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Published by abhijeet1828

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Published by: abhijeet1828 on Feb 03, 2010
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1. Which industry have greater ROE & why?
ROE (Return on equity)
It measures a firm’s efficiency at generating profits from every unit of shareholdersequity .Of all the fundamental ratios that investor look at, one of the most important isreturn on equity, and it’s a basic test of how effectively co. management uses investor’smoney.It is a measure of a corporation’s profitability that reveals how much profit a co.generates with the money shareholders have investedCalculated as,
ROE= Net IncomeShareholder Equity
Also known as “Return on net worth (RONW)”.ROE is useful for compairing the profitability of a company to that of other firms in thesame industry.What is more important than a greater singular ROE is consistency in past are far morelikely to do so in the future.
Consulting firm:
Some industries have high ROE because they require no assets,such as consulting firm
Manufacturing Industries:
Some industries require large infrastructure builds before they generate penny of profit such as oil refiners.
Construction industry:
Such industry requires are capital intensive industries, sothey will have low ROE.
less capital intensive assets & liabilities so high ROE
Technology Co.
:This companies with low debts often post high ROE numbersdue to high profit margins, not high debt levels
Service sector Co.
: Have high ROESo we cannot conclude that consulting firm are better investments than refiners just because of their ROE.
Generally capital intensive businesses have low ROE
Firm with small asset base have high ROE
High ROE levels may be due to a short term factors such as;
Restructuring charges & assets sales that lower equity & increase ROE
Stock buybacks that lower equity & increases ROE
One time gain that increase earnings & ROE
A strong economy or peak in the business cycle.Because it is much more difficult to maintain high ROE levels for the long term, it isalso important to consider ROE over long periods of time.
Drawback of ROE:
As mentioned earlier, a company that takes high levels of debt will show up a highROE. As such ‘Return on invested capital (ROIC)’ & not ROE will be a goodindicator of testing the co.s efficiency levels.How, for understanding the value of co.swith nil or marginal amts of debt. ROE is of great help
2. kind of co. which would generate cash flows at an early part of theirlives?Discounted cash flow:
In finance, the
discounted cash flow
(or DCF) approach describes a method of valuing a project, company, or asset using the concepts of the time value of money.All future cash flows are estimated and discounted to give their present values. Thediscount rate used is generally the appropriate WACC, which reflects the risk of thecash flows. The discount rate reflects two things:1. The time value of money (risk rate) - investors would rather have cash immediatelythan having to wait and must therefore be compensated by paying for the delay.2. a risk premium (risk premium rate) - reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might notmaterialize after all.Discounted cash flow analysis is widely used in investment finance, real estatedevelopment, and corporate financial management.To discount cash flow, the objective is to find the value of assets, given their cashflow growth and risk characteristic.In relative valuation the objective is to value assets based on how similar assets arecurrently priced in the market.
To do relative valuation correctively, we need to understand the fundamentals of discounted cash flows valuation.Discounted cash flow valuation has its foundation in the present value, where the valueof any assets is the present value of expected future cash flows on it.A valuation method used to estimate the attractiveness of an investment opportunity.Discounted cash flow (DCF) analysis uses future free cash flow projections anddiscounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the valuearrived at through DCF analysis is higher than the current cost of the investment, theopportunity may be a good one.Formula to calculate DCF:Where multiple cash flows in multiple time periods are discounted, it is necessary tosum them as follows:for each future cash flow (
)Where, N=life of an assetsCF= Cash flow in period tR=Discount rate reflecting the riskiness of the project.The cash flow will vary from assets to assets, dividends for stocks, interest rate etc. Thediscount rate will be a function of the riskiness of the estimated cash flow, with higher rates for riskier assets and lower rates for safer projects.Under discounted cash flow valuation, we estimate the intrinsic value of an assets basedon its fundamentals.Intrinsic value is the value that would be attached to the firm by an all knowing analyst,who not only estimates the estimated cash flow for the firm correctly but also attachesthe right discount rate to these cash flows and values them with absolute precision.With intrinsic valuation, one can get the value of any asset is the present value of theexpected cash flow on the assets and it is determined by the magnitude of the cash flow,the expected growth rate in these cash flows and uncertainty associated with receivingthese cash flow.

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