Chapter 15

Company Analysis and Stock

Valuation
Abdullah Al Mamun
ID-33068
 Analysis of Growth Companies

 Growth Companies: Generating Returns above Required Rate of Return.

 Earnings higher the required rate of return are pure profits.

 How long can they earn these excess profits?

 Is the stock properly valued?

 Analysis of Growth Companies

 Growth Companies: A growth company is any company whose business

generates significant positive cash flows or earnings, which increase at
significantly faster rates than the overall economy.

 Growth Stocks: a growth stock is a stock of a company that generates

substantial and sustainable positive cash flow and whose revenues and
earnings are expected to increase at a faster rate than the average company
within the same industry
 Analysis of Growth Companies

 Alternative growth models

 No growth Firm:
E = r X Assets = Dividends

E 1  b  E E
V  k
k k v
 Analysis of Growth Companies

 Long-run growth models

 assumes some earnings are reinvested.
 Simple growth model
bEmk bEm
2
 (Gross Present Value of Growth Investment s)
k k
bEm bE
 ( Net Present Value of Growth Investment s)
k k

E bEm bE E 1  b  bEm
v   v 
k k k k k
 Analysis of Growth Companies

 Expansion Model:

 Firm retains earnings to reinvest, but receives a rate of return on its

investment equal to its cost of capital

m = 1 so r = k

E E 1  b  bE E
V    
k k k k
 Analysis of Growth Companies

 Negative Growth Model: The negative

growth model applies to a firm that retains
earnings (b>0) and reinvests these funds in
projects that generate rate of return below
the firm’s cost of capital (r<k or m<1).
Savikun Nahar Mukta
ID-30005
 The Capital Gain Component

bEm/k
b Percentage of earnings retained for reinvestment
m relates the firm’s rate of return on investments and the firm’s required
rate of return (cost of capital)
1 = cost of capital
 >1 is growth company

 Time period for superior investments

 Dynamic True Growth Model

 Firm invests a constant percentage of current earnings in projects that generate rates of
return above the firm’s required rate of return

D1
V
kg
 Measures of Value-Added

 Economic Value-Added (EVA)

 Compare net operating profit less adjusted taxes (NOPLAT) to the firm’s total cost of capital
in dollar terms, including the cost of equity

 EVA return on capital

EVA/Capital

 Alternative measure of EVA

 Compare return on capital to cost of capital
 Measures of Value-Added

 Market Value-Added (MVA)

 Measure of external performance

 How the market has evaluated the firm’s performance in terms of market value of debt and
market value of equity compared to the capital invested in the firm

 Relationships between EVA and MVA

 mixed results
 Measures of Value-Added

 The Franchise Factor

 Breaks P/E into two components

 P/E based on ongoing business (base P/E)

 Franchise P/E the market assigns to the expected value of new and
profitable business opportunities

Franchise P/E = Observed P/E - Base P/E

Incremental Franchise P/E = Franchise Factor X Growth Factor

Rk
 G
rk
Faisal Mahmud
ID - 38035
 Growth Duration

 Evaluate the high P/E ratio by relating P/E ratio to the firm’s rate and
duration of growth

 P/E is function of

 Expected rate of growth of earnings per share

 Stock’s required rate of return

 Firm’s dividend-payout ratio

 Growth Duration
 E’(t)=E(0) (1+G)^t

 N(t)= N(0) (1+D)^t

 E’(t)=E’(t) N(t)=E(0)[(1+G)^t(1+D)}]^t

 E(t)=E’(0) (1+G+D)^t

(0) (1G g  D g )
t
p g
(0) E g

p d
(0)
E (0) (1G a  D a)
a
t
 Intra-Industry Analysis
 Directly compare two firms in the same industry

 An alternative use of T to determine a reasonable P/E ratio

 Factors to consider

 A major difference in the risk involved

 Inaccurate growth estimates

 Stock with a low P/E relative to its growth rate is undervalued

 Stock with high P/E and a low growth rate is overvalued

 Site visits and the art of
the interview

 Focus on management’s plans, strategies, and concerns

 Restrictions on nonpublic information

 “what if” questions can help gauge sensitivity of revenues, cost, and earnings

 Management may indicate appropriateness of earnings estimates

 Discuss the industry’s major issues

 Review the planning process

 Talk to more than just the top managers

Md Mehedi Hassan
Id: 39050
 When to Sell

 Holding a stock too long may lead to lower returns than expected
 If stocks decline right after purchase, is that a further buying
opportunity or an indication of incorrect analysis?
 Continuously monitor key assumptions
 Evaluate closely when market value approaches estimated
intrinsic value
 Know why you bought it and watch for that to change
 Efficient Market
Efficient Market is a market where there are large
numbers of rational profit maximizers actively
competing, with each trying to predict future market
values of individual securities, and where important
current information is almost freely available to all
participants
 Efficient Market

 Securities prices always fully reflect all available, relevant information about
the security.
Efficient Market

All Available Information:

 Weak Form : Past price related information

 Semi Strong Form : Past price, news etc..

 Strong Form : All information including inside information.

 Efficient Markets

 Opportunities are mostly among less well-known companies

 To outperform the market you must find disparities between stock values and
market prices - and you must be correct

 Concentrate on identifying what is wrong with the market consensus and what
earning surprises may exist
 Influences on Analysts

 Investment bankers may push for favorable

evaluations
 Corporate officers may try to convince analysts
 Analyst must maintain independence and have
confidence in his or her analysis
 Global Company and Stock
Analysis
Factors to Consider:
Availability of Data
Differential Accounting Conventions
Currency Differences (Exchange Rate Risk)
Political (Country) Risk
Transaction Costs
Valuation Differences
The End