FIN 360 3/26

Companies experience different growth rates throughout their lifecycle:
- Early Stage: Higher growth rates, sometimes exceeding market capitalization rate.
- Later Stage: Growth rate slows down and tends to stabilize at a constant rate.
The Multistage Growth Model is used to calculate the present value considering these variations.

Intrinsic Value of a Firm: Calculated by forecasting cash flows across different stages, finding present values for each stage, and summing them.
Example Details:
- An old firm introduces a new product with projected growth rates:
- Years 1-2: 12% growth per year
- Years 3-4: 8% growth per year
- Year 5 onwards: 5% constant growth rate
- Current dividend: $2.25, with a discount rate of 15%
Calculating Dividends for Initial Years:
- Year 1: $2.25 imes 1.12 = 2.52$
- Year 2: $2.52 imes 1.12 = 2.82$
- Year 3: $2.82 imes 1.08 = 3.05$
- Year 4: $3.05 imes 1.08 = 3.29$
- Year 5: $3.29 imes 1.05 = 3.46$
Terminal Value Calculation:
- The present value of cash flows from Year 5 onwards summarized at Year 4 using Gordon Growth Model:
- Formula: $PV = \frac{D_1}{r - g}$
- Growth rate: 5%, Discount rate: 15%, yields terminal value at Year 4.
Intrinsic Value Today Calculation:
- Total intrinsic value is the sum of the present value of dividends over the next four years plus the terminal value.
- Result: $27.98$

Considerations when estimating the value of non-dividend stocks:
- Other cash flow sources like share buybacks (recent trends highlighted).
- Takeovers and mergers impact equity valuation.
- Use Discounted Cash Flow (DCF) analysis to calculate enterprise value:
- $Enterprise ext{ } Value = Present Value ext{ } of ext{ } Cash ext{ } Flows$
- Market value of equity: $Enterprise ext{ } Value - ext{ Outstanding Debt } + ext{ Cash Holdings}$
Emphasize importance in verifying assumptions and skepticism toward analyst estimates.

Morgan Stanley error in analyzing Snap at IPO:
- Initial target price of $28$ per share based on cash flow estimates.
- Subsequent reports revised cash flow estimates down by nearly $2,000,000,000$ without adjusting the target price.
- Reduced discount rate from 10% to 8% to maintain target price, raising suspicions.
- Analysts tend to adjust inputs to maintain valuations, warranting skepticism about their recommendations.

Valuation of 'unicorns' (private companies with valuations over $1 billion$ ):
- Examples include Uber ($100 billion$) and WeWork ($47 billion$) at peak valuations.
- Necessity of increasing sales/profit margins unrealistically for justifying high valuations.
- The case of Uber vs. WeWork highlights the volatility and risks in these evaluations.

Use of relative valuation for assessing over/undervalued stocks using multiples:
- Example: Pfizer with an industry P/E ratio of 20:
- EPS: $2, implies valuation of $40$ per share.
- Current trading at $35$ signals undervaluation.
P/E Ratio Insights:
- Reflects relation between earnings growth expectations, debt costs, and investment returns:
- No-growth firm P/E: $\frac{1}{k}$ .
Different industry P/E ratios indicate varying market conditions and expected growth:
- Example data: Tobacco average P/E: 7.8, Business Software: 47.6
Other Multiples Considered: Price to Book, Price to Cash Flow, Price to Sales when applicable.

Different valuation methods (Intrinsic, Relative) are essential for assessing equity.
Intrinsic Value: Present value of expected future cash flows; must consider various cash flow sources.
Market value often diverges from intrinsic value, potentially presenting trading opportunities for investors.
Importance of due diligence and noted analyst habits in valuation skepticism stressed throughout.