Technicals Flashcards
What is enterprise value?
EV is the sum of all ownership interest in a company and claims on its assets from both debt and equity holders
What is the formula for EV?
Equity value + total debt + preferred stock + non-controlling interests - cash and cash equivalents where the equity value is calculated in a fully diluted basis
What is the formula for ROIC and what is it ?
Measures the return generated by all capital provided to a company. Thus, uses pre-Interest earnings statistic on numerator such as EBIT or EBIAT and a metric that captures both debt and equity in the denominator
EBIT / (average net debt + equity)
What is ROE?
Measures return generated in the equity provided to the company by its shareholders. Thus earnings is net of interest expense
Net Income / Average shareholders equity
What is ROA?
Measures the return generated by a company’s asset base
Uses net income / average total assets
What is the formula for implied dividend yield?
Recent quarter dividend per share x 4 / current share price or
Annualised dividends paid / market cap
What is the general formula for leverage and why?
Debt / EBITDA or
Debt / Total capitalisation
EBITDA is a rough proxy for the firms operating cash flow, thus this ratio measures how many years of a company’s, cash flows it will take to repay its debt
What is coverage and it’s general formula ?
Broad term that refers to a company’s ability to meet its interest expense obligations. Numerator consists of a statistic representing operating cash flow (LTM EBITDA) and LTM interest expense in the denominator. Better coverage translates to better credit profile
How do I calculate LTM financial data? With example.
LTM financials = last FY financials + current stub - prior stub
E.g if currently is 3Q2012, then LTM = FY2011 + 3Q12 - 3Q11
How do I calendarize Financials?
Month of fiscal year end/ 12 x sales number + ((12-month of fiscal year end/12)x following year sales )
What is the formula for P/E?
Market Cap / Net Income or
Share price / EPS
When do I use use p/e and when do I not?
Use: when the firm is large and mature with consistent earnings
Don’t use: when firm is small with little or negative earnings as denominator would be too small.
When the disparities due to capital structure or D&A or Taxes will make two otherwise very similar companies very different
What type of enterprise value multiples exist and why?
EV/EBITDA, EV/Sales, EV/EBIT
EV represents interests of both debt and equity holders and thus is a multiple of unlevered financial statistics.
Why is EV/EBITDA the most popular compared to the rest?
EBITDA does not reflect disparities caused by debt or D&A. For example, if one firm decides to spend heavily on new equipment while the other chooses to defer this spending to a future period, EBIT margins would be quite different but not reflected in EBITDA. Moreover, EBIT is also affected by recent acquisition related amortization
When do I use EV/EBIT?
When information about D&A is unavailable, or for companies with high capex
When do I use EV/Sales?
When the company has little or negative earnings. EV/Sales gives an indication of size but not Profitability or cash flow generation. For example good for early stage tech company going through aggressive sales but not profitable yet
What sectors do I consider using EBITDAR?
Casinos, Restaurants, Retail
What sectors do I consider using EBITDAX?
Natural gas, Oil and gas
X = exploration expense
What sectors do I use price/Net asset value?
FIG, Mining, Real Estate
What enterprise multiple can I consider for media and telecommunications firms?
EV/Subscriber
When projecting Sales without reliable guidance, what do I need to consider?
- Need to step down growth rates incrementally in the outer ward to arrive at a reasonable Long term growth rate by the terminal year (2-4%)
- For highly cyclical businesses like steel or lumber, sales levels need to track movements of the underlying commodity cycle. However, even so, it is crucial the terminal year financial performance represents a normalised level as opposed to a cyclical high or Low. Otherwise the TV which comprises a substantial portion of the overall value in a DCF will be skewed
What do I tie COGS and SG&A projections to?
COGS tie to gross Margins
SG&A tie to sales
In the case that the DCF is constructed in the basis of EBITDA or EBIT and not sales, what line items will be excluded? Consequently, how will NWC be projected in terms of what they will be tied to?
- COGS and SG&A
2. Tie to sales
How do I calculate FCF?
