London School of Economics

FM 412: Quantitative Security Analysis

Winter 2024

Guidelines for Project 1:

Valuation and Investment Analysis of a Chosen Firm

1. This project is done in groups of up to 4 members each. You will choose your own groups. Make
sure you have notified the course administrator of your group membership.

2. In this project, you will study and analyse the balance sheet and income statements of NVIDIA.

3. The objective is to prepare a simple but coherent analysis of the fair value of the equity stock and
the risks of investing in it. You can use the methods, and ideas we discuss in this course and that
you have learnt in your other courses (particularly your Corporate Finance course). Please be
logical in your analysis and explain any non-standard or unusual assumptions/methods.

4. Company analysis by its nature is an inexact analysis. You should make any reasonable
assumptions you think are necessary to proceed with your analysis. Don’t worry too much about
minutiae and focus on getting the big picture as well as you can.

I describe the parts of the project below.

Project 1, Part 1: Historical Analysis up to July 2020 (9 pages max)

1. For valuing companies, we must be familiar with their history. The objective for the first part
of the project is, therefore, to conduct a simple historical analysis of its financial statements.
2. You will prepare an at most 12 page report detailing the historical analysis, using an 11 or 12
pt font with single spacing. The page limit includes tables and graphs, but does not include the
bibliography. There is no need to use all of the 12 pages to get full marks.
3. This report will consist of the following parts (suggested page lengths in parenthesis):

a. Business Description (max 1 page)

Here you will provide a basic description of the business of the company, commenting
on the nature of the industry/industries that the company operates in, key
competitors of the firm and important drivers of profitability and value in the industry.

For this part, you should study the latest annual report of your company. A good
reading of the main parts of this report plus a small amount of web research will tell
 you enough about the business of the company. Do mention any significant stakes
taken by prominent investors.

b. Historical Trends in Revenues, costs, profit margins, free cash flows, capex, and the
operating assets of the company (max 3 pages)

This will involve a basic ratio analysis of the income statements and balance sheets of
the company and an analysis of growth rates your company has experienced. You
should comment on the key ratios and trends in the ratios that are relevant to gauge
the profitability, operating performance and growth over the last 5 years of your
company over this time period. There is no prescribed number of ratios, please
express good judgment. You should discuss the drivers of the growth and / or decline
that the company has had: organic growth, acquisitions, price increases? You should
also discuss the drivers of profitability (or losses) of your company. You will conclude
with a judgement on whether the growth rates and profit margins that your company
has experienced are sustainable.

On the course page on LSE Moodle, under the tab for Assignments and Feedback,
there is a link to the Mergent Database. The database has most of the relevant
information you need for Part 1 of Project 1. For your project, you can use the
information provided on Mergent Online for company financials as well as financial
ratios.

c. Stress Analysis (max 1-2 pages)

In this part, you should also comment on the effect of the stressful macro
environments on the firm’s revenues and profits. A look at how the company
performed after the internet bubble of 2000, after the financial crisis of 2008, after
the Covid March 2020 might be a useful guide. This may give you a bit of an idea of
the sensitivity of the firm’s business to severe aggregate market and macro-shocks.

d. Historical stock price performance (max 1 page): has the company outperformed the
broad market, and the industry it is in? What are possible reasons for historical
underperformance or outperformance?

e. Historical estimate of risk measures for the company (max 1 page): what are your
estimates of company’s beta, the standard deviation of its return, volatility of
revenue and of earnings growth, and volatility of margin changes?

f. Concluding comments summarising your opinion on key parameters you have chosen
and estimated in a. to e. above. (1 page)
Project 1, Part 2: The subsequent phase July 2020 to today (3-4 pages, including charts, tables,
references and appendices)

1. Briefly explain the main drivers of stock market performance during the AI buzz period.
2. What happened to the valuation metrics? What happened to fundamental valuation?
3. Was/is this a bubble or fundamentals?
4. Did the firm take advantage of the high valuation?
5. How/what did the company do during the COVID crisis and the subsequent inflationary and
interest rate surges?

Project 1, Part 3: Current and Prospective Analysis: Valuation, Risks, and Investment
Recommendation (10 pages, including charts, tables, references; appendices can be separate and are
for completeness but will not be graded)

While Parts 1 and 2 of the project look back in time, the third part aims to conduct a valuation analysis
which is necessarily prospective and hence inexact with a lot of room for judgement, creativity and
error. Nonetheless this is what financial markets are attempting to do every day so we should give it
a shot too.

In part 3, you will write a 10 page (max) report that estimates the fair value of the equity of the
company you have chosen.

As a common template, do go to Aswath Damodaran’s Linked In page

https://pages.stern.nyu.edu/~adamodar/pc/blog/NVIDIA2024.xlsx

and download his spreadsheet.

This report will consist of the following parts:

1. Projection of Free Cash flows

Look at his projections of next 10 years for the company’s free cash flows. Has he built his free
cash flow projections from projections of revenues, gross profits, Selling, General, Admin and R&D
expenses, EBIT, Taxes, Depreciation, and Capex? Do you agree (in particular in terms of the growth
rates and margin assumptions etc.) based on the historical analysis that you did?

2. Estimation of Terminal Value

To estimate the current fair enterprise value, you will need to discount next 10 years expected
free cash flows plus the terminal value at the end of year 10. In this step, your objective is to come
up with a reasonable estimate of this terminal value. There are no correct answers here but
hopefully good logic and the right amount of conservatism will produce a good estimate. Have a
look at the assumptions underlying Damodaran’s terminal value. Do you agree with his
assumptions on growth, RADR etc? Do they agree with the methods we covered in this course? If
you don’t agree, amend the spreadsheet to reflect your carefully explained views.

3. Valuation:

To compute the current estimate of fair enterprise value of the firm, you will discount projected
cash flows and terminal value at a risk-adjusted discount rate. The main input here is the risk
premium. Your estimates of beta from Part 1 will give you a good starting point. (Your equity beta
will need to converted into an estimate of firm beta).

The value of the equity of the firm will be the enterprise value less the value of debt. You might
need to account for employee stock options as well.

In what respects does your analysis agree or disagree with Damodaran’s? If you don’t agree,
amend the spreadsheet to reflect your carefully explained views.

If you have additional ideas for assessing value not in Damodaran, do include them and see if
conclusions given by different methods are similar. Be creative, but logical.

4. Sensitivity Analysis

The equity value you come up will differ almost certainly from the current market value, or the
one in the past few months for sure. You should conduct a sensitivity analysis of your valuation
to key assumptions made in your analysis. Are there any set of parameter values where current
pricing in the market is close to your estimate? Are those parameter values reasonable? If they
are then the company is probably fairly valued. If not, then there may be an investment possibility
(either long or short).

5. Risks

What are the key risks of investing in the company you have analysed? How resistant is your
company to macro shocks? Would you call it a defensive or an aggressive investment? Is it a good
investment in the current stage of the business cycle?

6. Recommendation

On the basis of your analysis, would you recommend buying the company or selling it or not
bothering with? You should make a clear recommendation, no matter how approximate you think
your analysis is. The real world is full of approximations, but investment decisions need to be made
all the time. Doing nothing is also a decision.