Transcript Valuation and Forecasting

HOW
FINANCIAL
STATEMENTS
ARE USED IN
VALUATION
Preface

Valuation models:
 Multiple
Analysis (The method of Comparables & Screening)
 Asset-Based Valuation
 Fundamental Analysis
 The Architecture of Fundamental Analysis
Multiple Analysis


Methods of Comparables
Screening on Multiples
 Technical
Screens
 Fundamental Screen
Price-To-Book Ratio - P/B Ratio
A ratio used to compare a stock's market value to its book
value. It is calculated by dividing the current closing price of
the stock by the latest quarter's book value per share.
Also known as the "price-equity ratio".
P/B =
Stock Price
(Total assets – Intangible Assets and Liabilities)/ No.
of Shares outstanding
Price-to-Book Ratio

Perhaps the least valuable ratio is the Price-to-Book Ratio.
Conceived in a time when world was made up mainly of
industrial companies that had actual hard assets like factories
to back up their stock, its utility has diminished in the past few
decades as more and more companies that are not very
capital intensive have grown and become commercial giants.
The fact that Microsoft doesn't have very much in the way of
book value doesn't mean the company is overvalued -- it just
means that the company does not need a lot of land and
factories to make a very high-margin product.
Price-to-Book Ratio

Traditional book value is simply the shareholders' equity
divided by the number of shares of stock outstanding. In order
to look at the company as a whole, you can use the aggregate
market capitalization of the company divided by the current
shareholders' equity.
Price-Earnings Ratio - P/E Ratio
A valuation ratio of a company's current share price compared to its per-share
earnings.
P/E =
Market Value per Share
Earnings per Share (EPS)
For example, if a company is currently trading at $43 a share and earnings over the last
12 months were $1.95 per share, the P/E ratio for the stock would be 22.05
($43/$1.95).
EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken
from the estimates of earnings expected in the next four quarters (projected or forward
P/E). A third variation uses the sum of the last two actual quarters and the estimates of
the next two quarters.
Also sometimes known as "price multiple" or "earnings multiple".
Explanation of P/E Ratio
Price –earning ratio compares current price with earning.
P/E =
Future Earnings
Current Earnings
Price the numerator is the market anticipated price is the market
anticipation of value to be added from sales in future, that is the future
earnings. The denominator is current earning , value added from
current sales. So P/E ratio compares forecasted future earnings to
current earning. If one considered more future earnings than current
earnings, the P/E ratio should be high and vice versa.
To be more concise P/E ratio reflects anticipated earning growth.
Forward Price To Earnings - Forward P/E
A measure of the price-to-earnings ratio (P/E) using forecasted earnings for
the P/E calculation. While the earnings used are just an estimate and
are not as reliable as current earnings data, there is still benefit in
estimated P/E analysis. The forecasted earnings used in the formula can
either be for the next 12 months or for the next full-year fiscal period.
Forward P/E =
Market Value per Share
Expected Earnings per Share (EPS)
Price-To-Sales Ratio - Price/Sales
A ratio for valuing a stock relative to its own past performance, other companies or
the market itself. Price to sales is calculated by dividing a stock's current price by
its revenue per share for the trailing 12 months:
PSR =
Share Price
Revenue Per Share
The ratio can also be referred to as a stock's "PSR".
The price-to-sales ratio can vary substantially across industries;
therefore, it's useful mainly when comparing similar companies. Because it doesn't
take any expenses or debt into account, the ratio is somewhat limited in the story
it tells
.
Price-To-Cash-Flow from operations Ratio
A measure of the market's expectations of a firm's future financial health. Because
this measure deals with cash flow from operations, the effects of depreciation and
other non-cash factors are removed. Similar to the price-earnings ratio, this
measures provides an indication of relative value.
P/CFO =
Share Price
Cash Flow from Operations per share
Because accounting laws on depreciation vary across jurisdictions, the price-to-cashflow ratio can allow investors to assess foreign companies from the same
industry (ex. mining industry) with a bit more ease.
Relative/Comparable Valuation
Digital
Lightwave
Price/Sales
TeleComm
Equipment
Market
Industry
2.78
1.56
1.28
-
-
64.74
Price/Book
2.06
2.90
2.53
Price/Cashflow
24.35
(23.28)
15.30
Price/Earnings
Pricing Multiples for Comparables Firms to Dell Computers
Company
Sales
Hew lett-Packard Co.
Gatew ay Inc.
45,226
6,080
Dell Com puters Corp. 31,168
Earning
Before
Extraordi
nary
Items
Book
Value
market
Value
13,953
32,963
(1,290)
1,565
1,944
1,246
4,694
624
Avearge
Multiple
for
Comparabl
es
Sales
Earning
Book value
Average valuations
P/S
P/E
P/
0.73
52.80
2.
0.32
(1.51)
1.
-
Dell's
Numbers
Dell's
Numbers
0.53
x
31,168
=
16,519
52.80
x
1,246
=
65,789
1.80
x
4,694
=
8,449
=
30,252
x
-
-
Enterprise Value