- Start from EBIT
- Take out tax expense to arrive at EBIAT
- Add back D&A
- Add back changes in deferred taxes if applicable
- Minus Capex
- Minus off NWC
- Arrive at FCF
If there isn’t guidance, how do we project CAPEX and why?
As a percentage of sales in line with historical levels as top line growth is typically supported by growth in the company’s asset base.
What is NWC, formula and in words?
Non-cash current assets - non-interest bearing current liabilities. NWC measures how much cash a company needs to fund its operations in an ongoing basis.
What is days sales outstanding, formula and in words? Do companies strive for higher or lower DSO?
DSO= AR/Sales x 365
It is the implied average number of days
The firm takes to collect payment after making a sale.
Companies strive for lower DSO as it represents a lower use of cash
What can increase a company’s DSO?
Customer leverage, renegotiation or terms, worsening customer credit, poor collection systems, change in product mix
What is days inventory held formula and in words? With the result of DIH, what statement can u make about the company in a year?
Inventory/COGS x 365
DIH implies the average number of days before the company can sell off its inventory.
The firm will have approximately 365/DIH number of inventory turns in a year
Do companies want a higher or lower DIH? Why?
Lower, because increases in inventory is a use of cash so minimising frees up cash that is tied to stock. Moreover, inventory is susceptible to theft, damages and obsolescence due to newer products or technologies.
What is the inventory turns ratio?
COGS / Inventory
What is days payable outstanding, formula and in words? Do firms want higher or lower DPO?
DPO = AP/COGS x 365
Measures the number of days it takes for the firm to make payment on its outstanding purchase.
Higher, as an increase in A/P represents a source of cash. Firms want to maximise DPO so as to increase short term liquidity where cash on hand can be used for other business purposes
What is the formula for WACC?
WACC = (cost of debt x (1-t) x d/total cap) + (cost of equity x e/ total cap)
Is cost of debt or equity more? Why?
Cost of debt is generally lower due to tax deductibility of interest expense
How does cost of debt affect WACC?
without debt in the capital structure, WACC = cost of equity. As proportion of debt in capital structure increases, WACC gradually decreases up till the optimal structure due to tax deductibility of interest expense. However beyond that point, WACC goes up again as the negative effects of an over-leveraged capital structure such as increased probability of insolvency outweighs the tax advantages of debt)
Explain the CAPM.
The CAPM is based on the premise that equity investors need to be compensated for their assumption of systemic risk in the form of a risk premium, or the amount of market return in excess of a stated risk-free rate. A company’s level of systemic risk depends on the covariance of its share price with movements in the overall market, as measured by its beta.
What is unsystematic risk? What firms have a larger unsystematic risk?
Unsystematic risk, or specific risk, is company or sector specific and can be avoided through diversification. Hence equity investors are not compensated for it in the form of a premium. General rule of thumb is that Smaller firms and the more specified their product, the higher the unsystematic risk.
What is the formula for the cost of equity?
Risk free rate + levered b(market returns-risk free rate) + country risk premium (if applicable) + size premium (if applicable)
Where market rerun - risk free rate = market risk premium (Wall Street average is 5-8%)
Why do we use s&p500 as a proxy for the market when calculating beta?
S&P covers TOP 500 stocks and has a beta of 1.0 so easy to compare
How does beta affect the cost of equity?
The higher the beta, the higher the cost of equity
Explain the process of bottoms up beta.
- We find a peer group similar to our target firm and find their historical betas
- However, they may or may not have a similar capital structure to one another or the target.
- Thus to neutralise the effects of different capital structures, (remove the influence of leverage) the banker must unlever the beta for each company to get the asset beta ( unlevered beta)
- Then we have to use the average unlevered beta and relever it back to our targets capital structure.
What is the formula for unlevering beta and relevering beta?
- Bu= BL/(1+D/E X (1-t))
2. BL= Bu x (1+ D/E X (1-t))
What is the formula for TV under the GGM?
Tv = (FCFn x (1+g))/ (WACC-G)
What is the formula for implied TGR using the EMM ?
With the mid year convention?
