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CFA Level 2 > Equity > Flashcards

Flashcards in Equity Deck (57):
1

Intrinsic Value

The value of an asset given a hypothetically complete understanding of the asset's investment characteristics. Reflects the 'true' or 'real' value.

2

Rational Efficient Markets Formulation

Investors will not rationally incur the expenses of gathering information unless they expect to be rewarded by higher gross returns compared with the free alternative of accepting the market price.

3

The Valuation Process

1) Understanding the business
2) Forecasting company performance
3) Selecting the appropriate valuation model
4) Converting forecasts to a valuation
5) Applying the valuation conclusions

4

Porter's Five Forces

1) Intra-industry rivalry
2) New entrants
3) Substitutes
4) Supplier Power
5) Buyer Power

5

Qualitative Factors

Includes the company's ownership structure, it's intellectual and physical property, the terms of its intangible assets such as licenses and franchise agreements, and the potential consequences of legal disputes or other contingent liabilities.

6

Absolute Valuation Models

A model that specifies an asset's intrinsic value. Produces an estimate of value that can be compared with the asset's market price.

7

Relative Valuation Models

Estimates and assets value relative to that of another asset. Similar assets should sell at similar prices.

8

Intrinsic Value (Formula)

Intrinsic value = year-ahead dividend/(required return - expected dividend growth rate)

9

Required Return Estimate

Required return estimate = (year-ahead dividend/market price) + expected dividend growth rate

10

Expected Equity Risk Premium

Expected equity risk premium =[ (1 + expected inflation)(1 + expected growth rate in real EPS)(1 + expected growth rate in P/E) - 1 + expected income component] - expected risk free rate

11

Unlevered Beta

Unlevered Beta = [1/(1 + D/E)] x Beta of Equity

Relevered Beta = (1 + D'/E') x Unlevered Beta

12

Bond Yield Plus Risk Premium

Bond yield plus risk premium = YTM on the company's long-term debt + risk premium

13

Industry Factors

1) Industry growth rate
2) Technology and Innovation
3) Government
4) Complementary Products and Services

14

Value of Growth

Also known as the Present Value of Growth Opportunities (PVGO). Sums the expected value today of opportunities to profitably reinvest future earnings.

15

No-Growth Value Per Share

The per-share value of assets in place because of the assumption that the company is not making any new investments because none are profitable.

V = E/r

E = EPS for the period
r = required rate of return

16

Determining Present Value of Growth Opportunities (PVGO)

1) Value of the company's options to invest, captured by the word 'opportunities'
2) The flexibility to adapt investments to new circumstances and information is valuable
3) Value of the company's option to time the start, adjust the scale, or even abandon future projects

Value of no-growth company = Dividend/r

P/E = 1/r + PVGO/E

17

P/E

Forward P/E = (D/E)/r - g = (1 - b)/r - g

Trailing P/E = [D(1 + g)/E]/r - g = [(1 - b)(1 + g)]/(r - g)

18

Return on Equity (ROE)

ROE = Net Income/Shareholder's Equity

ROE = Net Income/Total Assets x Total Assets/Shareholder's Equity

ROE = Net Income/Sales x Sales/Total Assets x Total Assets/ Shareholder's Equity

19

Growth Rate (g)

g = Retention Rate x ROE

g = (net income - dividends)/net income x net income/sales x sales/total assets x total assets/ shareholder's equity

20

PRAT Model

P = Profit Margin
R = Retention Ratio
A = Asset Turnover
T = Leverage

g = PRAT

21

Free Cash Flow to the Firm

The cash flow available to the company's suppliers of capital after all operating expenses (including taxes) have been paid and necessary investments in working capital (e.g.: inventory) and fixed capital (e.g.: equipment) have been made.

22

Free Cash Flow to Equity

The cash flow available to the company's holders of common equity after all operating expenses, interest, and principal payments have been paid and necessary investments in working and fixed capital have been made.

23

Constant-Growth FFCF Model (Single Stage FFCF)

Firm Value = FFCF(1 + g)/(WACC - g)

24

FFCF Formula

FFCF = NI + Non cash charged + Int(1 - tax) - FCInv - WCInv

FFCF = CFO + Int(1 - tax) - FCInv

25

FCFE (Formula)

FFCE = FCFF - Int(1 - tax) + Net borrowing

FCFE = CFO - FCInv + Net borrowing

26

Normalized EPS

The EPS that the business could be expected to achieve under mid-cyclical conditions.

Calculated as the average EPS over the most recent full cycle (4 quarters) or
Average ROE from most recent full cycle, multiplied by the current book value per share.