The enterprise value (EV) to shareholders' equity (SE)

EV/SE

=
(Shares Outstanding x Price) + Debt-Cash)
Shareholders' equity
This number will get you a simple multiple, much like the
price/earnings ratio or the price/sales ratio. If it is below 1,
then it means that the company is selling below book value and
theoretically below its liquidation value. Some value investors
will avoid any companies that trade above 2 times book value
or more
Enterprise Value

Enterprise
Value,
which
is
market
capitalization minus cash and equivalents plus
debt. The reason you subtract cash and
equivalents from market capitalization is
because if someone were to actually buy the
company, they would get all the cash the
company currently has, meaning it would
effectively be deducted from the cost after the
transaction was closed.
Advantages of Relative/Comparable Valuation

Relative valuation is much more likely to reflect market perceptions. This
can be an advantage when it is important that the price reflect these
perceptions as is the case when the objective is to sell a security at that
price today (as in the case of an IPO).

Relative valuation generally requires less information than discounted
cash flow valuation.

Easy to measure but chances of fallacy is relatively high.

Relative Valuation / Comparables Methods are used where similar
companies are available in the business.
(An initial public offering (IPO), referred to simply as an "offering" or "flotation", is when a company (called the
issuer) issues common stock or shares to the public for the first time. They are often issued by smaller, younger
companies seeking capital to expand, but can also be done by large privately owned companies looking to
become publicly traded.)
Disadvantages of Relative/Comparable Valuation
Relative valuation may require less information in the way in which most
analysts and portfolio managers use it. However, this is because implicit
assumptions are made about other variables (that would have been
required in a discounted cash flow valuation). To the extent that these
implicit assumptions are wrong the relative valuation will also be wrong.
(
Unlevered (or Enterprise) Multiples



Leverage involves borrowing. A given set of assets can be
financed by equity or by debt (borrowing). Hence, the balance
sheet equation, Assets = Liabilities (Debt) + Shareholders’
Equity. Some items in the financial statements have nothing to
do with the amount of debt relative to equity (the amount of
leverage). So the price multiple for this item should not reflect
the leverage. What is the price that is not affected by
leverage (the unlevered price)?
Value of the Firm = Value of Debt + Value of Equity
The unlevered value is the value of the firm – or the value of
the enterprise – that is, the value that is independent of the
amount of debt relative to equity.
Unlevered (or Enterprise) Multiples

Below are some unlevered multiples. The multiple
of sales, for example, must be an unlevered
multiple. Sometime people calculate the P/S ratio
as the price of the equity/sales. But sales are
generated by the assets of the enterprise, not by
the amount of equity. Sales are not affected by the
degree to which the assets are financed by
borrowing. So the appropriate price in the
numerator is the price of the enterprise, that is, the
price of the equity plus the price of the debt.
Unlevered Price to Sales, ebit & ebitda



Unlevered P/S
Market Value of Equity + Debt
sales
Unlevered P/ebit Market Value of Equity + Debt
ebit
Unlevered P/ebitda
Market Value of Equity + Debt
ebitda
Price-to-ebitda Ratios


