Professional Documents
Culture Documents
Valuation
Valuation
With contributions by
Stephen H. Penman Columbia University
Peter D. Easton and Gregory A. Sommers - Ohio State University
Luis Palencia University of Navarra, IESE Business School
1-3
McGraw-Hill/Irwin
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Debt Investors
Probability of default
Determination of lending rates
Covenant violations
Management
Strategic planning
Investment in operations
Evaluation of subordinates
Litigants
Disputes over value in the firm
Customers
Security of supply
Governments
Policy making
Regulation
Taxation
Government contracting
Competitors
Employees
Security and remuneration
1-5
Investment Styles
Intuitive investing
Rely on intuition and hunches: no analysis
Passive investing
Accept market price as value: no analysis
McGraw-Hill/Irwin
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Fundamental analysis
Requires work !
Prudence requires analysis: a defense against paying the wrong price (or
selling at the wrong price)
The Defensive Investor
McGraw-Hill/Irwin
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Alpha technologies:
1-8
CAPM
A model that describes the relationship
between risk and expected return and that is
used in the pricing of risky securities.
McGraw-Hill/Irwin
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CAPM
The general idea behind CAPM is that investors need to
be compensated in two ways:
time value of money and risk.
McGraw-Hill/Irwin
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What is a normal return for risk? A technology for pricing risk (asset
pricing model) is needed
Premium for risk = Risk premium on risk factors x sensitivity to risk factors
McGraw-Hill/Irwin
1-11
0.1%
19.2%
4.5
1.4
20.7
16.9
15.5
5.2
6.9
2.7
1.0
5.0
4.9
3.2
Treasury Bills
3.7
0.6
1.1
2.0
Change in Consumer
Price Index
9.2%
19.4%
7.8%
5.9%
17.5%
16.6%
13.0%
20.3%
11.5
15.8
16.5
17.7
33.9
1.7
6.2
13.0
10.2
6.1
8.7
0.1
1.4
5.5
12.6
10.7
5.6
9.2
0.4
1.9
3.9
6.3
8.9
5.0
3.8
3.2
5.4
2.2
2.5
7.4
5.1
3.1
3.2
4.5
______________________________________________________________________________
*
**
Source: Stocks bonds Bills and Inflation 1998 Yearbook, (Chicago: Ibbotson Associates, 1998).
Summary of Annual Returns on Stocks, Bonds, Treasury Bills and Changes in the Consumer Price Index, 1926-1995
McGraw-Hill/Irwin
1-12
Intrinsic Values
The actual value of a company or an asset based
on an
underlying perception of its true value including all
aspects of the business, in terms of both tangible
and intangible factors.
This value may or may not be the same as the
current market value. Value investors use a variety
of analytical techniques in order to estimate the
intrinsic value of securities in hopes of finding
investments where the true value of the investment
exceeds its current market value.
1-13
Normal Return,
PTC V0
V0
Actual Return,
PTC P0
Abnormal Return,
P0 V0
P0
Time
0
Actual Return,
PTC VTC
VTC
PTC P0
Normal Return,
VTC V0
P0 V0
Time
0
McGraw-Hill/Irwin
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McGraw-Hill/Irwin
1-15
Investing in a Business
S
D eco
eb n
th da
ol ry
de
rs
Sh Sec
ar on
eh da
ol ry
de
rs
Financing
Activities
Investing
Activities
Operating
Activities
D
eb
th
ol
de
rs
The investors:
The claimants on value
Sh
ar
eh
ol
de
rs
The firm:
The value generator
Business investment and the firm: value is surrendered by investors to the firm, the firm adds or losses
value, and value is returned to investors. Financial statements inform about the investments. Investors
trade in capital markets on the basis of information on financial statements
McGraw-Hill/Irwin
1-16
Business Activities
Financing Activities: Raising cash from investors
and returning cash to investors
Investing Activities: Investing cash raised from
investors in operational assets
Operating Activities: Utilizing investments to
produce and sell products
McGraw-Hill/Irwin
1-17
Firms
Business
Assets
Business
Debt
Business Debt
(Bonds)
Household
Liabilities
Business
Equity
Business Equity
(Shares)
Net
Worth
Other
Assets
1-18
McGraw-Hill/Irwin
1-19
Value-Based Management
Test strategic ideas to see if they generate value
1. Develop strategic ideas and plans
2. Forecast payoffs from the strategy
3. Use forecasted payoffs to discover value creation
Applications:
Corporate strategy
Mergers & acquisitions
Buyouts & spinoffs
Restructurings
Capital budgeting
1-20
McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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1-27
Valuation Technologies:
Methods that do not Involve Forecasting
Method of Comparables (Chapter 3)
Multiple Screening (Chapter 3)
Asset-Based Valuation (Chapter 3)
McGraw-Hill/Irwin
1-28
Valuation Technologies:
Methods that Involve Forecasting
Dividend Discounting (Chapter 3)
Discounted Cash Flow Analysis (Chapter 4)
Pricing Book Values: Residual Earnings Analysis
(Chapter 5)
Pricing Earnings: Earnings Growth Analysis (Chapter
6)
McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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Parts
I The Foundations
Valuation models
Incorporating financial statements into valuation
II
III
IV
V
McGraw-Hill/Irwin
Analyzing Information
Forecasting and Valuation
Accounting Analysis
Cost of Capital and Risk
1-32
Sneak Preview
Dividend Capitalization:
P0
d1 d 2 d3
2 3 ....
