Private and Confidential

Equity Valuation

Equity Analyst Training Program

Prepared by: Dheeraj Vaidya

dheerajvaidya@corporatebridge.net
dheerajvaidya@gmail.com

Private and Confidential – Not for Circulation

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 Discussion topics

 Valuation overview
 Some Stock Questions?
 Why valuation?
 Importance of valuation
 Important valuation questions
Equity Valuation

 Valuation – subjectivity versus objectivity

 Valuation approach
 Macro Analysis – Monetary/Fiscal Policy/ Stages of business cycle
 Strategic Analysis - Industry Life Cycle/Porter’s five forces
 Retrospective Analysis
 Prospective Analysis

 Understanding Companies / Stocks

 Equity Value versus Enterprise Value
 Key valuation tools
 Valuation summary table
 Discounted cash flow (DCF)
 Overview of DCF
 Steps in a DCF

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Equity Valuation

Valuation Overview

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Private
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and Confidential
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 Some Stock Questions!

 Anyone can make a killing just by investing in the stock market?

 Investing in stock is like gambling?

 New economy stocks generate better returns than the old economy stocks?
Equity Valuation

 Business success is a function of rising stock prices?

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 Why Valuation?

CEO/CFO/Operating Mgr

Insiders Decision Making

Identifying Opportunities
Equity Valuation

FIIs / MFs / Insurance Comp

Investors Pension/Hedge Funds

Retail Investors

Investment Bankers

Consultants Sell side / Buy Side Analysts

Credit Analysts

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 Importance of Valuation

• Mergers and Acquisition

• Defense Analysis – Hostile Takeover
Valuations
• Start-ups / Joint Ventures
• De-listing/ Share Option Program
Equity Valuation

• Initial Public Offerings

Raise Money from Public • Subsidiary IPOs
• Follow-on IPOs

• Capitalization
Debt and Equity Offering • Leveraged Buyout (LBOs)
• Share repurchase programs

How much is your valuation?

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 Important Valuation Questions

 Liquid stocks?
 Public

 Private Willing but not anxious buyer

 What is the Fair value? Fair Value of an asset

Who is the seller?

Equity Valuation


Willing but not anxious seller
 Public or private

 Who are the potential buyers?

 Strategic or financial

 What is the context of the transaction?

 Privately negotiated sale or auction

 Hostile or friendly

 Economic conditions
 Index performance

 Economic Outlook

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 Valuation: Subjectivity / Objectivity

Valuation
Equity Valuation

Subjective Objectivity

 Judgment & interpretation of data  Reasonable analytical justification

 Making assumptions  Macro to Micro Approach
 Selling the story / crafting the deal  Ratio Analysis
 Information available may be limited  Valuation tools – DCF,
 Time constraints Relative Valuation, Sum of Parts

 Do all analyst have the same rating?

 Is valuation all about Gut feeling?

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 Valuation Approach

 Top to Bottom Approach

 EIC (Economy Industry Company) Framework

Prospective Analysis
 M2M (Macro to Micro) Method  Forward Looking
 Forecasting Financials
Equity Valuation

 Valuations - DCF

Retrospective Analysis
 Company Financials
 Ratio/Margin Analysis
 Comparable Analysis

Strategic Analysis
 Industry Analysis
 SWOT Analysis
 Porter’s five forces

Macro Analysis
 Fiscal Policy
 Monetary Policy

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 Valuation Approach – Macro Analysis

 Monetary Policy
 Process by which the government, central bank, or monetary authority of a country controls
• Supply of money

• Availability of money

• Cost of money or rate of interest

Equity Valuation

 Attain a set of objectives oriented towards the growth and stability of the economy

 Fiscal Policy
 Fiscal policy, taking place within the scope of budgetary policy, refers to government policy that attempts
to influence the direction of the economy through changes in
• Government taxes

• Fiscal allowances

 Five stages of business cycle

Late Expansion
 Recovery Early Recession

 Early expansion
 Late expansion Early Expansion
Late Recession
 Early recession
Recovery
 Later recession

 United States – monetary policy, fiscal policy, business cycle?

