Firman v_aluaatio

Question 1

Can you name the 4 valuation approaches?

Answer 1

1. Present value
2. Relative valuation (= price multiples)
3. The asset based approach
4. Contingent claim valuation

Question 2

Mitä Present value -valuation approach sisältää esimerkiksi?

ei tarvii varmaan muistaa ulkoo

Answer 2

1. Enterprise value (EV)
2. Equity value
3. Discounted cash flow (to firm) model
4. Discounted cash flow (to equity) model
5. Economic value added model
6. Residual income model
7. Adjusted present value model
8. Dividend discount model

Question 3

Mitä Relative valuation (multiples) -valuation approach sisältää esimerkiksi?

(ei tarvii varmaan muistaa ulkoo)

Answer 3

1. Enterprise value (EV)
2. Equity value
3. EV/IC
4. EV/NOPAT
5. P/B
6. P/E
7. EV/EBIT
8. EV/EBITDA
9. EV/revenue

Question 4

Mitä The asset based approach -valuation approach sisältää esimerkiksi?

(ei tarvii varmaan muistaa ulkoo)

Answer 4

1. Net asset value (NAV) approach
2. Sum-of-the-parts approach
3. Liquidation approach

Question 5

What are the steps of valuation process?

Answer 5

1. Business analysis
2. Financial statement analysis
3. Forecasting
4. Valuation

Question 6

Forecasting in the valuation process.

Answer 6

We make assumptions of the future: future cash flows, sales, balance sheet items.

So, future financial statements are projected.

Question 7

What are the different methods used in Forecast assumptions?

Answer 7

Methods of predicting financial information can be classified as follows:

MECHANICAL:
1) Statistical models (UNIVARIATE) 2) Statistical models (MULTIVARIATE)

NON-MECHANICAL:
3) Trend analysis (UNIVARIATE) 4) Security analyst approach (MULTIVARIATE)

Different methods are based on different forecasting tools and data sources.

Question 8

How do you select from the different methods used in Forecast assumptions?

Answer 8

Data availability and the purpose for which the predictions are made affect the selection of different prediction methods.

Question 9

Mechanical prediction methods

Answer 9

Mechanical prediction methods include:

1) Univariate statistical models that are based on the analysis of the time-series of a single financial variable
2) Multivariate statistical models that are based on the analysis of the time-series of multiple financial variables

Question 10

How are Mechanical prediction methods used?

Answer 10

In mechanical methods, predictions of the financial variable are mechanically driven from the data by applying a specified statistical model:

• Statistical model is applied to the past data to estimate the model parameters
• The estimated paremeters are then applied to current data to predict the future value of the variable

Question 11

Example of a mechanical univariate statistical model is a model that forecasts earnings!

Answer 11

Example of a mechanical univariate statistical model is a model that forecasts earnings (X) to be an equally weighted average of the past four year’s earnings.

This approach assumes that future earnings can be simply predicted from the time-series of past earnings.

Ei oo mitenkään erityisen hyvä metodi. Toimii enemmän yleisluontoisena mallina toimialan tarkasteluun, eikä company specific.

Question 12

Tell me about Non-mechanical prediction methods?

Answer 12

In non-mechanical prediction approach, an analyst incorporates a judgemental factor of her own into the analysis

This factor may reflect an ever-changing mix of economic inputs

A typical example of univariate non-mechanical approach is ’free-hand’ extrapolation of a time-series plot of earnings referred to as a trend analysis

Analysts’ earnings forecasts are a typical example of a multivariate non-mechanical prediction method
-> Analysts use many quantitative and qualitative information sources including financial reports of the firm, macro-economic forecasts, company visits etc.

Question 13

Can you tell me about Analysts’ earnings forecasts?

Answer 13

Analysts’ earnings forecasts are frequently used to assess the future performance of the firm

Consensus earnings forecasts refer to the means or medians of the analysts’ earnings forecasts
-> Consensus earnings forecasts are probably the most important piece of financial information, at least for the valuation purposes

Range of the earnings forecasts of individual analysts measure the uncertainty in the analysts’ opinions regarding the value of the upcoming earnings

Question 14

Companies Routinely Steer Analysts to Deliver Earnings Surprises

Answer 14

With nudges and phone calls, analysts are urged to lower their estimates, making it easier for companies to beat them; ‘a rigged race,’” says Barry Diller.

An analysis by The Wall Street Journal found that earnings estimates often decline steadily after the end of a quarter. That can turn what might have been an embarrassing “miss” for the company into a positive surprise.

