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Valuation Exam Flashcards

(77 cards)

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1
Q

Goal of investor

A

find strong businesses and invest them at reasonable prices

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2
Q

Market Capitalization

A

total market value of all the company’s outstanding stock (share price*number of shares outstanding)

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3
Q

Problem with Market Cap

A

measures only the market value of a company’s equity

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4
Q

Enterprise value

A

used to get around problem with market cap. Measures how much it would cost someone to buy out all the owners of a company, pay off all debts and take out any cash left over (Equity market cap + long-term debt - cash)

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5
Q

Basic Valutaion (two parts)

A

current value of all assets and liabilities, including buildings, employees, inventories and so forth
Value the profits the business is expected to make in the future

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6
Q

What types of companies use current value of assets and liabilities?

A

Mature, stable business with a lot of growth prospects (utilities and real estate companies)

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7
Q

What types of companies use the value of the future profits?

A

Younger, with a lot of growth potential (biotechnology companies)

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8
Q

Two approaches to equity valuation

A

Ratio-based approach (relative value)

Intrinsic value approach (fundamental analysis)

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9
Q

Downside of ratio-based approach

A

requires context (competitors, history, and other info)

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10
Q

Intrinsic Value

A

projecting future cash flows. Comparing the market price of a stock with the intrinsic value to see if it is overpriced, underpriced or fair

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11
Q

Advantages of Fundamental Analysis

A

relatively easy to understand and does not require as much context

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12
Q

Disadvantage of Fundamental Analysis

A

Estimating future cash flows requires time and effort

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13
Q

Most common stock valuation approach

A

ratios between a stock’s market price and an element of the underlying company’s performance (earnings, sales, book value…etc)

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14
Q

Price/Sales (P/S)

A

Stock price / Sales per share
Hard to bump up sales, so usually pretty honest. More stable benchmark and can be be used for companies that don’t have positive earnings

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15
Q

Drawbacks of P/S ratio

A

sales may be worth a little or a lot depending on the company’s profitability (big sales, but losing money on transactions)

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16
Q

Price/Book (P/B) ratio

A

Share price / BV (equity balance on a firm’s balance sheet / number of shares outstanding)

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17
Q

Advantages of P/B ratio

A

good for conservative investors because it’s more tangible than earnings (Benjamin Graham big advocate)
Ties in with ROE- higher ROE means higher P/B

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18
Q

Drawbacks of P/B ratio

A

CV of an asset on a company’s B/S may not reflect the true value
The BV of a company doesn’t always accurately measure its true worth (esp. intangible assets)

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19
Q

Price/Earning (P/E) Ratio

A

Stock price / EPS
most popular valuation ratio
The higher the P/E ratio means investors are willing to pay more for a dollar’s worth of a company’s earnings

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20
Q

Advantages of P/E ratio

A

accounting earnings are a much better proxy for cash flow than sales
EPS results and estimates are easily available

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21
Q

Ways to use P/E ratio

A

compare it to a certain benchmark (P/E of another company or historical P/E)
Better growth prospects, lower risk, and lower capital reinvestment means higher P/E

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22
Q

Drawback of P/E ratio

A
  • It only becomes useful with context
  • Analysis can be skewed when comparing to other companies or the industry (internet P/E might be lower than rest, but the rest are overvalued)
  • Firms that have sold off a business recently can have inflated EPS which decreases P/E
  • Reported earnings can sometimes be inflated by one-time accounting charges and gains
  • Cyclical firms require more investigation
  • two kinds of P/E (forward is always lower than the trailing), Wall Street can be too optimistic at times
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23
Q

Two kinds of P/E ratios

A

Trailing- last 4 quarters

Forward- next 4 quarters

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24
Q

Price/Earnings Growth (PEG)