E E E
Accounting:
Bt Bt 1 earnt d t
...
2
E
E
McGraw-Hill/Irwin
1-33
4 Years
180.00%
Forecasts
available
for next
4 Years
160.00%
Source: Penman and Sougiannis A Comparison of Dividend, Cash Flow and Earnings Approaches
to Equity Valuation. Contemporary Accounting Research, 1998: 343-382.
Forecast Period
140.00%
120.00%
100.00%
80.00%
Used to
estimate
implicit
price
60.00%
40.00%
20.00%
0.00%
McGraw-Hill/Irwin
Dividends
Cash
Flows
Residual
Earnings
Dividends
Cash
Flows
Residual
Earnings
1-34
Forecast Period
4 Years
180.00%
140.00%
Source: Penman and Sougiannis A Comparison of Dividend, Cash Flow and Earnings Approaches
to Equity Valuation. Contemporary Accounting Research, 1998: 343-382.
176.20%
160.00%
120.00%
100.00%
80.00%
63.30%
60.00%
40.00%
10.30%
20.00%
0.00%
McGraw-Hill/Irwin
Dividends
Cash
Flow s
Residual
Earnings
Dividends
Cash
Flow s
Residual
Earnings
1-35
4 Years
180.00%
176.20%
160.00%
Growth
beyond
Year 4
140.00%
Source: Penman and Sougiannis A Comparison of Dividend, Cash Flow and Earnings Approaches
to Equity Valuation. Contemporary Accounting Research, 1998: 343-382.
Forecast Period
120.00%
100.00%
80.00%
63.30%
60.00%
40.00%
10.30%
20.00%
0.00%
McGraw-Hill/Irwin
Dividends
Cash
Flow s
Residual
Earnings
Dividends
Cash
Flow s
Residual
Earnings
1-36
4 Years
180.00%
176.20%
160.00%
140.00%
Source: Penman and Sougiannis A Comparison of Dividend, Cash Flow and Earnings Approaches
to Equity Valuation. Contemporary Accounting Research, 1998: 343-382.
Forecast Period
Combine
forecasts
to
determine
implicit
price
120.00%
100.00%
80.00%
63.30%
60.00%
40.00%
10.30%
20.00%
0.00%
McGraw-Hill/Irwin
Dividends
Cash
Flow s
Residual
Earnings
Dividends
Cash
Flow s
Residual
Earnings
1-37
4 Years
180.00%
176.20%
160.00%
Source: Penman and Sougiannis A Comparison of Dividend, Cash Flow and Earnings Approaches
to Equity Valuation. Contemporary Accounting Research, 1998: 343-382.
Forecast Period
140.00%
120.00%
100.00%
76.50%
66.30%
80.00%
60.00%
40.00%
10.30%
20.00%
16.70%
6.10%
0.00%
Dividends
McGraw-Hill/Irwin
Cash
Flows
Residual
Earnings
Dividends
Cash
Flows
Residual
Earnings
1-38
FORECASTS OF
CASH FLOWS
DISCOUNTED
CASH FLOWS
VALUE OF
THE FIRM/
DIVISION
McGraw-Hill/Irwin
FORECASTS OF EARNINGS
(and Book Values)
BUDGETS,
TARGETS,
FORECASTED EVA
* Performance Evaluation
*Benchmarking
DISCOUNTED
RESIDUAL EARNINGS
FORECASTING
1-39
Cost of
Capital
BOOK VALUE
of Investment in
the Firm
ADJUSTED
BOOK VALUE
of Investment in
the Firm
Cost of
Capital
McGraw-Hill/Irwin
1-40
Course Materials
Text Book:
Financial Statement Analysis and Security Valuation Second Edition by
Stephen Penman)
Course Notes
on website
Accounting Clinics
on website
McGraw-Hill/Irwin
1-41
A text on US GAAP:
Keiso & Weygandt, Intermediate Accounting, Wiley, 10th Edition, 2001.
McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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