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CFA Level 2 COPY > Equity > Flashcards

Equity Flashcards

1
Q

Porter’s five forces

A
  • Competition
  • Substitutes
  • Supplier power
  • Buyer power
  • New entrants
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2
Q

Differences between bills, notes and bonds

A
  • T-bill: maturity of one year or less, is sold at a discount
  • Note: maturity of two, three, five and ten years, interest is paid semi-anually
  • Bond: maturity of ten years or more, interest is paid semi-anually
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3
Q

Money Vs. Time-Weighted Return

A
  • Money-weighted: IRR
  • Time-weighted: HPR = ((MV1 - MV0 + D1 - CF1)/MV0)
  • Where: MV0 = beginning market value, MV1 = ending market value,
    D1 = dividend/interest inflows, CF1 = cash flow received at period end (deposits subtracted, withdrawals added back)
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4
Q

ex ante

A

forward-looking

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5
Q

ex post

A

based on actual results

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6
Q

Ibbotson and Chen model

A
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7
Q

Ibbotson and Chen model abbr.

A
  • EINFL: expected inflation
  • EGREPS: expected growth rate in real earnings
  • EGPE: expected growth rate in the P/E ratio
  • EINC: expected income component
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8
Q

Unleveraged beta

A
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9
Q

Leveraged beta

A
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10
Q
  • Operating Income
  • g
  • Capital expenditure (Capex)
  • Net PPE
A
  • EBIT
  • ROE x b
  • FCInv
  • Net Property Plant and Equipment
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11
Q

Arbitrage pricing theory (APT) - Multifactor model

A
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12
Q

Fama-French model

A
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13
Q

Fama-French model abbr.

A
  • RMRF: Rm - Rf (Rf = return on the one month T-bill)
  • SMB: small minus big, average return on 3 small-cap portfolios minus the average return on 3 large-cap portfolios
  • HML: high minus low, average return on 2 high book-to-market portfolios minus the average return on 2 low book-to-market portfolios
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14
Q

Pastor-Stambaugh model

A

FFM model + LIQ

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15
Q

GICS

A

Global industry classification standard

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16
Q

Barriers to entry

A
  • Supply-side economies of scale
  • Demand-side benefits of scale
  • Customer switching costs
  • Capital requirements
  • Incumbency advantages independent of size
  • Unequal access to distribution channels
  • Restrictive government policy
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17
Q

Strategic styles

A
  • A classical strategy works well for companies operating in predictable and immutable environments
  • A shaping strategy is best in unpredictable environments that you have the power to change
  • An adaptive strategy is more flexible and experimental and works far better in immutable environments that are unpredictable
  • A visionary strategy (the build-it-and-they-will-come approach) is appropriate in predictable environments that you have the power to change
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18
Q

Return on invested capital (ROIC)

A
  • NOPLAT / Invested capital
  • NOPLAT= net operating profit less adjusted taxes (NOP before interest expenses)
  • NOPLAT = Operating Income (EBIT) x (1 - Tax Rate)
  • Invested capital = Operating assets - Operating liabilities
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19
Q

Return on capital employed (ROCE)

A
  • Operating profit (EBIT) / Capital employed (debt and equity capital)
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20
Q
  • Effective tax rate
  • Marginal tax rate
A
  • Total tax paid as a percentage of the company’s accounting income instead of as a percentage of the taxable income
  • Tax rate an individual would pay on one additional dollar of income
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21
Q

Weak-Form EMH

A

The weak-form EMH implies that the market is efficient, reflecting all market information. This hypothesis assumes that the rates of return on the market should be independent; past rates of return have no effect on future rates. Given this assumption, rules such as the ones traders use to buy or sell a stock, are invalid

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22
Q

Semi-Strong EMH

A

The semi-strong form EMH implies that the market is efficient, reflecting all publicly available information. This hypothesis assumes that stocks adjust quickly to absorb new information. The semi-strong form EMH also incorporates the weak-form hypothesis. Given the assumption that stock prices reflect all new available information and investors purchase stocks after this information is released, an investor cannot benefit over and above the market by trading on new information

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23
Q

Strong-Form EMH

A

The strong-form EMH implies that the market is efficient: it reflects all information both public and private, building and incorporating the weak-form EMH and the semi-strong form EMH. Given the assumption that stock prices reflect all information (public as well as private) no investor would be able to profit above the average investor even if he was given new information

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24
Q

P/E in relation to PVGO

A
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25
Q
  • Trailing P/E
  • Forward P/E
A
  • Today’s market price divided by the trailing 12 months’ earnings per share
  • Today’s market price divided by a forecast of the next 12 months’ earnings per share
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26
Q

Gordon growth model

A
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27
Q

(1 - b)