Some analysts use the ratio, price/ebitda, to value shares.
Ebitda is earnings before interest, taxes, depreciation and
amortization. The use of this multiple can lead to errors.
Taxes have to be paid (but excluded in ebitda), so you should
pay less for a firm that has higher taxes. So taxes must be
taken into account in the earnings you are buying. We all wish
that we could ignore taxes, but we can’t unfortunately. And
depreciation is a real cost, just like wages expense: plants rust
and becomes obsolescent and have to be replaced.
Amortization expense can be a real cost also: patents expire
and goodwill can decline in value.
P/E Ratios and Dividends

P/E Ratios and Dividends
Trailing P/E ratios from rolling P/E and leading (or
forward) P/E ratios. It also indicates that, in
calculating standard and rolling P/E ratios, price in
the numerator should be adjusted for dividends that
have been paid.
Percentile for Common Stock Multiples
Percent
ile
P/B
Enterpris Trailing Forward
e P/B
P/E
P/E
95.00
7.90
12.70
75.00
2.90
50.00
P/S
Unlevere
P/CFO
d P/S
Unlevere Unlever
d
ed
P/ebitda P/ebit
-ve Ern's49.20
8.90
8.10
-ve CF
30.10
-ve eb
2.70
23.50
19.10
1.70
2.00
18.80
10.60
15.30
1.70
1.50
15.20
13.10
0.80
0.90
9.90
7.00
9.90
25.00
1.00
1.00
10.30
9.20
0.30
0.50
5.60
4.80
6.60
5.00
0.50
0.60
5.90
5.60
0.10
0.20
2.30
2.50
3.30
Technical Analysis

Two major types of analysis for predicting the
performance of a company’s stock
Technical Analysis / Technical screening
 Fundamental Analysis / Fundamental Screening

Technical Analysis




looks for peaks, bottoms, trends, patterns, and other factors affecting
a stock’s price movement
makes a buy/sell decision based on those factors
The world of technical analysis is huge
Hundreds of different patterns and indicators investors claim to be
successful
What is Technical Analysis?

Method of evaluating securities by analyzing
statistics generated by
 Market
activity
 Past Prices
 Volume


It does not attempt to measure intrinsic value
Instead look for patterns and indicators on charts to
determine future performance
What is Technical Analysis




Technicians believe that securities move in very
predictable trends and patterns
Trends continue until something happens to change the
trend
Until that change takes place, price levels are
predictable
Most agree that technical analysis is much more
effective when combined with fundamental analysis
The Bar Chart
The Bar Chart


Some of the most popular type of charts are bar
charts
Advantage is that it show the high, low, open and
close for each day
Technical Analysis / Technical Screening

Price Screening
Buy stock whose price drop a lot, sell whose price have increase a lot

Small Stock Screening
Buy stock with low market value and sell stock with high market value

Neglect Stock Screening
Buy stock not followed by many analysis

Seasonal Screening
Buy stock that are certain time of the year

Momentum Screening
Buy stock that have had increase in stock price

Insider Trader Screening
Get real data from SECP about the firm and then decided where to invest
Fundamental Analysis / Fundamental Screening

Price to Earning (P/E)Screening
Buy firm with low P/E ratio and sell firm with high P/E ratio

Price to Book Value (P/B) Screening
Buy firm with low P/B ratio and sell firm with high P/B ratio

Price to Cash Flow (P/CFO) Screening
Buy low price relative to cash from operations, sell high P/CFO

Price to dividend (P/D)Screening
Buy low p/d & sell high p/d
The Bar Chart
10, 25, 50, 75 and 90 percentiles of price to sales (P/S) ratios for NASDAQ firms, 1963-1998
14
10
12
25
50
90
8
6
4
2
0
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
Year
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
1970
1969
1968
1967
1966
1965
1964
1963
Source: Calculated from Standard & Poor's COMPUSTAT data.
1999 was excluded from the graph.
Price-to-sales ratio
10
75
http://screen.yahoo.com/stocks.html
Some engines rank firms on particular price ratios. For
example,
http://screen.morningstar.com/stocksearch/stockrank.html
http://www.globalfindata.com