Equity

Intrinsic Value

the underlying value of the security given complete understanding (IV)

Estimated Value

investor’s estimated intrinsic value (VE)

Going Concern Value

typically the relevant intrinsic value for publicly traded companies; assumes assets remain in place and continue to produce cash flow into the future via continuing operations

Liquidation Value

the value if firm ceases to operate; all assets are sold, liabilities are paid off and firm is dissolved

Orderly Liquidation Value

assumes adequate time to realize liquidation value

Fair Market Value

price at which an arm’s length transaction between a willing and informed buyer & willing and informed seller; usually market price = FMV

Investment Value

value to a specific buyer, including the value of perceived synergies; useful for valuation in acquistions

Porter’s Elements of Competitive Strategy

• Cost Leadership - lowest cost producer

• Differentiation - unique products or services

• Focus - target segments of industry using either of the above

Absolute Valuation Models

intrinsic value based on fundamental characteristics → EPS, asset turnover, leverage, ROE

Ex: DDM, FCF, Residual income

Relative Valuation Models

value derived from relative comparison to similar assets, based on law of one price

Ex: P/E, P/B, P/CF, P/S models

Sum of Parts Valuation

value each division separately and add the component values to obtain whole company value

Conglomerate Discount (CD)

Sum of parts value - market price

Market is valuing the company at a value less than the value of its parts

Free cash Flow to Firm (FCFF)

cash flow distributable to all providers of capital (dept & equity); useful for majority owner

Free Cash Flow to Equity (FCFE)

cash flow distributable to equity holders; useful for majority owner

Residual Income

earnings in excess of the investor’s required return on the beginning of period investment

focuses on probability in relation to all opportunity costs faced by the firm

think economic profit

Two-Stage DDM

appropriate for minority interest; useful when growth rate is expected to drop suddenly:

• patent expiration

• firm enters mature phase of life cycle after a rapid growth stage

Net Cash Charges

Depreciation/ Amortization, Impairment / Write-Down, Gains (losses) on asset sale, Early Debt Retirement, Provision for Restructuring Expense, Deferred Tax Liability, Amortization of Bond Discount

Net Fixed Capital Investment (FCInv)

CapEx- proceeds from sales of long-term assets

or

Change in Carrying value [opening net PPE - closing net PPE] + dep expense - gain on disposal

Working Capital Investment (WCInv)

change in operating current assets - operating current liabilities

Excludes: cash, short-term interest bearing debt, dividends payable, current portion of long-term debt

Terminal Value

forecasted value at beginning of normal growth phase

added to the last period cash flow and then discounted along with prior period dividends / FCFs

Method of Comparables

involves using a price multiple to evaluate whether an asset is relatively fairly valued, relatively undervalued, or relatively overvalued in relation to benchmark

most widely used method by analysts, economic rationale is law of one price

Method of Forecasted Fundamentals

relates multiples to company fundamentals - growth, risk and payout

based on discounted cash flow model

Justified Price Multiple

what the price multiple should be if the price is fairly valued

Fed Model

used for broad-based market indexes (not individual stocks)

if E/P of the index > 10 yr Treasury; undervalued

Yardeni Model

used for broad-based market indexes (not individual stocks)

P/E = 1 / (CBY - k x LTEG)

where:

CBY = Moody’s A-rated corporate bond yield

LTEG = five-yr consensus earnings growth rate

k = constant assigned by the market to earnings growth

PEG Ratio

stock’s P/E dividend by the expected long-term earnings growth rate (g)

Terminal Value

value projected at end of estimation horizon

EV / EBITDA Ratio

provides an indication of company / firm value, not equity value

< benchmark = undervalued ; > benchmark = undervalued

Standardized Unexpected Earnings

Earnings Suprise / Std Dev. of earnings suprise

Weighted Harmonic Mean

effect of outliers depends on market value weight; reduces impact of large outliers, corresponding to portfolio value

Residual income

Net income - opportunity cost of equity capital; economic profit

• evaluates managerial effectiveness

• executive compensation

• equity valuation

Economic Value Added (EVA)

alternative RI measure; measures value added to shareholders by management

Market Value Added (MVA)

alternative RI measure; measures the effect on value of management’s decisions since teh firm’s inception

Continuing Residual Income

expected RI beyond the estimation horizon

usually fades toward industry mean; based on trends in industry ROE

Measured by persistence

Clean Surplus Relation

ending book value of a company's equity equals its beginning book value plus net income minus dividends; weakness of residual income model is that is assumes this holds

Discount for Lack of Control (DLOC)

estimate using reported earnings instead of normalized earnings

added for minority interest

control premium is for majority interest valuation

Discount for Lack of Marketability

assumes lower liquidity, lowering value of stock

Estimate by:

• restricted vs. publicly traded shares

• Pre-IPO vs. post- IPO prices

• ATM put prices of comparable companies