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SIA EDUCATIONAL SERIES
Spring 2017 Part 1: Fall Semester Review
February 1, 2017
MSU Student Investment Association
OVERVIEW
All critical information is reported by the
company in their annual report
• 10-Q and 10-K: set of interconnected reports
released quarterly and annually by public
companies
• Reflect the financial health and performance of
the organization
• Provides data to shareholders to assist them in
making informed decisions
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SELECTED FINANCIAL DATA
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Provides consolidated summary of financial data
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Net sales
Net income
Earnings per share
Dividends per share
Shares outstanding
Assets
Equity
Recall: how many years of data is presented here?
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MANAGEMENT’S DISCUSSION & ANALYSIS
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One of the most important sections
10 – 20 pages of critical data and analysis
Read every word
Management’s opinion of financial health and strategy
going forward
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Explanation for recent performance
Important financial evaluation metrics
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INCOME STATEMENT
Presents operational results over a period of time. Always pull
most recently reported data.
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Revenue
Expenses
Profit
Key concept: Revenue – Expenses = Profit
Recall: what line-items might depreciation be baked into?
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BALANCE SHEET
Details a company’s financial position at a specific point in time
(“snapshot”).
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Assets
Liabilities (debt)
Equity
Key concept: Assets = Liabilities + Equity
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CASH FLOW STATEMENT
Reconciles the inflows and outflows of cash over a period of
time.
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Operating Cash Flow
Investing Cash Flow
Financing Cash Flow
Key concept: Net income ≠ cash flow
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CONNECTING THE STATEMENTS
FREE CASH FLOW
How much cash does this company’s core business generate on
a recurring, predictable basis?
This is the cash flow available to the shareholders of a
company. 2 kinds of FCF, unlevered and levered.
Unlevered FCF = EBIT – Taxes + D&A – CapEx – ΔNWC
Concepts: Unlevered FCF can be used to pay down debt.
Levered FCF is only available to equity investors.
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COMPETITOR ANALYSIS
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What industry does the company operate in?
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Does the company have multiple operating units?
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Comparable metrics
• Gross margin
• Sales / EBITDA growth
• Price / sales, Price / Book, EV / EBITDA
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Critical part of fundamental value analysis
• Often overlooked in SIA stock pitches
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CONGLOMERATE STUDY
Firm vs. Unit Metrics
• Does it make sense to compare
GE to an infrastructure company?
• We must look at individual
operating segments to see how
competitive a company is
• Look in 10K, management
presentation, sell-side reports to
see individual evaluations
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BETA
Measure of volatility, or systematic risk, of a
security in comparison to the whole market
• Alternatively, how much a stock will rise or fall,
on average, when the overall market moves xx%
• Defensive stocks β < 1
• Cyclical stocks β > 1
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MSU Student Investment Association
CAPITAL ASSET PRICING MODEL (CAPM)
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Describes systematic risk and expected return for assets
CAPM relates to a company’s equity (stock) valuation
Expected return will be used to discount levered FCF
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WEIGHTED AVERAGE COST OF CAPITAL
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Weighted average of cost of equity and cost of
debt
WACC = (% equity) * (cost of equity) +
(% debt) * (cost of debt) * (1-T)
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Use this to discount unlevered FCF
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PRESENT VALUE
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Money today is worth more than the same
amount of money in a year… why?
PV = FV / (1+R)^T
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What is R?
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MULTIPLES METHOD
Assumes a sale at the end of the forecast period
Assign a multiple to the terminal year data
Multiple should be chosen based on public comps
• Again, comps analysis is critical…
• Historical averages for specific company
• Common valuation multiples:
• Price-to-earnings
• EV/EBITDA (low CapEx)
• EV/EBIT (high CapEx)
• If we use EBITDA multiple, what FCF should we use?
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GORDON GROWTH METHOD
The perpetuity growth method assumes that the TV will
grow indefinitely
• What is an appropriate number? Above 3%?
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TV = terminal year FCF * (1 + G) / (R – G)
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Professionals primarily use P/E and EV/EBITDA:
• Current EBITDA and FCF data is better
• Uneven CapEx spending among comps
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EQUITY VALUE
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Earnings = $20
P/E multiple = 10x
Market capitalization (equity value) = $200
Shares outstanding = 50
Share price = firm’s market cap / shares outstanding
• Share price = $200 / 50 = $4 per share
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ENTERPRISE VALUE
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Enterprise Value: measure of firm’s entire value
We’re equity investors
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EQUITY VALUE FROM ENTERPRISE VALUE
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EBITDA = $20
EV/EBITDA multiple = 5x
Enterprise value = $100
(-) market value of net debt: $10 (15 debt, 5 cash)
(-) minority interest, preferred shares: $10
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Equity value = $80
Shares outstanding = 20
Share price = $4
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REVENUE FORECASTING
Check MDA and notes to the statements, as well as sellside research reports (via Thomson Reuters)
• Management will breakdown by segment, product,
division, geography
• Will cover this topic extensively next week when we
walk through a DCF model
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MSU Student Investment Association
INCOME STATEMENT FORECASTING
Can be taken as a simple growth rate
– 100*(1+G)
• Bottoms up approach
– X amount of units and Y price
– X*Y=Revenue
• Other line items as % of revenue
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BALANCE SHEET FORECASTING
Often taken as historical % from revenue
• Allocate capital where it is needed
• More sales increase need for capacity and
inventory
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REVIEW QUESTIONS
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What is the cash flow effect of an increase in
current liabilities?
If you could only analyze 1 statement, which
one would you choose? If you could choose 2?
What are FCF and why do investors care?
What discount rate does CAPM give us?
What is WACC?
Derive equity value from enterprise value?
MSU Student Investment Association