Transcript Financial Statement Analysis and Security Valuation

Financial Statement Analysis
and Security Valuation
Stephen H. Penman
Prepared by
Peter D. Easton and Gregory A. Sommers
Fisher College of Business
The Ohio State University
With contributions by
Stephen H. Penman – Columbia University
Luis Palencia – University of Navarra, IESE Business School
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
14-1
Simple Forecasting and
Simple Valuation
Chapter 14
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
14-2
What you will learn in this chapter
Chapter 14
Page 455
• How simple forecasts can be made from financial
statements
• How simple forecasts give simple valuations
• When simple forecasts and simple valuations work as
reasonable approximations
• How simple forecasting works as a tool in sensitivity
analysis
• How simple valuation models work in reverse engineering
• How sensitivity analysis is done
McGraw-Hill/Irwin
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14-3
Chapter 14
Page 456
Review: The Perfect Balance Sheet
MS, Inc.
Balance Sheet, December 31, Year 0
Assets
Equities
Marketable equity
securities (at market)
NOA
Year 0
Prior
Year
23.4
20.3
23.4
Year 0
Prior
Year
Long-term debt (NFO)
7.7
7.0
Common shareholders’
equity (CSE)
15.7
13.3
23.4
20.3
20.3
With a perfect balance sheet, expected residual
earnings are zero
McGraw-Hill/Irwin
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14-4
Residual Earnings Components
Chapter 13
Page 424
Table 13.1
Net Income Component
Book Value Component
Residual Earnings Component
Operating Income (OI)
Net Operating Assets (NOA)
ReOI=OIt – (F – 1) NOAt-1
Net Financial Expense (NFE)
Net Financial Obligations (NFO)
ReNFE=NFEt – (D – 1) NFOt-1
Earnings (earn)
Common Stockholders’ Equity (CSE)
RE=earnt – (E – 1) CSEt-1
McGraw-Hill/Irwin
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14-5
Simple Forecasts: Forecasting from
Book Values (SF1)
Chapter 14
Pages 456-457
Table 14.1
Earnings
Component
Forecasts of
Earnings Components
Forecasts of Residual
Earnings Components
Operating
O I1  (  F  1) NOA0
O I1  (  F  1) NOA0  0
Financing
NFE1  (  D  1) NFO0
NFE1  (  D  1) NFO0  0
Comprehensive
e a r n1  (  E  1)CSE0
e a r n1  (  E  1)CSE0  0
MS, Inc.
Pro Forma Income Statement, Year 1
Operating income:
Interest expense:
Net income:
McGraw-Hill/Irwin
.1134 x 23.4
.10 x 7.7
.12 x 15.7
© The McGraw-Hill Companies, Inc., 2001 All rights
2.654
(.770)
1.884
14-6
SF1 Valuation
Chapter 14
Page 457
V  CSE0
E
0
NOA
0
V
McGraw-Hill/Irwin
 NOA0
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14-7
Review: The Imperfect Balance Sheet
Chapter 1
Page 459
Exhibit 14.1
PPE, Inc.
Balance Sheet, December 31 Year 0
Assets
Equities
Property, plant & equipment
(at cost less accum deprec)
Year 0
Prior
Year
74.4
69.9
Year 0
Long-term debt (NFO)
Common shareholders’
equity (CSE)
NOA
74.4
69.9
Prior
Year
7.7
7.0
66.7
74.4
62.9
69.9
PPE, Inc.
Income Statement, Year 0
Operating income
Sales of products
Cost of goods sold
(included dep. of 21.4)
Other operating expenses
Interest expense: 0.10 x 7.0
124.9
(114.6)
10.3
(0.5)
9.8
(0.7)
McGraw-Hill/IrwinNet income
© The McGraw-Hill Companies, Inc., 2001 All 9.1
rights
14-8
Simple Forecasts: Forecasting from
Earnings and Book Values (SF2)
Chapter 14
Page 458
Table 14.2
Earnings
Component
Forecasts of
Earnings Components
Forecasts of Residual
Earnings Components
Operating
O I1  OI 0  (  F  1)NOA0
O I1  (  F  1) NOA0  OI 0  (  F  1) NOA1
Financing
NFE1  NFE0  (  D  1)NFO0 NFE1  (  D  1) NFO0  NFE0  (  D  1) NFO1
Net
e a r n1  earn0  (  E  1)CSE0 e a r n1  (  E  1)CSE0  earn0  (  E  1)CSE1
PPE, Inc.
Pro Forma Income Statement, Year 1
Operating income:
Interest expense:
Net income:
McGraw-Hill/Irwin
9.8 + (.1134 x 4.5)
0.7 + (.10 x 0.7)
9.1 + (? x 3.8)
© The McGraw-Hill Companies, Inc., 2001 All rights
10.310
(.770)
9.540
14-9
SF2 Valuation
Chapter 14
Pages 459-460
Re OI 0
V  CSE0 
F 1
E
0
NOA
0
V
O I1   F  1NOA0
 NOA0 
F 1
O I1   F  1NOA0
 NOA0 