Implied TGR = ((TV x WACC) - FCFterminalyear)/(TV + FCFterminal year)
Numerator and denominator x (1+WACC)*0.5
How do you get implied exit multiple using GGM?
With mid year convention?
TV / terminal year EBITDA Numerator x (1+WACC)^0.5
What is the discount factor, formula and in words?
Discount factor = 1/(1+WACC)^n
It is the fractional value representing the present value of one dollar received at a future date given an ashamed discount rate
How does the mid year convention affect valuation? Why?
Mid year convention results in a slightly higher valuation as it assumes cash flows through the year instead of at the end, thus the discounted value will be higher.
Basically because FCF is received sooner
What is the formula for discount factor with a mid year convention?
1/(1+WACC)^n-0.5
How does mid year convention affect discounting for EMM and GGM?
If we use the mid year convention for FCF projections,
Under GGM, TV will also use mid year discount as the banker is discounting perpetual future FCF assumed to be received throughout the year
Under EMM, TV will use end of year discount as it uses LTM trading multiples
How to get enterprise value and equity value in a DCF? How to get share price?
EV = sum of PV of cumulative FCF + PV of TV
Implied equity value = EV -(net debt + preferred stock + non-controlling interests)
Share price = implied equity value / fully diluted shares outstanding
What are the Pros and Cons of a DCF?
Pros
- cash flow-based - which represents a more fundamental approach to valuation than using multiples based approach
- market independent as it is more insulated from market aberrations such as bubbles and distressed periods
- Self-sufficient so it can be particularly important when there are limited or no pure play public comparables to the company being valued
- Flexibility as it allows for scenario analysis
Cons
- Sensitivity to assumptions
- large dependence on terminal value
- assumes constant capita structure across the projection period
What’s the shortcut formula for getting AR in your projections using DSO?
Sales / 365 x DSO
What is an LBO? What is the buyers goal?
It is the acquisition of a target (can be a company, division or collection of assets) using debt to finance a large portion of the purchase price
To realise an acceptable return on its equity investment upon exit, typically through an IPO or sale of the target. Investors have historically sough a 20%+ annualised return and an investment exit within five years
What does payment-in-kind (PIK) mean?
Means that the interest is paid in the form of additional shares of preferred stock or whatever instrument
Why do we need to adjust BETA?
Adjusted / predicted beta is basically a statistically adjusted historical beta to reflect an expectation that the individual company’s beta will revert toward the mean over time. For example if historical beta < 1 den adjusted will be > historical but still < 1.
How do I calculate the cost of preferred stock? With growth as well?
Dividends / stock price
Dividends / stock price + growth rate
What is the difference between your marginal tax rate and your effective tax rate?
Marginal tax is the highest bracket of tax u fall into based on income
Effective tax is the actual tax you paid / taxable income. Basically it is the average tax rate since ur income will likely span across several tax brackets
Why do companies pay a premium to acquire a target company?
- Realising synergies
- Control premiums
- Supply and demand
Where is stock based comp in income statement if applicable and how do we need to adjust for it?
SBC issued today direct labour is allocated to COGS
SBC issues to R&D Engineers is included within R&D expenses
SBC for management and those involved in selling and marketing is included in SG&A and other operating expenses
We need to add SBC back in cash flow from operations since it is a non-cash expense
Could you ever end up with negative shareholders equity? What does it mean?
Yes. Common to see in two scenarios
- LBOs with large dividend recaps - meaning the owner has taken out a large portion of its equity which can sometimes turn the number negative
- Can also happen if the company is losing money consistently and therefore has a declining retained earnings which is a portion of SE
What are deferred tax assets and liabilities and how do they arise?
DTL arose when you have a tax expense on the income statement but haven’t actually paid that tax in cash get.
DTA arise when you pay taxes in cash but haven’t expensed them on the income statement yet
What flows into additional paid in capital?
APIC = last APIC + stock based comp + value of stock created by option exercises
What are examples of non-recurring charges we need to add back to a company’s EBIT/EBITDA when looking at its financial statements?
