Reading 30: Valuation Concepts

Question 1

A. Define Valuation:

B. Define Intrinsic Value:

C. Explain the sourcs of mispricing:

Answer 1

A. Valuation: estimation of an asset’s value based on estimates or comparable assets.

B. Intrinsic Value: value given a hypothetically complete understanding of the asset’s investment characteristics

C. Two Possible Sources of Mispricing

1. Difference between market & intrinsic value
2. Difference between valuation estimate and intrinsic value (valuation error)

Question 2

A. Explain the going concern assumption

B. Contrast a going concern to a liquidation value

Answer 2

A. Going Concern Assumption: the assumption that the company will continue for the forseeable future

B. Liquidation Value: is the value of the company if it was dissolved and asset sold individually

Question 3

A. Describe definitions of value

B. Justify which definition is most relevant to publc company valuation

Answer 3

A. Definitions of Value:

1. Fair market value: the amount at which something would trade hands
2. Investment value: value to a specific buyer

B. Intrinsic value:‘true’ likely value and most appropriate for public companies

Question 4

A. Describe the applications of equity valuation

Answer 4

A. Applications of equiyt valuation:

1. Stock Picking
2. Inferring market expectations
3. Evaluating corporate events
4. Rendering fairness opinions
5. Evaluating business and strategic models
6. Communicating with analysts and shareholders
7. Appraising businesses
8. Share-based compensation

Question 5

A. Describe questions that should be addressed in conducting an industry and competitive analysis

Answer 5

A. Questions that should be addressed while conducting industry and competitive analysis:

1. How attractive is the industry? (profitability and prospects)
2. Porter’s five forces: rivalry, new entrants, substitutes, supplier power, buyer power
3. What is the company’s competitive position & strategy in its industry? (cost leadership, differentiation, focus)
4. How well has the company executed? Can they continue to execute their strategy?
5. Management structure, intangibles, legal disputes, etc. …

Question 6

A. Contrast absolute and relative valuation models, and describe examples of each type of model

Answer 6

A. Absolute Valuation Models: specify an intrinsic value i.e. DCF or Asset backed

B. Relative Valuation Models: specify a value in relation to another similar asset

Question 7

A. Describe sum-of-the-parts valuation, and

B. explain a conglomerate discount

Answer 7

A. SOP Valuation: value of each of a business’s parts, as if they were independent, AKA breakup value, or private market value

B. Conglomerate discount: market applies a discount to companies who operate in many unrelated businesses.

C. Likely causes of a conglomerate discount:

1. inefficeient internal company capital allocation
2. tendancy for failing companies to acquire more business to stop the bleeding.

Question 8

A. Explain broad criteria for choosing an appropriate approach for valuaing a given company

Answer 8

A. Broad criteria for choosing an appropraite valuation approach:

1. Consistent with the characteristics of the company being valued
2. Appropriate given the availability of data
3. Consistent with the purpose of the valuation, including the analyst’s perspective