A

Forward P/E ratio / 5-year EPS Growth Rate

linking P/E with the company’s growth rate

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25
Drawbacks of PEG
- risk and growth often go hand in glove (fast-growing firms tend to be riskier than average) - if using PEG ration alone you are assuming that all growth is equal - firms that are able to generate growth with less capital should be more valuable, as should firms that take on less risk
26
EV/EBITDA
Enterprise Value / EBITDA Unaffected by a company's capital structure Compares value of a business, free of debt, to earnings before interest Use forecast profits rather than historical
27
Advantages of EV/EBITDA ratio
EV includes the cost of paying off debt. EBITDA measures profits before interest and before non-cash costs of depreciation and amortization
28
Drawbacks of EV/EBITDA ratio
It is harder to calculate than P/E It does not take into account the cost of assets or the effects of tax Inappropriate for comparisons of companies in different industries, as capital expenditure requirements are different
29
Yield-Based Valuation Models
We can invert P/E and get an earnings yield | Can be compared with alternative investments to see what return we can expect from each investment
30
Dividend Yield
Annual Dividend per share / market price
31
Drawbacks of Dividend Yield
- Must be careful of stocks with very high dividend yields because they might be going through financial problems that have plunged their stock price - useless for companies that don't pay a dividend (many technology stocks)
32
Cash Return
(Free Cash Flow + Net interest expense) / Enterprise Value
33
Free Cash Flow
Cash from operations - Capital expenditures
34
Net interest expense
Interest expense - interest income
35
Goal of Cash Return method
measure how efficiently the business is using its capital (equity and debt) to generate free cash flow
36
Advantages of Cash Return
Helps find cash cows trading at reasonable prices
37
Drawbacks of Cash Return
not very meaningful for banks and other firms that earn money via their balance sheets
38
Advantages of DCF model
Much more flexible than ratios Allow an investor to incorporate assumptions about factors like growth prospects, whether its profit margins are likely to expand or contract
39
DCF Model
stock's worth is equal to the present value of all its estimated future cash flows -using future sales growth and profit margins
40
What to consider when predicting revenue growth
industry trends, economic data and competitive advantages
41
Operating Leverage
as a company grows larger, it is able to spread its fixed costs across a broader base of production -should grow at a faster rate than revenue
42
What kind of cash flows are an investor going to be using?
Free cash flows | -used to be based on dividend but not every company pays dividends
43
Free Cash Flow
the cash a company has left over after spending the money necessary to keep the company growing at its current rate -estimate how much the company reinvests itself each year via capital expenditures
44
Two types of DCF models
free cash flow to equity | cash flow to the firm
45
Free cash flow to equity
cash flow available to stockholders
46
Cash flow to the firm
cash flow available to both debt and equity holders (more complicated)
47
PV of CF in Year N
CF at Year N / (1+r)^N
48
Cost of Capital
rate used to discount a company's future cash flows back to the present -company raises capital form its lenders and owners, both of them require a return on their investment
49
Types of Cost of Capital
``` Low= stable, predictable company High= risky company (future cash flows are worth less) ```
50
WACC Formula
it accounts for both the firm's cost of equity and debt | -(weight of debt)(cost of debt) + (weight of equity)(cost of equity)
51
Using Cash flow to the firm method
discounts operating earnings before interest but after taxes | -very complicated adjustments for interest and taxes
52
Cost of Debt
the interest rate a company must pay to borrow money, based on the current yield on any of the bonds the company has issued
53
Cost of Equity
determined by measuring the risk-free rate investors can achieve and an equity premium (determined by company's stock volatility) -calculation= CAPM
54
Risk factors for valuation (Fundamental risk premium)
- how cyclical the business is - how big it is - how much cash flow it generates - strength of its balance sheet - economic moat
55
Debt usually costs less than equity
True | -interest payments associated with debt are tax deductible
56
Perpetuity Value
estimate future cash flows for a certain period (5-10 years), then estimate the rest in one lump sum
57
Perpetuity Value Equation
Cash flow in last individual year estimated * (1 + g) / r - g
58
Step 1 of DCF Model
Project future cash flow - look at historical data for the past 4 or 5 years - project future cash flows - estimate the company's perpetuity year
59
Step 2 of DCF Model
Determine the discount rate | -come up with the assumed cost of equity
60
Step 3 of DCF Model
Discount Projected Free Cash Flows to Present
61
Step 4 of DCF Model
Calculate discounted perpetuity value (generally use 3%)
62
Step 5 of DCF Model
Add it all up then divide by the number of shares outstanding
63
Issues in Calculating EPS
EPS dilution Underlying earnings Normalized earnings Differences in accounting methods
64
Methods of Comparables
Industry peers Industry or sector index Broad market index Own historical values
65
Price to Book rationales and drawbacks
Book value usually > 0, more stable than EPS, appropriate for firms that will terminate and financial firms Doesn't recognize nonphysical assets, misleading if asset levels vary or differ from accounting practices, less useful when asset age differs
66
Issues in calculating Book values
intangible assets Inventory accounting Off-balance-sheet items Fair value
67
Price to Sales Rationales and Drawbacks
Sales less easily distorted, sales always positive, P/S more stable than P/E, appropriate for many firms -Sales does not equal earnings and cash flow, numerator and denominator not consistent, does not reflect cost differences
68
Measures of Cash flow
CF: Earnings + Depr. + Amortization + Depletion CFO: from statement of cash flows FCFE: most valid but volatile EBITDA: best used with enterprise value
69
Dividend Yield Rationales and Drawbacks
- A component of return, dividends less risky than future capital gains - Only one component of return, dividends may displace future earnings
70
Porter's Competitive Advantage
New entrants, supplier power, buyer power, rivalry, substitutes
71
Issues in Financial Statement Analysis
``` Nonnumerical analysis Regression to the mean Mature Firms vs. Start-ups Sources of info Quality of Earnings ```
72
Stable Dividend Discount Model
Value of stock= DPS/(k-g)
73
Two-Stage Model
Project future dividends then find perpetuity value. Add discounted versions of both together to find the value of the stock
74
What you can use to determine FCFF
Net income, EBIT and EBITDA, Cash flow from operations
75
FCFF vs. FCFE
FCFF= Cash flow available to all firm capital providers FCFE= Cash flow available to common equityholders (FCFF is preferred when FCFE is negative or when capital structure is unstable)
76
Issues in FCF Analysis
- Financial statement discrepancies - Dividends vs. FCF - Shareholder cash flows and leverage - FCFF and FCFE vs. EBITDA and net income - Country adjustments - Sensitivity analysis - Nonoperating assets
77
Issues with Gordon Growth Model
- Non applicable to non-dividend-paying firms - g must be constant - stock value is very sensitive to r-g - most firms have nonconstant growth in dividends

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