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 Valuation Approach – Strategic Analysis

 Industry Life Cycle

Total Market
Sales
 Pioneering
 Rapid Growth
 Mature Growth Introductory Growth Maturity
Maturity
Stage Stage Stage
Stage
 Stabilization and Market Maturity
Equity Valuation

 Deceleration of growth and decline

Time

Threat of
new
 Porter’s Five forces entrants

 Rivalry Among the Existing Competitors

 Threat of New Entrants
Bargaining Bargaining
 Threat of Substitute Products power of
Competitive
power of
Rivalry
suppliers Buyers
 Bargaining Power of Buyers
 Bargaining Power of suppliers

Threat of
substitute
products

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 Valuation Approach: Retrospective / Prospective Analysis

 Retrospective Analysis
 Financial Statement analysis of the company
 Understanding the accounting policies – conservative / aggressive
 Ratio Analysis of the company – Liquidity, Operating, Risk and Growth
 Ratio comparison with other companies in the industry/sector
Equity Valuation

 Prospective Analysis
 Forward looking Discounted Cash Flows

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 Understanding Companies / Stocks

 Growth companies versus growth stocks

 Growth company is where the management has the ability to consistently select investments (projects)
which earn higher returns than required by their risk
 Growth stock earns higher returns than other stocks of equivalent risk
• Regardless of whether the firm is defined as growth company, if a firm’s stock price is below fair value, it can be a growth
stock
Equity Valuation

 Defensive companies versus defensive stocks

 Defensive companies has earnings that are relatively insensitive to downturn in the economy
• Utility / Retail grocery chains are defensive companies

 Defensive stock does not decline as much as the market when the overall market declines
• Low Beta stocks?

 Cyclical companies versus cyclical stocks

 Cyclical companies earnings tend to follow the business cycle
• Steel, automobile and heavy equipment companies are cyclical companies

 Cyclical stocks rates of return changes more than the return on the overall market
• High Beta stocks?

 Speculative companies versus Speculative stocks

 Speculative companies has assets that are very risky, but the assets have the potential to generate
very large earnings
• Mining, oil exploration, real estate?

 Speculative stocks highly likely to have very low or negative returns because it is always overpriced

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 Equity Value versus Enterprise Value

 Enterprise Value = Market value of operating assets

 Equity Value = Market value of shareholders’ equity

Liabilities and
Total Assets Shareholders’ Equity
Equity Valuation

Net Debt

Enterprise
Enterprise Value Value
Equity Value

= Enterprise Value -
Equity Value Net Debt

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 Equity Value versus Enterprise Value

 Equity Value  Enterprise Value (EV)

 Express the value of  Cost of buying the right to the
shareholders’ claims on the whole of an enterprise’s core
assets and cash flows of the cash flow
business  Includes all forms of capital –
 Reflects residual earnings after equity, debt, preferred stock,
Equity Valuation

the payment to creditors, minority interest

minority shareholders & other
non-equity claimants

 Advantages of Equity Value  Advantages of Enterprise Value

 More relevant to equity  Accounting policy differences
valuations can be minimized
 More reliable?  Avoid influence of capital
 More familiar to investors structure
 Comprehensive
 Enables to exclude non-core
assets
 Easier to apply to cash flow

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 Key Valuation tools

 Present value of projected unlevered free cash flow

Discounted Cash Flow
 Captures the “intrinsic value” of the business

 Based on market trading multiples of comparable comp

Equity Valuation

Relative Valuation
 Usually focuses on forward looking Profit / EBITDA / Cash Flow

 Based on multiple paid for comparable comp. assets in sale transaction

M&A Comparables
 Focus mainly on multiples of Historical Profit / EBITDA / Cash Flow

 Based on fair value of individual assets

Asset Valuation
 Book Value may not be equal to fair value

 Divides the business into separate sub-entities (parts)

Sum of Parts
 Add the value of each part to find the total value

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 Valuation Summary Table

 General diagram showing different types of valuations

$60
XYZ Corp. Share Price ($)

$50
Equity Valuation

$40

$30

$20

$10

$0
DCF Public Comp Asset Repl M&A Comp Repl Cost Sum of Parts

 Key Conclusions
 Replacement cost provides highest valuation range (from this graph only!)

 M&A Comp provides the lower range

 Mean valuation is around $35/share

 Provides a full view of valuation multiples using all different methods

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