A

Dividend per share/ Earnings per share

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28
Q

Required rate of return with the Gordon growth model

A
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29
Q

Two-stage DDM

A
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30
Q

The H-model

A
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31
Q

The H-model variables

A
  • H: half life in years of the high-growth period
  • gS: initial short-term dividend growth rate
  • gL: normal long-term dividen growth rate after
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32
Q

g using ROE

A

g = b x ROE

/

b = retention rate

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33
Q

H-model required rate of return

A
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34
Q

ROE decomposition

A
  • NI / Common shareholders’ equity
  • (NI / Total assets) x (Total assets / Common shareholders’ equity)
  • (NI / Sales) x (Sales / Total assets) x (Total assets / Common shareholders’ equity)
  • g = (NI - dividends / NI) x (NI / Sales) x (Sales / Total assets) x (Total assets / Common shareholders’ equity)
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35
Q

PRAT

A
  • Profit margin
  • Retention rate
  • Asset turnover
  • Financial Leverage
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36
Q

PVGO

A
  • PVGO = P0 (intrinsic stock price) - D1 / r
  • No growth → D1 / r = E1 / r
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37
Q

FCFF

A
  • NI + NCC - WCInv + Int(1 - tax rate) - FCInv
  • CFO + Int(1 - tax rate) - FCInv
  • EBIT(1 - tax rate) + Dep - FCInv - WCInv
  • EBITDA(1 - tax rate) + Dep(tax rate) - FCInv - WCInv
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38
Q

FCFE

A
  • CFO + Net borrowing- FCInv
  • FCFF + Net borrowing- Int(1 - tax rate)
  • NI + NCC - WCInv + Net borrowing - FCInv
  • NI - (1 - DR)(FCInv - Dep) - (1 - DR)(WCInv)
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39
Q

Cases in which the FCFF model is often chosen

A
  • A levered company with negative FCFE
  • A levered company with a changing capital structure
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40
Q

Residual income valuation context

A
  • The company’s expected free cash flows are negative or difficult to predict within the analyst’s comfortable forecast horizon
  • Dividends are volatile or the company is not paying dividends
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41
Q

FCFF firm value

A
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42
Q

FCFE equity value

A
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43
Q

Constant growth FCFF

A
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44
Q

Constant growth FCFE

A
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45
Q

Two-stage FCFF

A
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46
Q

Two-stage FCFE

A
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47
Q

Method of comparables - other given names

A
  • Comparables
  • Comps
  • Guideline assets
  • Guideline companies
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48
Q

Molodovsky cycle

A

Cyclicality of P/Es due to the business cycle

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49
Q

Normalized cyclical EPS - two of several methods

A
  • Historical average EPS - Average EPS over the most recent cycle
  • Average return on equity - Average ROE for the most recent cycle times the current book value per share
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50
Q

Inverse price ratio

A
  • Earnings yield - E/P
  • Book-to-market - B/P
  • Sales-to-price - S/P
  • Cash flow yield - CF/P
  • Dividend yield - D/P
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51
Q
  • TTM
  • NTM
A
  • Trailing twelve months
  • Next twelve months (based on the average on the current and forecasted EPS)
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52
Q

Thomson first call

A
  • FY1 - current fiscal year - based on the mean of analyst’s forecasts and actual data
  • FY2 - following fiscal year - entirely forecasted
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53
Q

Yardeni Model

A
  • CEY = CBY - b x LTEG + residual
  • P/E = 1 / (CBY - b x LTEG)
  • CEY = current earning yield
  • CBY = current bond yield (Moody’s Investors Service A-rated corporation)
  • LTEG = Long-term earning growth (5 years consensus of the earnings growth rate forecast)
  • b = weight given to the 5 years earnings projection
54
Q

P/E for a company with no growth considering inflation

A
  • λ represents the percentage of inflation in costs that the company can pass through to revenue
  • ρ = r - I
55
Q

P/B based on fundamentals

A
56
Q

P/B based on the residual income valuation

A
57
Q

P/E x Net profit margin = P/S

A

Sales x Net profit margin = Net income

58
Q

P/S based on fundamentals

A
59
Q

Alternative sustainable growth rate equation

A
60
Q

Dividend displacement of earnings

A

Investors may trade future earnings to receive higher dividends now

61
Q

Trailing dividend yield

A

Calculated using the current dividend rate

62
Q

Fundamental dividend yield

A
63
Q

Value stocks

A
  • High dividend yield
  • Low P/B
  • Low P/E
64
Q

Enterprise value (EV)

A

MV of debt, common and preferred equity and minority interests - MV of cash and short-term investments

* does not necessarily equal the market value of the company

65
Q

Total invested capital (TIC)

