Académique Documents
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=
1
Present Value of
Free Cash Flow to Equity
FCFE = the expected free cash flow in period 1
k = the required rate of return on equity for the firm
g
FCFE
= the expected constant growth rate of free cash
flow to equity for the firm
FCFE
g k
FCFE
Value
=
1
Present Value of
Operating Free Cash Flow
Discount the firms operating free cash flow
to the firm (FCFF) at the firms weighted
average cost of capital (WACC) rather than
its cost of equity
FCFF = EBIT (1-Tax Rate)
+ Depreciation Expense - Capital Spending
- A in Working Capital - A in other assets
Present Value of
Operating Free Cash Flow
OFCF
FCFF
g WACC
FCF Oper
or
g WACC
FCFF
Value Firm
=
1
1
.
Present Value of
Operating Free Cash Flow
Where: FCFF
1
= the free cash flow in period 1
Oper. FCF
1
= the firms operating free cash flow in period 1
WACC = the firms weighted average cost of capital
g
FCFF
= the firms constant infinite growth rate of free cash flow
g
OFCF
= the constant infinite growth rate of operating free cash flow
OFCF
FCFF
g WACC
FCF Oper
or
g WACC
FCFF
Value Firm
=
1
1
.
An Alternate Measure of Growth
g = (RR)(ROIC)
where:
RR = the average retention rate
ROIC = EBIT (1-Tax Rate)/Total Capital
Calculation of WACC
WACC = W
E
k + W
d
i
Calculation of WACC
WACC = W
E
k + W
d
i
where:
W
E
= the proportion of equity in total capital
k = the after-tax cost of equity (from the SML)
W
D
= the proportion of debt in total capital
i = the after-tax cost of debt
Relative Valuation Ratio
Techniques
Price Earnings Ratio
g k
E D
E P
=
1 1
1
/
/
Estimating Company Earnings
Per Share
Function of
Sales forecast
Estimated profit margin
Walgreens Competitive Strategies
The Internal Performance
Industry Factors
Company Performance
Net Profit Margin Estimate
Computing Earnings per Share
Importance of Quarterly Estimates
Estimating Company Earnings
Multipliers
Macroanalysis of the Earnings Multiplier
Microanalysis of the Earnings Multiplier
Comparing Dividend-Payout Ratios
Estimating the Required Rate of Return
Estimating the Expected Growth Rate
Computing the Earnings Multiplier
Estimate of the Future Value for Walgreens
Additional Measures of Relative
Value
Price/Book Value Ratio
Price/Cash Flow Ratio
Price-to-Sales Ratio
Analysis of Growth Companies
Generating rates of return greater than the
firms cost of capital is considered to be
temporary
Earnings higher the required rate of return
are pure profits
How long can they earn these excess
profits?
Is the stock properly valued?
Analysis of Growth Companies
Growth companies and the DDM
constant growth model not appropriate
Alternative growth models
no growth firm
E = r x Assets = Dividends
( )
k
E b
k
E
V
= =
1
v
E
k =
Analysis of Growth Companies
Long-run growth models
assumes some earnings are reinvested
Simple growth model
s) Investment Growth of Value Present Gross (
2
k
bEm
k
bEmk
=
s) Investment Growth of Value Present Net (
k
bE
k
bEm
=
k
bE
k
bEm
k
E
v + =
( )
k
bEm
k
b E
v +
=
1
Simple Growth Model (cont.)
