Equity Valuation

How attractive is the industry ?

• Porter 5 forces

• Pestel

What is the company position in the industry (Business model) ?

• Cost Leadership

• Differentiation

• Focus

How well was the strategy executed ?

How the financials reflect the strategy

How to analyse the cost structure

Profit Margin

High proportion of accrual in earnings

Low quality earning

Research Format report

• Table of content

• Executive summary

• Business summary

• Risks

• Valuation

• Historical & ProForma table

When to apply a DDM

• The company pays dividends

• There is a dividend policy

• The investor takes a no control perspective

When to Use Free Cash Flow models

• No/Unstable dividends

• Easy to forecast

• The investor takes a control perspective

Present Value of Growth opportunity in DDM

Vo = E1/R + PVGO or P/E = 1/r + PVGO/E1

Forward P/E

P/E = Payout ratio / (r-g)

H model DDM

Vo = (D0(1+g1) + DoH(g0-G1)) / (r-Gg1)

growth rate of dividends

g = Retention ratio x ROE

Free Cash Flow To Firm general formula

FCFF = NI + NCC + Int(1-t) - CAPEX - Change in WC

Free Cash Flow to firm from CF Statement

CFO + Int (1-t) - CAPEX

From FCFF to FCFE

FCFE = FCFF - Int(1-t) + net borrowing

FCFF from EBIT

EBIT(1-t) + D&A - Change in WC - CAPEX

FCFF from EBITDA

EBITDA(1-t) + D&A(t) - change in NWC - CAPEX

What to do in Non operating assets

Do FCFF calculation on operating and add back non operating asset at market value

Normalised EPS

EPS adjusted for cyclicality

2 methods for normalised EPS

• Historical average over full cycle

• average ROE x BVPS

Earning Yield

E/P

Prdicted PE factors

• Growth rate in earning

• payout ratio

• standard deviation of earning

PEG

P/E / Growth rate of earning

Own Historical P/E

Justified price = (Benchmark Value of historical P/E) x Most recent EPS

Tangible BVPS

Shareholder Equity - intangible

Justified Forward P/E

Payout Ratio /r-g

Justified Trailing P/E

Payout ratio x (1+g) / (r-g)

Justified P/B Ratio

1+ (ROE - r) / r-g

Justified P/S Based on forecast

Po/S1 = (E1/S1)*Payout ratio / (r-g)

Justified Trailing P/S ratio

Po/So = (Eo/So) x payout ration x (1+g)/r-g

growth rate in P/S ratio

g = retention rate x Dupont decomposition

Scaled earning surprised

EPS surprise/ SD(EPS surpise)

how to average multiple

Use the harmonic mean

Residual income

Residual remaining income after deduction of cost of capital

2 approaches for residual income

• Nopat - Capital Charge

• Net income - Equity charge

Economic Value Added Formula

NOPAT x (C% x TC)

NOPAT adjustment in EVA Calculation

• R&D is added back to earning

• Charge for capital can be suspended

• deferred tax are eliminated

• LIFO reserve is added back to capital

• Operating lease are treted as capital lease

Market Value Added

Market Value - Book Value

Residual income model

Book Value + Discounted residual income

RIM Formula

Bo + Somme(Et -rBt-1)/(1+r)^t

Excess earning method

Bo + Somme(( ROEt - r) Bt-1)/ (1+r)^t

Single stage dividend model for residual income

Vo = Bo + (ROE- r)/(r-g) x Bo

Tobin s q

Market Value of debt and equity / Replacement cost of asset

Multistage residual income valuation

Residual income with fading persistence

When to use a RMI model

• A company do not pay dividends

• FCF are negtive

• Uncertainty around the terminal value

3 important topics in private valuation

• Normalised earnings

• Discount rate

• Valuation Discount/Premium

expanded CAPM

An adaptation of the CAPM that adds to the CAPM a premium for small size and company-specific risk.

Discount for lack of control

1 - (1/1+control premium)

Discount for lack of marketability

• At the money put option premium as a % of the stock

Total discount for DLOC ant DLOM

(1 - (1-DLOC) x (1- DLOM))

Re investment rate

g / WACC

Firm Value for private company from NOPAT

EBIT (1-t) (1-RIR) / (WACC - g)

Excess earning method for private company

DDM but D= Normalised income - WC x cost WX - Fixed asset x cost of fic=xed assets

Unlevering Beta

Bu = Bl / (1 + (1-t) x D/E)