F 1
F 1
O I1

F 1
McGraw-Hill/Irwin
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14-10
Chapter 14
Page 461
Box 14.1
SF2 Valuation: Nike
Nike, Inc.
Required return for operations
Core operating income,
Net operating assets
Core residual operating income
– 1996
 1995
 1996
– 1996: 567  (0.110 x 2,208)
11.0%
$567 million
$2,208 million
$2,659 million
$324.1 million
SF2 forecast of operating income
SF2 forecast of ReOI
– 1997: 567 + (0.110 x 451)
– 1997
$616.6 million
$324.1 million
Value of common equity
E
V1996
 CSE 1996 
Re OI1996
324.1
 2,431
0.11
0.11
Value per share on 143.629 million shares
$5,377 million
$37.44
Value of operations
NOA
E
V1996
 V1996
 NFO1996  5,377 228
NOA
V1996
 NOA1996 
NOA
V1996

Re OI1996
324.1
 2,659 
0.11
0.11
OI1997 616.6

0.11
0.11
$5,605 million
$5,605 million
$5,605 million
Nike traded at $104 per share at the end of fiscal year, 1996.
McGraw-Hill/Irwin
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14-11
SF2 Valuation: Reebok
Chapter 14
Page 461
Box 14.1
Reebok International Ltd.
Required return for operations
Core operating income,
Net operating assets
Core residual operating income
– 1996
 1995
 1996
– 1996: 174  (0.101 x 1220)
10.1%
$174 million
$1,220 million
$1,135 million
$50.8 million
SF2 forecast of operating income
SF2 forecast of ReOI
– 1997: 174 + (0.101 x[- 85])
– 1997
$165.4 million
$50.8 million
Value of common equity
E
V1996
before minorit yint erestMI  CSE 1996  MI1996 
 415
Re OI1966
0.101
50.8
0.101
Value of minority interest (at 14 times 1996 MI earnings)
Value of common equity
Value per share on 55.840 million shares
$918 million
$210 million
$708 million
$12.68
Value of operations
NOA
E
V1996
 V1996
before MI  NFO1996  918  720
NOA
V1996
 NOA1996 
NOA
V1996

Re OI1996
50.8
 1,135 
0.101
0.101
OI1997
165.4

0.101
0.101
$1,638 million
$1,638 million
$1,638 million
Reebok traded at $43 per share at the end of fiscal year, 1996.
McGraw-Hill/Irwin
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14-12
Simple Forecasts: Forecasting from Current
Accounting rates of Return (SF3)
Earnings
Component
Operating
Financing
Forecasts of
Earnings Components
O I1  RNOA0  NOA0
Chapter 14
Pages 462-463
Table 14.3
Forecasts of Residual
Earnings Components
R NO A  ( 
1
F
NB C  ( 
NFE1  NBC0  NFO0
1

 1) NOA0  RNOA0  (  F  1)NOA0
D

 1) NFO0  NBC0  (  D  1)NFO0


e a r n1  ROCE 0  CSE0 R O C E1  (  E  1) CSE0  ROCE 0  (  E  1)CSE0
Net
For PPE, Inc. the current RNOA, NBC and ROCE (with beginning of year
amounts in the denominator) are 14.02%, 10.00% and 14.47% respectively
PPE, Inc.
Pro Forma Income Statement, Year 1
Operating income:
Interest expense:
Earnings:
McGraw-Hill/Irwin
.1402 x 74.4
.10 x 7.7
? x 66.7
10.431
.770
9.661
© The McGraw-Hill Companies, Inc., 2001 All rights
14-13
SF3 Forecasting:
An Adjustment for Leverage
Chapter 14
Page 463
NFO0 end 
RNOA0  NBC 0 
Adjusted ROCE 0  RNOA0 
CSE 0 end 
For PPE, Inc.,
 7.7
.1402  .10  .1448
Adjusted ROCE 0  .1402  
 66.7

earn1  .1448  66.7  9.661
McGraw-Hill/Irwin
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14-14
Valuation with Constant RNOA
Growth Rate in ReOI1 
Chapter 14
Pages 463-464
[ RNOA1   F  1]NOA0
[ RNOA 0   F  1] NOA1
If RNOA1 = RNOA0
NOA 0
Growth Rate in ReOI1 
NOA 1
If RNOA is constant for all periods,
V0E  CSE0 
RNOA0   ρF  1NOA0
V0NOA  NOA0 
ρF  g NOA
RNOA0   F  1NOA0
 F  g NOA