27

P/E to Growth Ratio (PEG)

A calculation of a stock's P/E per percentage point of expected growth.

PEG Ratio = (P/E)/Expected earnings growth in %

Stocks with lower ratios are more attractive. Some say a number under 1 is an indicator of value.

28

Adjustments to Book Value

Some adjustments to book value:

1) Tangible book value - subtract reported intangible assets from shareholders' equity
2) Adjusting LIFO to FIFO
3) Adjust for off-balance sheet assets and liabilities

29

Price to Book Ratio

P/B = (ROE -g)/r - g

P/B = 1 + present value of expected future residual earnings/B

30

Price-to-Sales

P/S = price per share/annual net sales per share

P/S = [(Profit Margin)(Payout Ratio)(1 + g)]/(r - g)

P/S = P/E x Net profit margin

Sales x Net profit margin = Net income

Annual net sales per share = total sales - returns and customer discounts

31

Dividend Displacement of Earnings

Holding return on equity constant, dividends paid now displace earnings in all future periods.

32

Dividend Yield

D/P = (r - g)/(1 + g)

33

Enterprise Value

Total company value (market value of debt, common equity and preferred stock) minus cash and short term investments.

34

Return on Invested Capital (ROIC)

ROIC = operating profit after-tax/total invested capital

Is relevant measure of profitability because EBITDA flows to all providers if capital.

35

Total Invested Capital (TIC)

A measure of total firm value, sometimes also known as market value of invested capital - includes the market value of equity and debt, but does not deduct cash and investments.

36

Unexpected Earnings (Earnings Surprise)

UE = EPS - E(EPS)

37

Method of Average ROE P/E

EPS = Avg ROE x Est. BV

P/E = Price/EPS

38

Earnings Yield

The inverse of P/E, the Earnings Yield helps compare companies with negative earnings. The lower the ratio, the richer the valuation.

39

Residual Income

Net income less a charge for common shareholders' opportunity cost in generating net income. It is the residual remaining income after considering the costs of all of a company's capital. The residual income modem analyzes the intrinsic value of equity as the sum of 1) current book value of equity 2) the present value of expected future residual income.

40

Capital Charge

Takes the perspective of all providers of capital.

Equity capital x after-tax cost of debt + equity capital x cost of equity

41

Economic Value Add (EVA)

EVA = NOPAT - (C% x TC)

C% = cost of capital
TC = Total Capital

42

Tobin's Q

Tobin's q = market value of debt and equity/replacement cost of total assets

43

Continuing Residual Income

Residual income after the forecast horizon. Should be based on the ability to explicitly forecast inputs in the model.

44

Private Company Valuation Approaches

1) Income Approach
2) Market Approach
3) Asset-Based Approach

45

Capitalized Income Method

Values a private company by using a single representative estimate of economic benefits and dividing that by an appropriate capitalization rate to derive an indication of value.

46

Excess Earnings Method (EEM)

Involves estimating the earnings remaining after deducting amounts that reflect the required returns to working capital and fixed assets.

47

Discount for Lack of Control

DLOC = 1 - [1/(1 + Control Premium)]

48

Fama French Model

The idea that small-cap stocks might generate higher returns in the long run. The Fama French model addresses perceived weaknesses in the CAPM with multifactors in the model. Excess return on the market, excess return small cap stocks, and excess return on low book to market stocks.

49

Fama French Model

The idea that small-cap stocks might generate higher returns in the long run. The Fama French model addresses perceived weaknesses in the CAPM with multifactors in the model. Excess return on the market, excess return small cap stocks, and excess return on low book to market stocks.

50

Fama French Model

The idea that small-cap stocks might generate higher returns in the long run. The Fama French model addresses perceived weaknesses in the CAPM with multifactors in the model. Excess return on the market, excess return small cap stocks, and excess return on low book to market stocks.

51

Justified Price Multiple

The estimated fair value of that multiple, which can be justified on the basis of the method of comparables or the method of forecasted fundamentals.

52

Look-Ahead Bias

The use of information that was not contemporaneously available in computing a quantity.

53

Justified Price Multiple

The estimated fair value of that multiple, which can be justified on the basis of the method of comparables or the method of forecasted fundamentals.

54

Look-Ahead Bias

The use of information that was not contemporaneously available in computing a quantity.

55

Persistence Factor

High Persistence is associated with low dividend payments.

Low Persistence is associated with significant levels of nonrecurring items.

56

Confidence Risk

Represents the unexpected change in the difference between the return of risky corporate bonds and corporate bonds.

57

Business Cycle Risk

Represents the unexpected change in the level of real business activity.