(Present value of Constant Dividend plus
the Present Value of Growth Investment)
k
bE
k
bEm
k
E
v + =
( )
k
bEm
k
b E
v +
=
1
k
bEm
k
D
v + =
( )
k
m bE
k
E
v
1
+ =
(Present value of Constant Earnings plus
the Present Value of Excess Earnings
from Growth Investment)
Expansion Model
Firm retains earnings to reinvest, but
receives a rate of return on its investment
equal to its cost of capital
m = 1 so r = k
k
E
V =
( )
k
E
k
bE
k
b E
= +
=
1
Negative Growth Model
Firm retains earnings, but reinvestment
returns are below the firms cost of capital
Since growth will be positive, but slower
than it should be, the value will decline
when the investors discount the
reinvestment stream at the cost of capital
The Capital Gain Component
bEm/k
b Percentage of earnings retained for reinvestment
m relates the firms rate of return on investments and
the firms required rate of return (cost of capital)
1 = cost of capital
>1 is a true growth company
Time period for superior investments
Dynamic True Growth Model
Firm invests a constant percentage of
current earnings in projects that generate
rates of return above the firms required rate
of return
g k
D
V
=
1
Measures of Value-Added
Economic Value-Added (EVA)
Compare net operating profit less adjusted taxes
(NOPLAT) to the firms total cost of capital in
dollar terms, including the cost of equity
EVA return on capital
EVA/Capital
Alternative measure of EVA
Compare return on capital to cost of capital
Measures of Value-Added
Market Value-Added (MVA)
Measure of external performance
How the market has evaluated the firms
performance in terms of market value of debt
and market value of equity compared to the
capital invested in the firm
Relationships between EVA and MVA
mixed results
Measures of Value-Added
The Franchise Factor
Breaks P/E into two components
P/E based on ongoing business (base P/E)
Franchise P/E the market assigns to the expected value of
new and profitable business opportunities
Franchise P/E = Observed P/E - Base P/E
Incremental Franchise P/E = Franchise Factor X Growth Factor
G
rk
k R
=
Growth Duration Model
Evaluate the high P/E ratio by relating P/E
ratio to the firms rate and duration of
growth
P/E is function of
expected rate of growth of earnings per share
stocks required rate of return
firms dividend-payout ratio
Growth Duration
E(t) = E (0) (1+G)
t
N(t) = N(0)(1+D)
t
E(t) = E(t) N(t) = E (0) [(1+G)
t
(1+D)]
t
t
D) G (1 (0) E E(t) + +
'
~
( )
|
|
.
|
\
|
+ +
+ +
~
|
|
.
|
\
|
T
a a a
T
g g g
d
g
) D G (1 (0) E
) D G (1 (0) E
0 P
(0) P
Growth Duration
( )
|
|
.
|
\
|
+ +
+ +
~
|
|
.
|
\
|
T
a a a
T
g g g
d
g
) D G (1 (0) E
) D G (1 (0) E
0 P
(0) P
( )
|
|
.
|
\
|
+ +
+ +
~
|
|
.
|
\
|
T
a a
T
g g
a d
g g
) D G (1
) D G (1
(0) E / 0 P
(0) (0)/E P
( )
|
|
.
|
\
|
+ +
+ +
~
|
|
.
|
\
|
) D G (1
) D G (1
ln
(0) E / 0 P
(0) (0)/E P
ln
a a
g g
a d
g g
T
Intra-Industry Analysis
Directly compare two firms in the same industry
An alternative use of T to determine a reasonable
P/E ratio
Factors to consider
A major difference in the risk involved
Inaccurate growth estimates
Stock with a low P/E relative to its growth rate
is undervalued
Stock with high P/E and a low growth rate is
overvalued
Site Visits and the
Art of the Interview
Focus on managements plans, strategies, and
concerns
Restrictions on nonpublic information
What if questions can help gauge sensitivity
of revenues, costs, and earnings
Management may indicate appropriateness of
earnings estimates
Discuss the industrys major issues
Review the planning process
Talk to more than just the top managers
When to Sell
Holding a stock too long may lead to lower returns than
expected
If stocks decline right after purchase, is that a further
buying opportunity or an indication of incorrect
analysis?
Continuously monitor key assumptions
Evaluate closely when market value approaches
estimated intrinsic value
Know why you bought it and watch for that to change
Influences on Analysts
Efficient Markets
Paralysis of Analysis
Analyst Conflicts of Interest
Efficient Markets
Opportunities are mostly among less well-known
companies
To outperform the market you must find
disparities between stock values and market
prices - and you must be correct
Concentrate on identifying what is wrong with
the market consensus and what earning surprises
may exist
Analyst Conflicts of Interest
Investment bankers may push for favorable
evaluations
Corporate officers may try to convince
analysts
Analyst must maintain independence and
have confidence in his or her analysis
Global Company and Stock
Analysis
Factors to Consider:
Availability of Data
Differential Accounting Conventions
Currency Differences (Exchange Rate
Risk)
Political (Country) Risk
Transaction Costs
Valuation Differences
The Internet
Investments Online
http://www.better-investing.com
http://www.fool.com
http://www.cfonews.com
http://www.zacks.com
http://www.valueline.com
http://iaschicago.org
http://moneycentral.msn.com/investor/home.asp
End of Chapter 14
Company Analysis and
Stock Selection
Future topics
Chapter 15
Technical Analysis
Assumptions and Advantage
Technical Trading Rules and
Indicators
Techniques and Charts