A

Market value of debt and equity

*different definitions given to invested capital

66
Q
  • Amortization
  • Depreciation
A
  • Intangibles
  • Tangibles
67
Q
  • Global Industry Classification Standard (GICS)
  • Industry Classification Benchmark (ICB)
A
  • MSCI and S&P
  • FTSE
68
Q

Standardized unexpected earnings (SUE)

A
69
Q

Momentum Oscillators

A
  • Measures the rate-of-change of a security’s price
  • Bound within a range
70
Q

P/E-to-growth (PEG)

A

(P/E ratio) / Expected earnings growth rate

71
Q

Residual income alternative names

A
  • Abnormal earnings
  • Discounted abnormal earnings model
  • Edwards-Bell-Ohlson model
72
Q

Economic valued added (EVA)

A
  • = NOPAT - (C% x TC)
  • C% = cost of capital
  • TC = total capital = net working capital + net fixed assets OR book value of long-term debt + book value of equity
73
Q

Market value added (MVA)

A

= market value of the company - accounting book value of total capital

74
Q

Residual income model

A
75
Q

Clean surplus relation

A
76
Q

Residual income model using ROE

A
77
Q

Constant growth of residual income

A
  • g = long-term dividend growth rate
  • Current book value often captures a large portion of the firm’s equity
78
Q

Tobin’s q

A

Market value of debt and equity / Replacement cost of total assets

79
Q

Multistage RI valuation

A

PT = Premium over book value

80
Q

Multistage RI valuation where ROE fades over time

A
  • ω = persistence factor, between 0 and 1
  • 1 implies that RI will not fade
  • 0 implies that RI will not persist
81
Q

The 3 different valuation approaches

A
  • Income
  • Market
  • Asset-based
82
Q

WACC

A
83
Q

Build-up method required rate

A

ri = Risk-free rate + Equity risk premium + Size premiumi + Specific company premiumi + Industry premiumi

84
Q

Build-up method beta

A

The beta is assumed to be 0 and there might be an industry risk premium

85
Q

Build-up method context

A

Usually applied to closely held companies where the beta is not readily available

86
Q

Capitalized cash flow method - FCFF or FCFE with r - g (CCM)

A
87
Q

3 market approach methods for private company valuation

A
  • Guideline public company (GPCM) - Multiple of any trade size
  • Guideline transaction (GTM) - Multiple of entire companies
  • Prior transaction (PTM)
88
Q

CEIC

A

Closed end investment company

89
Q
  • Discount for lack of control
  • Discount for lack of marketability
A
  • DLOC = 1 - [1 / (1 + control premium)]
  • DLOM = discount in %
  • Combined discount = 1 - (1 - DLOC) x (1 - DLOM)
90
Q

Required rate of returns models and estimation issues

A
  • Size premiums
  • CAPM
  • Expanded CAPM - premium for small size and company-specific risk
  • Build up approach - beta of 1.0, industry risk premium
  • Availability of debt
  • Discount rate in an acquisition context - use the discount rate of the target
  • Discount rate adjustment for projection risk
91
Q

Strategic and financial investors

A
  • Both will normalized salaries
  • Only the strategic will consider the benefits of synergies
92
Q

FCFE versus FCFF context

A
  • If the company’s capital structure is relatively stable, using FCFE to value equity is more direct and simpler than using FCFF
  • The FCFF model is often chosen for:
    • A levered company with negative FCFE
    • A levered company with a changing capital structure
93
Q

Best approach to valuing a buyout

A
  • FCFF because it takes a control perspective
  • FCFE, trailing P/E and DDM take a minority perspective
94
Q
  • CAPM
  • Expanded CAPM
  • Build-up approach
A
  • Rf + Beta (Equity risk premium)
  • Rf + Beta (Equity risk premium) + Small stock premium + Company-specific risk
  • Rf + Equity risk premium + Small stock premium + Company-specific risk + Industry risk premium
95
Q
  • Confidence risk
  • Business cycle risk
A
  • Represent the unexpected change in the difference between the return of risky corporate bonds and government bonds
  • Represents the unexpected change in the level of real business activity
96
Q

FCInv or Capex

A

Net cash spent to maintain fixed assets

97
Q

Net Operating Assets

A
  • Net Operating Assets = Operating Assets - Operating Liabilities
  • Operating Assets = Total Assets - Cash & Investments
  • Operating Liabilities = Total Liabilities - Long-term Debt(LTD) - Current Portion of LTD
98
Q

Working capital

A
  • Operating assets minus operating liabilities
  • Receivables + inventories + prepaid expenses - payables and accrued expenses
  • *Accrued taxes but not deferred taxes
99
Q

