15. Company analysis and company valuation methods Flashcards
(19 cards)
Relevant ratios from an equity SH point of view?
Dividends
Dividend Payout Ratio (DPR)
Dividend Yield
Earnings
Earnings Per Share (EPS)
Price/Earnings ratio (PE)
Dividend Payout Ratio (DPR)
Measures earnings for to SH paid out in dividends
Higher payout ratio = co sharing more earnings with equity SH
Depends on company policy and industry
Formulae = Equity dividends/ profit for the year x 100
Dividend Yield
How much co pays a year relative to equity share price
Only profitable co should pay dividends
ROE = annual dividend + capital growth
Formulae = Dividend per share/Marker price per share x 100
DPS/MPPS x 100
Earnings per share
Residual profit
Higher the EPS =
more attractive shares to investors
Good financial health
EPS changes when profit increases/ decreases
Limitations
- Not rep actual income
- Option to buy back shares
- Not consider debt element
Price/Earnings ratio
Measures current market price relative to EPS
Market price driven by supply and demand
Relationship between market value of shares and profit for the year
Applied same industry with similar company risk, finance risk, growth rate)
Loss making company = 0 P/E ratio
Low P/E = undervalued shares
Shows no of years co take to payback investor paid for share
Limitations
- Applied based on acc policies
- Assumes markets accurately value equity shares
- Backward looking
- Not be sole measurement
Relative value measures
Method determine asset value
Investors interested in valuation of asset in relation to peers
Investor measure share value in relation to comparable co (risk, liquidity and return)
Steps
1. Identify comparable company
2. Calculate price multiples P/E ratios
3. Compare ratios with those of peers
Valuation using Dividend Valuation Model
Current value of equity share = discounted value of dividend payments
NPV calculated using risk adjusted rate
Assumptions
Future income is dividends paid
Dividend paid forever
Dividends will be constant or growing at fixed rate
Variable growth model (Dividend Valuation Model)
Real life = Dividends co’s pay do not remain constant
3 phases
Initial phase of fast growth
Slower transition phase
Sustainable long run lower growth phase
Growth rate (g) = r x b
r = annual rate of return from investing
b = proportion of annual earnings retained
Valuation of discounted cash flows
Estimate value of potential investments
NPV = Cash inflow and outflows
Using discount rate of return
Valuation using CAPM
CAPM = relationship between systematic risk and expected rate of return
Used for pricing risk securities
Formulae
Beta = measure of systematic risk of a company’s shares
Market rate of return = overall rate of return on the market
CAPM = rate of return proportional to systematic risk and excess return to the market
Shareholder Value Analysis
Management strategy
Focuses on the creation of economic value or wealth for SH
Wealth creation = dominant company objective
Assumption = company is worth its ability to create value for shareholders measured as the NPV
Value of a share (amount SH willing to pay) dependant on:
1. Expected dividends to be earned
2. Expected returns from share
NPV and IRR common approaches to est. future cash flow and finding present value
NPV = difference between inflow and outflow
SVA, Value drivers
Value drivers = creates value in a company
Impact future cash flow and NPV
Key financial value drivers include:
- growth in sales revenue
- improvement of profit margins
- investment in non current assets
- investment in working capital
- cost of capital
- corporate tax rate
SVA and Free Cash Flow
Method for valuing a co based on ability to generate profits above cost of capital
Projects have positive or negative NPV
Positive NPV = cost of project would be completely recovered
Free Cash Flow = Surplus cash after costs needed for project
Indicates amounts free to be distributed to equity SH
Remaining surplus sometimes retained (new investments, retain flexibility, absorb losses)
OP - tax, investment in projects
Calculation of SVA
Calculate free cash flow
Calculate NPV of the FCF
Estimate value attributable for period beyond planning horizon
Strengths and weaknesses of SVA
Strengths
- Uses accounting values
- Easy to understand
- Reliability of valuation universally accepted
- Management focus on value drivers
Weaknesses
- DCF uses fixed rate for all future years
- Assumed to grow at constant rate
- Calculations depend on accounting figures (revenue and profits)
Economic Value Added
Alternative to SVA
Measures profitability and wealth created for SH over and above cost of capital invested
(OPAT) - (WACC X capital invested)
x WACC by capital invested to assess cost of using capital invested by SH
Positive EVA = project has recouped its cost of capital
Strengths and weaknesses of EVA (Economic Value Added)
Strengths
- Uses familiar accounting concepts
- Looks at economic value
- No req to produce additonal reports
- Best for asset rich companies
Weaknesses
- Restricted to ST projects
- Subjective
- Assets such as brand and reputation not recorded
Measuring Value Creation
Total SH return
Total amount returned to an investor
Market value added
Value of company as a result of existence and operation in market. Represents market value > funds invested
Effects of dividend payments on SH wealth
Co pays dividend = Market value and equity reduced by same amount
Calculation of MVA unaffected
Stock market influences
Keep SH in loop of new projects
Maintains confidence
Market efficiency and competive advantage
Market Value Creation - stock market influences
Markets influenced by various factors
SH kept informed about success of projects
Communications to SH and the SE important for maintaining confidence in company
Concepts of market efficiency (how quickly co respond) and competitive advantages are relevant
