Equity Valuation: Concepts and Basic Tools

Question 1

Market Value > Intrinsic Value

Answer 1

• stock is overvalued

Question 2

Market Value = Intrinsic Value

Answer 2

• stock is fairly valued

Question 3

Market Value < Intrinsic Value

Answer 3

• stock is undervalued

Question 4

Three major categories of Equity Valuation Models

Answer 4

• present value
• multiplier models
• asset-based valuation models

Question 5

Dividend payment chronology:

Answer 5

1. declaration date
2. ex-dividend date
3. holder-of-record date
4. payment date

Question 6

Ex-dividend date

Answer 6

• cutoff date on or after which buyers are not eligible for the dividend
• ie need to own before this date

Question 7

Holder-of-record date

Answer 7

• list of sh.h who are able to receive the dividend

- usually two days after the ex dividend date

Question 8

r =

Answer 8

• cost of equity

- required rate of return on a share

Question 9

CAPM model

Answer 9

r = rfr + B(MRP)

Question 10

FCFE def

Answer 10

• the residual CF available to be distributed as dividends to common shareholders

Question 11

FCFE model is used because

Answer 11

• FCFE is a measure of a firm’s dividend-paying capacity
• can be used for non-dividend paying stocks
• not all of the available cf is distributed

Question 12

FCFE equation

Answer 12

FCFE = CFO - FCInv + net borrowing

Question 13

FCFE Model equation

Answer 13

Vo = FCFE t / (1+r) ^t

Question 14

Preferred stock valuation formula

Answer 14

Vo = Do / r

Do might = Par * dividend

• for non-callable, non-convertible perpetual pref shares

Question 15

The Gordon Growth Model

Answer 15

• dividends grow indefinitely at a constant rate

- aka the constant-growth dividend discount model

Question 16

The Gordon Growth Model formula

Answer 16

Vo = D1 / (r - g)

Question 17

To estimate g (growth rate of dividend

Answer 17

• use historic growth rate of the firm
• use the industry median g rate
• estimate the sustainable growth rate: g = b * ROE

Question 18

Sustainable growth rate formula (g)

Answer 18

g = b * ROE

b= retention rate
b = (1 - dividend payout ratio)

Question 19

Earnings retention rate formula

Answer 19

b = (1 - dividend payout ratio)

Question 20

The higher the retention rate, the higher the _____

Answer 20

higher growth rate

- ie less dividends are paid out = higher g

Question 21

Higher ROE = higher

Answer 21

g

Question 22

Price-to-book ratio

Answer 22

P/B
= Price per share / book value per share

book value per share = A - L / shares outstanding

*evidence suggests that companies with low P/B tend to outperform stocks with high P/B

Question 23

Book value per share formula

Answer 23

book value per share = A - L / shares outstanding

Question 24

Price-to-earnings ratio

Answer 24

PE = price per share / trailing 12 months EPS

*can use for trailing or leading EPS

Question 25

Price-to-sales ratio

Answer 25

P/S = price per share / sales per share * can use for trailing or leading sales per share * can never be negative unlike the PE ratio

Question 26

Price-to-cash-flow ratio

Answer 26

P/CF = price per share / cash flow per share *CFO, FCF, etc

Question 27

Justified (Forward) P/E ratio

Answer 27

Justified PE = dividend payout / r-g

Question 28

A higher payout ratio may mean a company is retaining less for reinvestment, which in turn means:

Answer 28

a slower growth rate

Question 29

Enterprise Value

Answer 29

measures the market value of the whole company (debt and equity)

Question 30

Enterprise Value formula

Answer 30

EV = market value of debt + market value of equity + market value of pref stock - cash and equivalents EV = MVD + MVE + MVP - cash and equivalents

Question 31

EBITDA

Answer 31

- earnings before interest taxes, depreciation, and amortization - a proxy for cash flow

Question 32

When is the EV/EBITDA ratio used?

Answer 32

- when earnings are negative - for comparing companies with significant differences in capital structure - to evaluate the cost of take over *MVD can be difficult to obtain

Question 33

Asset-based valuation

Answer 33

(A - L) / sh.o