Question 15

Accuracy of analysts’ earnings forecasts and time before the earnings announcement?

Answer 15

Earnings announcement date affects the Accurace of analysts’ earnings forecasts:

Mitä kauempana ollaan siitä julkaisupäivästä, sitä huonompia kaikkien arviot.
Mutta mitä lähemmäksi sitä tulevaa julkaisupäivää mennään, sitä pienempi hajonta eri analyytikoiden arvauksille tulee ja sitä lähempänä ne on totuutta!

Question 16

We derive abnormal earnings model from what model?

Answer 16

Deriving abnormal earnings model is done from the dividend discount model.

Question 17

What is same in the abnormal earnings model as in the DDM and DCF models…

Answer 17

Principle in the abnormal earnings model is the same as in the DDM and DCF models…

Question 18

What is Abnormal earnings model?

Answer 18

The abnormal earnings valuation technique evaluates a company’s worth based on two factors, i.e., the book value of the company and its expected earnings. The valuation model looks at the expected profit that can be generated by the management.

If the earnings are higher than expected, an investor would be willing to pay more than the book value.

Question 19

Tell more about Abnormal earnings model?

Answer 19

One assumption = Clean Surplus Relation

Definition of ROE as current Net Income over last period’s book value of equity

Definition of abnormal earnings as the difference between:

• > Net Income and cost of equity (in $ terms), or equivalently,
• > ROE and r_E, multiplied by last period’s book value of equity (in % terms)

A firms creates value when ROE > rE

Question 20

What does Firm valuation mean?

Answer 20

The term firm valuation refers to determining the true or intrinsic value of the firm.

This value may significantly differ from the asset-based book value of the firm.

Question 21

Why do investors and financial analysts conduct firm valuations?

Answer 21

Investors and financial analysts conduct firm valuation for various purposes needed in their decision making:

A) Investment decisions
B) In M&A transactions and IPOs, firm valuation plays a key role

Question 22

How do valuation models help firms?

Answer 22

From firms’ point of view, valuation models help understanding the key value drivers of the firm.

Question 23

What is Business analysis in the valuation process?

Answer 23

Business analysis

• internal and external
• ELI industry, competitors, products etc.
• Business analysis is used to adjust the forecasts

Question 24

What is Financial statement analysis in the valuation process?

Answer 24

Financial statement analysis

- we use the published Financial statements to analyse profitability, leverage, growth etc

Question 25

What is Valuation step in the valuation process?

Answer 25

• we use Valuation models
• and Relative valuation

To get: What is the value of the equity of the firm?

Question 26

Can you name the Two different types of valuation tools that are mainly used?

Answer 26

Two different types of valuation tools are mainly used:

1) Relative valuation based on price multiples
- P/E-, P/B-, EV/EBIT- etc. ratios

2) Valuation models
- Dividend discount model (DDM)
- Free cash flow model (DCF)
- Abnormal earnings model (AE)

Question 27

Relative valuation vs. valuation models as a valuation tools?

Answer 27

Relative valuation is a simple valuation tool.

Valuation models are more sophisticated:

• Infinite forecast horizon
• Risk and time-value of money are taken into account

Question 28

What are Price multiples?

Answer 28

Valuation multiples are financial measurement tools that evaluate one financial metric as a ratio of another, in order to make different companies more comparable.

These ratios, also called as price multiples, are used in relative valuation to determine the intrinsic value of the firm.

Price multiples can be defined in numerous ways.

Question 29

In Section 2, WHY did we calculate P/E- and P/B-ratios from per-share numbers?

Answer 29

In Section 2, we calculated P/E- and P/B-ratios from per-share numbers to:

• Show the link between accounting numbers and stock prices
• Calculate the expected return of a stock

Question 30

Relative valuation can answer what question?

Answer 30

Relative valuation can answer the question

“I want to buy a stock in a brewing industry, which one should I buy?”

Question 31

Relative valuation: what does it mean?

Answer 31

The value of the firm (a target firm) is estimated by looking at how the market prices similar or comparable firms

The value of the firm is whatever the market is willing to pay for it given its financial characteristics like earnings, book equity or sales

Question 32

Relative valuation: what information is needed?

Answer 32

Information needed

• A group of similar or comparable firms
• Median value of the price multiples of similar or comparable firms
• Typically, price multiples like P/E- or P/B-ratio are used

Question 33

Relative valuation: how to do it?

