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ACCT 647 > Valuation > Flashcards

Valuation Flashcards

1
Q

What are the two approaches to valuation?

A
  1. Income Perspective
  2. Asset Perspective
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2
Q

Valuation in terms of the income perspective

A

Predict future earnings and cash flows based on the available information

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3
Q

Valuation in terms of the asset perspecitve

A

Measure of the firm’s net assets
(Assets-Liabilities=BV of Common Equity aka SHE)

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4
Q

Why are there differences in P/E ratios?

A
  • Expected growth rates differ (different strategies, strengths, lines of business, managerial expertise)
  • Risks of expected cash flows differ
  • Earnings are computed differently (accounting policies: revenue recognition, depreciation, inventories) (accounting estimates: bad debts, warranties)
  • Earnings contain transitory items
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5
Q

What is the average PE ratio for the market?

A

30

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6
Q

Price Earnings Ratio

A

Earnings per Share/Share Price

Basic net income per common share attributable to the company/Share Price

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7
Q

What does share price indicate?

A

It is determined partially by the shares outstanding, by looking at the share price alone we can’t tell anything (instead look at price relative to earnings)

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8
Q

What affect do stock splits have?

A

Increased number of shares, for an decreased share price

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9
Q

In isolation, per-share stock prices reflect…

A

the number of shares the company chooses to issue

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10
Q

What do companies believe about their stock when they issue a stock split?

A

They often believe that the stock will trade around the same as it was prior to the split

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11
Q

Walmart’s EPS was $1.81 and its share price was $47.8 - what is the PE ratio?

A

26.4

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12
Q

How do unusual and non-recurring items affect PE ratios?

A

PE ratios are based on reported income, investors use recuring income to value the firm’s assets and it’s stock price

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13
Q

Why does the economy-wide PE ratio change over time?

A

World events
(ex: .com bubble, real estate crisis, COVID, inflation, war, energy and food crisis, supply chain snags, central bank tightening)

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14
Q

What are the advantages of the PE approach?

A
  • Quick screening tool
  • Easily understood summary measure
  • Widely used
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15
Q

What are disadvantages of the PE approach?

A
  • Based on one year’s earnings
  • Ignores many causes of PE differnce (ex: growth)
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16
Q

What is noncontrolling interest?

A

Equity owned by owners that aren’t common shareholders

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17
Q

Book Value Ratio

A

(Shares outstanding*Price per share)/Shareholder’s Equity

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18
Q

What does the price to book ratio represent?

A
  • Market valuation of owners’ equity (net recorded assets) on the balance sheet
  • “Net recorded assets”=Assets-Liabilities=BV of Owner’s Equity
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19
Q

Why might PE and PB ratios diverge?

A

Nonrecurring items

20
Q

If the price-to-book ratio equals one what does that mean?

A

Accountants and investors perfectly agree on the value

21
Q

What might a PB ratio of 0.65 imply?

A

Overstated assets

22
Q

If the PB ratio is more than one..

A

it could imply conservative accounting or intangible assets

23
Q

If the PB ratio is less than one…

A
24
Q

Why is the PE ratio not meaningful when earnings are negative?

A

The PE ratio calculation assumes that current earnings are representative of future earnings and subject to expected growth and risk

25
Q

Why to PB ratios vary?

A
  • Expected growth rates
  • Risk
  • BV computations differ: accounting policies and estimates
  • Some assets are not recorded (R&D assets and advertising are sometimes labeled as “goodwill”)
26
Q

Why is the PB ratio ever less than one?

A
  • Outdated book values overstate market value or liquidation value
  • Asset values may have fallen below historical cost (outdated and misleading accounting numbers)
  • Specialized assets with no ready markets
  • Liquidation is not immediate -> takeover target
27
Q

Why do some firms’ PB ratios sharply exceed one?

A
  • Unrecorded assets
  • Balance sheets focus on historical cost and miss “intangible assets”
  • For example: managerial expertise and technological advantages ->high expected growth->investors value the assets at more than the assets acquisition cost
28
Q

What are advantages of the price-to-book ratio?

A
  • Summary measure focused on the balance sheet
29
Q

What are disadvantages of the price-to-book ratio?

A
  • Ignores differences in growth and risk
  • Ignores accounting differences
30
Q

Dividend Discount Model

A

P0=D1/1+re + D2/(1+re)^2 +… DT/(1+re)^T + PT/(1+re)^T

31
Q

The dividend discounting model with predicted steady-state growth

A
  • In steady state, earnings and book value grow at a constant rate
  • The firm’s dividend payout is a constant percentage of earnings
  • The firm’s return on equity is constant
32
Q

How realistic is the steady-state concept? Do firms experience long periods of above-normal growth?

A
  • Growth is theoretically limited by the size and growth of the firm’s market
  • Empirical evidence suggests that most firms only expeirence a few years of above-normal or below-normal growth
33
Q

Outstanding shares

A

the number of shares held by investors
Shares Issued - Treasury Stock = Outstanding Shares

34
Q

Authorized shares

A

The maximum number of shares the company can issue

35
Q

Par Value

A

Historical fiction

36
Q

Capital Surplus

A

APIC

37
Q

Reinvested earnings

A

Retained earnings

38
Q

Treasury stock

A

Stock bought back by the company from the shareholders

39
Q

What do you do to find dividends in the dividend discount model?

A

Include all payments to and from shareholders (Issuance of Common Stock, Purchases of Treasury Stock, Dividends)

40
Q

The dividend and earnings predictions are fundamentally different

A

Dividends: The board of directors could adopt whatever dividend policy they choose
Earnings: Economic performance achieved given its strengths and competitors’ actions

41
Q

Clean Surplus

A

The only changes in SHE are from earnings and payments to and from shareholders

42
Q

Dirty Surplus Items

A
  • Adoption of accounting standards
  • Other comprehensive loss
  • Foreign currency translation
  • Other activities
43
Q

Payments to/from shareholders

A

Dividends
+Treasury Stock
- Issuance of Stock
- Proceeds from Stock Options

44
Q

If the discount rate falls or the growth rate increases what happens to the PV of all future dividends?

A

It increases

45
Q

Market value only exceeds book value if…

A

Residual income is positive, or if ROE exceeds the cost of capital

46
Q

Market-to-book value only exceeds 1 if…

A

ROE exceeds the cost of capital

ACCT 647 (6 decks)

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