOPLAT (Net Operating Profits Less Adjusted Taxes) represents the profits generated from the company’s core operations after subtracting ing the income taxes related to the core operations.
Invested Capital
Invested Capital represents the cumulative amount the business has invested in its core operations-primarily property, plant, and equipment ment and working capital.
Net investment
Net Investment is the increase in invested capital from one year to the next.
Free Cash Flows
The cash flows generated by the core operations of the business after deducting investments in new capital
FCF = NOPLAT - Net Investment
ROIC
ROIC (Return on Invested Capital) is the return the company earns on each dollar invested in the business. (ROIC can be defined in two ways, as the return on all capital or as the return on new or incremental mental capital. For now, we assume that both returns are the same.)
ROIC = NOPLAT / Invested Capital
Investment Rate
The portion of NOPLAT invested back into the business.
IR = NET INVESTMENT / NOPLAT
