* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download For a terminal investment
Survey
Document related concepts
Short (finance) wikipedia , lookup
Internal rate of return wikipedia , lookup
Early history of private equity wikipedia , lookup
Private equity in the 1980s wikipedia , lookup
Systemic risk wikipedia , lookup
Environmental, social and corporate governance wikipedia , lookup
Investment fund wikipedia , lookup
Technical analysis wikipedia , lookup
Derivative (finance) wikipedia , lookup
Stock trader wikipedia , lookup
Financial crisis wikipedia , lookup
Leveraged buyout wikipedia , lookup
Transcript
Chapter 3 How Financial Statements are Used in Valuation How Financial Statements are Used in Valuation Link to Previous Chapter Chapter 1 introduced fundamental analysis and Chapter 2 introduced the financial statements. This Chapter This chapter shows how fundamental analysis and valuation are carried out and how the financial statements are utilized in the process. It lays out a five-step approach to fundamental analysis and forecasting of financial statements. Simpler schemes involving financial statements are also presented. Link to Next Chapter Chapter 4 will begin the implementation of the analysis outlined in this chapter with valuation based on forecasting cash flow statements Link to Web Page The web page offers further treatment of comparable analysis and screening analysis, as well as an extended discussion of valuation techniques and asset pricing. It also links you to fundamental research engines. What is the methods of comparables? How are fundamental screens used in investing? How is fundamental analysis carried out? How does fundamental analysis utilize the financial statements? How is a valuation model constructed? What you will learn from this Chapter • • • • • • • • • • • • • • • • What a valuation technology looks like What a valuation model is and how it differs from an asset pricing model How a valuation model provides the architecture for fundamental analysis The practical steps involved in fundamental analysis How the financial statements are involved in fundamental analysis How one converts a forecast to a valuation The difference between valuing terminal investments and going concern investments (like business firms) What business activities generate value The dividend irrelevance concept Why financing transactions do not generate value, except in particular circumstances Why the focus of value creation is on the investing and operating activities of a firm How the method of comparables works (or does not work) How asset-based valuation works (or does not work) How multiple screening strategies work (or do not work) What is involved in contrarian investing How fundamental analysis differs from screening Simple (and Cheap) Approaches to Valuation Fundamental analysis is detailed and costly. Simple approaches avoid forecasting and minimize information analysis. But they lose precision. Simple methods: • Method of Comparables • Screening on Multiples • Asset-Based Valuation The Method of Comparables: “Comps” 1. Identify comparable firms that have similar operations to the firm whose value is in question (the “target”). 2. Identify measures for the comparable firms in their financial statements – earnings, book value, sales, cash flow – and calculate multiples of those measures at which the firms trade. 3. Apply these multiples to the corresponding measures for the target to get that firm’s value. The Method of Comparables: Dell, Gateway and Hewlett Packard, 2002 ________________________________________________________________________ Sales Earnings Book Value Market Value P/S P/E P/B $45,226 $624 $13,953 $32,963 0.73 52.8 2.4 Gateway 2000 Inc. 6,080 (1290) 1,565 1,944 0.32 - 1.2 Dell Computer Corp. 31,168 1,246 4,694 ? ? ? ? Hewlett-Packard Co. ________________________________________________________________________ _______________________________________________________________________ _ Average Multiple for Comparables Dell's Number Dell's Valuation Sales 0.53 $31,168 $16,519 Earnings 52.8 1,246 65,789 Book Value 