Restructuring charges Goodwill impairment Asset Write downs Bad debt expenses Legal expenses Disaster expenses Change in accounting procedures
However this one off adjustments need to affect operating income. If it’s below the line u don’t add it back to EBITDA / EBIT calculation
Also note that D&A and SBC are added back to get EBITDA but are not one - off. Happened every year just a non cash adjustment
What are NOLs and how do they work?
When u incur negative pretax Income, u generate NOLs that can be used to reduce taxable income in the next periods.
If a company has 100 pretax income and initial NOL of 175:
Apply 100 of NOL to offset taxable income so 0 paid in true cash taxes. DTA item decreases by tax rate * 100.
On IS nth changes as taxes are still recorded. However, on CFS the DTA decreasing by 40 increases cash flow by 40 so operating cash flow is up by 100
BS side balances cos cash is up DTA is down balanced by Net income increase
What is minority interest?
When a company owns > 50% of another company’s shares, they are required to consolidate their financials and report as their own. However, in reality they do not own 100% of the other company so they need to split up the net income and equity based on the % they own and use a minority interest line item to balance this out
How do I calculate fully diluted shares?
Start with basic shares outstanding, add in the dilutive effect if stock options, warrants, convertible debt, preferred stock, etc.
How do I calculate fully diluted shares using the treasury stock method?
If we have 100 shares outstanding at 10 dollar per share and 10 options outstanding at 5 dollars per option, we exercise the options to create 10 new shares. However we need to pay 5x10=50 to the company for these options and they will then use this new 50 to buy back 5 more shares.
The fully diluted share count is thus 105 and fully diluted equity value is 1050
Can a company have negative Equity value?
What about enterprise value? What does it mean?
- No. Shares outstanding and share count cannot be negative
- Yes. Happens when the firm has a karate cash balance or Low market cap or both.
- we see this with companies on the brink of bankruptcy
- or banks with large cash balances but banks don’t use EV so this doesn’t matter much
Why do we add preferred stock to EV?
PS pays out a fixed dividend and holders have a higher Claim to a company’s assets than equity investors do. As a result it is seen as more similar to debt than common stock.
How do we add preferred stock to get to enterprise value?
If it is in the money, we count them as additional dilution to equity value.
If not, we add the face value to the debt value
A company has 1 mil shares outstanding at 100/ share. It also has 10 mil of convertible bonds with par value of 1000 and conversion price of 50. How do I calculate diluted shares outstanding?
First find out the number of convertible bonds: 1mil device by 1000 = 10,000 bonds
Next find out how many shares this translates to:
1000/50 = 20 shares for each bond
Thus 20 x 10,000 = 200,000 new shares.
Fully diluted shares outstanding = 1mil + 200k = 1.2mil
What is the difference between equity value and shareholders equity?
Equity value is the market value while SE is the book value.
Equity value can never by negative whereas SE can be any value. Healthy companies will see equity value»_space;> SE
What is a MBS? What is a CDO? CLOs?
A MBS is a security made up of a pool of underlying mortgages. Banks sell off their mortgage loans to IBs which then packages multiple loans into a MBS. Banks do this to remove the loans from their books while also having the opportunity to make a quick profit off the spread if possible. IBs than split this MBS into tranches reflecting maturity and risk profile of the borrowers. Essentially the risk is transferred from the banks to the investors (usually hedge funds).
CDOs on the other hand are made up of underlying debt obligations which also include MBS. This means CDOs are two layers away from the individual mortgages whereas MBS is one layer between the individual mortgage and the MBS.
CLOs are similar to MBS but made up of loans so also one layer
Thing to note here is that these sort of collateralised securities often take the riskier and lower rated portions of securities to bundle up into a new security. Also CDOs tranches were designed to retain value if losses kept below high single digits and be 100% wiped out if loses went beyond Low double digits
Why is CLO and CDO bad comparisons?
Use the way CDOs manufactured to lose all its value in Low double digits to show that comparing these irresponsible and often fraudulent securities that were made out of securities which were engineered to lose all their value in adverse circumstances to the default risk on conventionally risky loans is a textbook apples to oranges comparison