Answer 33

1. Identify comparable firms that have similar operations to the firm whose value you are calculating
   - > Operate in the same industry or otherwise have similar business models
2. Calculate price multiples for the comparable firms by using their financial statement numbers and current stock price
   - > Earnings, book value, sales
3. Apply these multiples to the corresponding measures for the target to get its intrinsic value
   - > Example: P(target) = EPS(target) × P/E(comps)

Question 34

Example on relative valuation

Answer 34

Suppose we have identified 5 firms which are similar to the firm we want to evaluate:

• Firm A: P/E –ratio = 16
• Firm B: P/E –ratio = 18
• Firm C: P/E –ratio = 12
• Firm D: P/E –ratio = 14
• Firm E: P/E –ratio = 20
• The median P/E –ratio is 16
• Our firm has EPS of 5.00€

Implied stock price of our firm is 5.00€ × 16 = 80€

Question 35

Relative valuation: some considerations

Answer 35

Use financial statement numbers consistently when calculating price multiples

• Use exactly the same financial statement numbers for target firm and for all comparable firms
• For example, the same earnings numbers must be used for all firms when calculating P/E ratio
• What if accounting methods are different for comps and target?
• What about negative denominators?

Conceptual problem: circular reasoning
- Firm value is calculated from the market values of the comps

Question 36

Many ways to calculate P/E-ratios.

Answer 36

There are a number of variants on the P/E-ratio based upon how the price and the earnings are defined

Price:
- Usually the current price (though some like to use average price over last 6 months or year)

EPS:

• EPS in most recent fiscal year (current)
• EPS in most recent four quarters (trailing)
• EPS expected in next fiscal year or next four quarters (both called forward)
• EPS in some future year
• EPS in many past fiscal years
• Some combination of all these…

Question 37

What are the links between P/E, P/B and ROE?

Answer 37

P/B ratio increases with ROE
-> P/B as such is not indicative of the firm value without considering ROE

P/E ratio is the ratio of P/B ratio to ROE
-> P/E ratio indicates the current valuation of the firm relative to its profitability

Value of the firm having high ROE should be higher than that of the firm having low ROE

• > Simple investment strategy
  a) Buy firms having low P/B ratios and high ROE
  b) Sell firms having high P/B ratios and low ROE

Question 38

Some empirical evidence from Helsinki Stock Exchange:

a) P/B vs. ROE calculated by using analysts’ EPS forecasts
b) P/B vs. ROE calculated by using EPS from previous year

What can you learn from these two graphs?

Answer 38

a) P/B vs. ROE calculated by using analysts’ EPS forecasts

• Opettaja ei päivitä tuota taulukkoa enää, koska firmat muuttuu ja pisteet vähän, mutta yleinen tulos ei muutu!
• When ROE goes up, the P/B goes up too -> There is a clear positive trend! Pisteet on regressioviivan lähellä lähinnä.

• Tässä ne yritykset on paljon kauempana regressioviivasta, eli hajaantumeenpia! MIKSI? Past earnings are not related to P/B ratios as forecasted earnings.

ELI –> Value of the firm is based on the future expectations of the firm! So future earnings are related to stock prices, NOT past earnings!

Question 39

Denumerator of the price multiple can be based on what?

Answer 39

Denumerator of the price multiple can be based on:

Earnings:

• Price/Earnings Ratio (PE) and its variants (PEG)
• Enterprise value/EBIT
• Enterprise value/EBITDA
• Enterprise value/Cash Flow

Book value of the asset

• Price/Book Value (of Equity) (PB)
• Value/ Book Value of Assets
• Value/Replacement Cost (Tobin’s Q)

Revenues generated by the asset

• Price/Sales per Share (PS)
• Value/Sales

Asset or industry specific variables (Price/kwh, Price per ton of steel ….)

Question 40

How do you calculate EV/EBIT-ratio (and its parts)?

Answer 40

EV/EBIT = Enterprise value (EV) / Earnings before interest and taxes (EBIT)

Enterprise value (EV) = Market value of equity + Net interest-bearing debt

Net interest-bearing debt = Interest bearing debt - Financial assets

Question 41

How do you calculate Price-Sales Ratio (P/S)?

Answer 41

P/S
= Stock price / Sales per share
= Market value of equity / Sales

Question 42

What are the deficiencies of P/S ratio?

Answer 42

P/S ratio is commonly used despite its deficiencies:

• By relying on sales, it neglects all the costs need to generate sales
• Firm having a high level of sales can be deeply unprofitable

Question 43

Good things to know about relative valuation?

Answer 43

Selection of the group of comparable firms is essential in relative valuation!

Relative valuation can give very strange results!