DuPont decomposition

A
100
Q

DuPont notation

A
  • Tax burden is (Net income ÷ Pretax profit) or (NI/EBT)
  • Interest burden is (Pretax income ÷ EBIT) or (EBT/EBIT)
  • Operating profit margin or return on sales (ROS) is (EBIT /Sales)
  • Asset turnover (ATO) is (Sales /Assets)
  • Leverage ratio is (Assets/ Equity)
  • Return on assets (ROA) is (Return on sales x Asset turnover)
101
Q

The Fed model

A

The justified or fair-value P/E for the S&P 500 is the reciprocal of the 10-year T-bond yield

  • P/E = 1 / (yield of the 10-year T-bond)
102
Q
  • Absolute valuation model
  • Relative valuation model
A
  • A model that specifies an asset’s intrinsic value
  • A model that estimates an asset’s value relative to that of another asset
103
Q

Pro forma

A

Used to describe a practice or document that is provided as a courtesy and/or satisfies minimum requirements

104
Q

Adjusted beta for future value (Blume method)

A

Adjusted beta = (2/3)(Unadjusted beta) + (1/3)(1.0)

105
Q

Justified P/E

A

Based on fundamentals

106
Q

NI from EBIT and EBITDA

A
  • = (EBIT – Int) (1 – Tax rate)
  • = EBIT (1 – Tax rate) – Int (1 – Tax rate)
  • = (EBITDA – Dep – Int) (1 – Tax rate)
  • = EBITDA (1 – Tax rate) – Dep (1 – Tax rate) – Int (1 – Tax rate)
107
Q

FCFF forecasting

A

FCFF is calculated by forecasting EBIT(1 − Tax rate) and subtracting incremental fixed capital expenditures and incremental working capital expenditures

108
Q

Increase in FCInv and WCInv as a percentage of sales

A
  • Increase in FCInv = (Capex − Depreciation expense) / Increase in sales
  • Increase in WCInv = Increase in working capital / Increase in sales
109
Q

Net borrowing using the target debt ratio DR

A

Net borrowing = DR (FCInv – Dep) + DR (WCInv)

110
Q

FCFE using DR

A
  • FCFE = NI – (FCInv – Dep) – WCInv + (DR) (FCInv – Dep) + (DR) (WCInv)
  • FCFE = NI – (1 – DR) (FCInv – Dep) – (1 – DR) (WCInv)  
111
Q

FCFF with preferred dividends

A

FCFF = NI + NCC + Int (1−Tax rate) + Preferred dividends − FCInv − WCInv

112
Q

Basic EPS

A
113
Q

Diluted EPS using the if-converted method for preferred stock

A
114
Q

Diluted EPS using the if-converted method for convertible debt

A
115
Q

Diluted EPS using the treasury stock method

A
116
Q
  • Trailing dividend yield
  • Leading dividend yield
A
  • Generally calculated using the current dividend rate
  • Calculated using the forecasted dividend per share for the next year
117
Q

Harmonic mean

A
118
Q

Weighted harmonic mean

A
119
Q

Comprehensive income

A

Comprehensive income is the sum of net income and other items that must bypass the income statement because they have not been realized, including items like an unrealized holding gain or loss from available for sale securities and foreign currency translation gains or losses

120
Q

Treynor ratio

A
121
Q

M2

A
122
Q

Jensen’s alpha

A
123
Q

Growth capital

A

Growth capital (also called expansion capital and growth equity) is a type of private equity investment, usually a minority investment, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a significant acquisition without a change of control of the business

124
Q

Finding the long-term growth rate using the dividend yield

A
  • Replace D0 / P0 by the trailing dividend yield
125
Q

Finding the value of a stock with decreasing earnings

A
  • Use the Gordon growth model with a negative g
  • V0 = D0 (1 + g) / (r - g)
126
Q

High persistence factor

  • Associated with low dividend payments
A

Low persistence factor

  • Associated with significant levels of nonrecurring items
  • Associated with high dividend payments
127
Q

Violation of the clean surplus relation

A
  • Occurs when items bypass the income statement and affect equity directly
  • Ex.: Foreign currency gains and losses under the current rate method bypass the income statement and are reported under shareholders equity as currency translation adjustment
128
Q

Forward-looking equity risk premium

A

= dividend yield + long-term EPS growth rate - long-term government bond yield

129
Q
  • Justified leading P/E
  • Justified trailing P/E
A
130
Q

Joint venture

A

Both IFRS and US GAAP require the equity method of accounting for joint venture

131
Q

Forward-looking versus historical estimates

A
  • Forward-looking models use current information and expectations concerning economic and financial variables (Gordon growth model)
  • Historical estimates consist of the difference between the historical mean return for a broad-based equity market index and a risk-free rate over a given time period

CFA Level 2 COPY (14 decks)

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