1.8 4,694 8,449 Average of Valuations 30,252 _______________________________________________________________________ _ How cheap is this Method? • Conceptual problems: – Circular reasoning: Price is ascertained from price (of the comps) – Violates the tenet: “When calculating value to challenge price, don’t let price enter the calculation” – If the market is efficient for the comparable companies....Why is it not for the target company ? • Implementation problems: – Finding the comparables that match precisely – Different accounting methods for comps and target – Different prices from different multiples – What about negative denominators? • Applications: – IPOs; firms that are not traded (to approximate price, not value) Unlevered (or Enterprise) Multiples (that are Unaffected by the Financing of Operations) Unlevered Price/Sale s Ratio Unlevered Price/ebit Market Value of Equity Net Debt ebit Unlevered Price/ebit da Enterprise P B Market Value of Equity Net Debt Sales Market Value of Equity Net Debt ebitda Market Value of Equity Net Debt Book Value of Equity Net Debt Variations of the P/E Ratio Trailing P/E Rolling P/E Price per share Last annual Eps Price per share Sum of Eps for most recent four quarters Forward P/E Price per share Forecast of next year' s Eps Dividend–Adjusted P/E Dividend - Adjusted P/E Price per share Annual Dps Eps Rationale : Dividend affects prices but not earnings Typical Values for Common Multiples Multiple Enterprise Trailing Forward Unlevered Unlevered Unlevered P/B P/E P/E P/S P/S P/CFO P/ebitda P/ebit Percentile P/B 95 7.9 12.7 75 50 25 5 2.9 1.7 1.0 0.5 2.7 1.5 1.0 0.6 Negative earnings 23.5 15.2 10.3 5.9 49.2 8.9 8.1 19.1 13.1 9.2 5.6 1.7 0.8 0.3 0.1 2.0 0.9 0.5 0.2 Negative cash flow 18.8 9.9 5.6 2.3 30.1 10.6 7.0 4.8 2.5 Negative ebit 15.3 9.9 6.6 3.3 Screening Analysis • Technical screens: identify positions based on trading indicators. - Price screens Small stock screens Neglected stocks screens Seasonal screens Momentum screens Insider trading screens • Fundamental screens: identify positions based on fundamental indicators of the firm’s operations relative to price - Price/Earnings (P/E) ratios Market/Book Value (P/B) ratios Price/Cash Flow (P/C) ratios Price/Dividend (P/d) ratios • Any combination of these methods is possible How Multiple Screening Works 1. Identify a multiple on which to screen stocks. 2. Rank stocks on that multiple, from highest to lowest. 3. Buy stocks with the lowest multiples and (short) sell stocks with the highest multiples. Fundamental Screening: Return to Price-to-Book Mean Price/Book Monthly Group Return (%) 1 (High) 0.49 2 0.87 3 0.97 4 1.04 5 1.17 6 1.30 7 1.44 8 1.50 9 1.59 10 (Low) 1.88 Mean Beta 1.35 1.32 1.30 1.28 1.27 1.27 1.27 1.27 1.29 1.34 Average Monthly Returns and Estimated Betas from July 1963 to December 1990 for Ten Price/Book Groups. Returns to two fundamental screens Year by Year Returns: Value minus Glamour Problems with Screening • You could be loading up on a risk factor – You need a risk model • You are in danger of trading with someone who knows more than you – You need a model that anticipates future payoffs A full-blown fundamental analysis supplies this Asset Based Valuation • Values the firm’s assets and then subtracts the value of debt: V0E V0F V0D • The balance sheet does this calculation, but imperfectly: – Shareholders’ Equity = Total Assets -Total Liabilities • Problems with this approach: – Getting the value of operating assets when there is not a market for them – Identifying value in use for a particular firm – Getting the value of intangible assets (brand names, R&D) – Getting the value of “synergies” of assets being used together • Applications: – “Asset-base” firms such as oil and gas and mineral products – Calculating liquidation values The Process of Fundamental Analysis 1 Knowing the Business · The Products · The Knowledge Base · The Competition · The Regulatory Constraints Strategy 2 Analyzing Information · In Financial Statements · Outside of Financial Statements Forecasting Payoffs · Measuring Value Added · Forecasting Value Added 3 Convert Forecasts to a Valuation 4 Trading on the Valuation 5 Outside Investor Compare Value with Price to BUY, SELL or HOLD Inside Investor Compare Value with Cost to ACCEPT or REJECT Strategy Figure 1.2 The Process of Fundamental Analysis How Financial Statements are Used in Fundamental Analysis The analyst forecasts future financial statements and converts forecasts in the future financial statements to a valuation. Current financial statements are used to extract information for forecasting. Current Financial Statements Financial Statements Year 1 Financial Statements Year 2 Forecasts Financial Statements Year 3 Other Information Valuation of Equity Convert forecasts to a valuation The Architecture of Fundamental Analysis: The Valuation Model Role of a valuation model: 1. Directs what is to be forecasted (Step 3) 2. Directs how to convert a forecast to a valuation (Step 4) 3. Points to information for forecasting (Step 2) From an Equity Research Report on Electrolux Analysts forecast a variety of attributes. Which one should be used for valuation? Payoffs to Investing: Terminal Investments and Going-Concern Investments The first investment is for a terminal investment; the second is for a goingconcern investment in a stock. The investments are made at time zero and held for T periods when they terminate or are liquidated. For a terminal investment I0 Initial investment Investment horizon: T 1 2 3 CF1 CF2 CF3 T-1 T 0 CFT-1 CFT Terminal cash flow Cash flows Io For a going concern investment in equity P0 Initial price 1 2 3 T-1 d1 d2 d3 dT-1 T Investment horizon When stock is sold 0 Dividends For terminal investment, I 0 = amount invested at time zero CF = cash flows received from the investment For investment in equity, P0 = price paid for the share at time zero d = dividend received while holding the stock PT= price received from selling the share at time T. PT +dT Selling price at T + Dividend (if sold at T) Two Terminal Investments: A Bond and a Project A Bond: Periodic cash coupon 100 100 100 100 Cash at redemption Purchase price Time, t 100 1000 (1080) 0 1 2 3 4 5 430 460 460 380 250 A Project: Periodic flow Salvage value Initial investment Time, t 120 (1200) 0 1 2 3 4 5 The Valuation Model: Bonds V0D CF1 CF2 CF3 CF T 2 3 T rD rD rD rD T r Dt CF t t 1 rD is (one plus) the required return on the debt Required return: 8% Year Coupon Redemp. Discount Present Value 1 100 0 0.926 92.59 2 100 0 0.857 85.73 3 100 0 0.794 79.38 4 100 0 0.735 73.50 5 100 1000 0.681 748.64 V0D = 1079.85 Valuation issue: Discount rate rD The Valuation Model: A Project CF1 CF 2 CF3 CF T V 2 3 T rp rp rp rp p 0 T r p t CF t t 1 ρp is the required return (hurdle rate) for the project) Required return: 12% Year Cash Flow Discount Present Value 1 430 0.893 383.93 2 460 0.797 366.71 3 460 0.712 327.41 4 380 0.636 241.50 5 370 0.567 209.95 V0p = 1529.49 Valuation issues: Forecasting cash flows Discount rate Value Creation: V0 > I0 • The Bond (no value created): V0 I0 NPV = = = 1,079.85 1,079.85 0.00 • The Project (value created): V0 I0 NPV = = = 1,529.50 1,200.00 329.50 Valuation Models: Going Concerns A Firm 0 1 2 3 4 5 CF 1 CF2 CF3 CF4 CF5 1 2 3 4 5 T d1 d2 d3 d4 d5 dT TV Equity 0 Dividend Flow T The terminal value, TVT is the price payoff, PT when the share is sold Valuation issues : The forecast target: dividends, cash flow, earnings? The time horizon: T = 5, 10, ? The terminal value The discount rate Criteria for Practical Valuation To be practical, we require: 1. Finite horizon forecasting – Forecasting over infinite horizons is impractical 2. Validation – Whatever we forecast must be observable ex post 3. Parsimony – Information gathering & analysis should be straightforward – The fewer pieces of information, the better The Question for Forecasting: What Creates Value in a Firm Equity Financing Activities ? – Share Issues ? – Share Repurchases ? – Dividends ? Debt Financing Activities ? Investing and Operating Activities? – Distinguish anticipated (exante) value in investing activities from realized (expost) value in operations Value is created in product and factor markets