RNOA0  g NOA  1
 NOA0 
 F  g NOA
McGraw-Hill/Irwin
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14-15
Chapter 14
Page 466
Box 14.2
SF3 Valuation: Nike
Nike, Inc.
Cost of capital for operations
Core RNOA, 1996 (on average NOA)
Forecasted growth rate for net operating assets
Net operating assets
1996
SF3 forecast of operating income 1997: 2,659 x 23.3%
SF3 forecast of ReOI
1997
11%
23.3%
7%
$2,659 million
$619.5 million
$327.1 million
Value of common equity
E
V1996
 CSE 1996 
Re OI1997
327.1
 2,431
1.11 1.07
0.04
Value per share on 143.629 million shares
$10,607 million
$73.85
Value of operations
NOA
E
V1996
 V1996
 NFO1996  10,607  228
NOA
V1996
 NOA1996 
RNOA1996  0.11 NOA1996
1.11 1.07
0.233 0.11 g  1
 2,659
0.04
NOA
V1996
 NOA1996 
$10,835 million
RNOA1996  g  1
1.11 1.07
0.233 0.07
 2,659
0.04
McGraw-Hill/Irwin
$10,835 million
$10,835 million
© The McGraw-Hill Companies, Inc., 2001 All rights
14-16
Chapter 14
Page 466
Box 14.2
SF3 Valuation: Reebok
Reebok International Ltd.
Required return for operations
Core RNOA, 1996 (on average NOA)
Forecasted growth rate for net operating assets
Net operating assets
1996
SF3 forecast of operating income 1997: 1,135 x 14.8%
SF3 forecast of ReOI
1997
10.1%
14.8%
7.0%
$1,135 million
$168.0 million
$53.4 million
Value of common equity
E
V1996
beforeminorityinterestMI  CSE 1996  MI1996 
Re OI1996
1.101 1.07
Value of minority interest (at 14 times 1996 MI earnings)
Value per share on 55.840 million shares
$2,136 million
210 million
$1,926 million
$34.49
Value of operations
NOA
E
V1996
 V1996
beforeMI  NFO1996  2,136 720
NOA
V1996
 1,135 
NOA
V1996
 1,135 
McGraw-Hill/Irwin
0.148  0.1011,135
0.031
0.148  0.07 
0.031
$2,856 million
$2,856 million
$2,856 million
© The McGraw-Hill Companies, Inc., 2001 All rights
14-17
Chapter 14
Page 465
Table 14.4
Simple Forecasts and Simple Valuations
Simple
Forecast
Simple Valuation of the Equity
Simple Valuation of the Operations
SF1
V0E  CSE0
V0NOA  NOA0
SF2
Re OI 0
V  CSE0 
F 1
V0NOA  NOA0 
E
0

SF3
V0E  CSE0 
RNOA0   F  1 NOA0
 F  g NOA
Re OI 0
F 1
OI 1
F 1
V0NOA  NOA0 
RNOA0   F  1 NOA0
 F  g NOA


RNOA0  g NOA  1
 NOA0 
 F  g NOA
McGraw-Hill/Irwin
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14-18
Simple Valuation: PPE, Inc.
SF1:
V  66.7
SF2:
1.873
V  66.7 
 83.22
.1134
E
0
E
0
SF3:
g
NOA
 1.0644
1.994
V  66.7 
 107.39
1.1134  1.0644
E
0
McGraw-Hill/Irwin
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14-19
Chapter 14
Page 467
Simple Forecasts of
Growth in NOA
1
NOA  Sales 
ATO
If ATO is constant,
Growth in NOA  Growth in Sales 
1
ATO
Forecast growth in NOA with forecasted
sales growth rate
McGraw-Hill/Irwin
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14-20
ROCE
Group
Price-to-Book
Ratios &
ROCE 1968-85
Chapter 14
Page 469
Table 14.5
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
ROCE
(%)
P/B
43.3
28.7
23.8
21.0
19.1
17.7
16.5
15.4
14.4
13.5
12.6
11.7
10.6
9.5
8.3
6.8
4.9
2.2
-3.2
-22.5
3.43
2.57
2.20
1.89
1.65
1.45
1.36
1.25
1.16
1.10
1.06
1.00
.97
.91
.84
.80
.78
.75
.74
1.01
Based on all NYSE, AMEX and NASDAQ firms. The grouping is done each
year; the numbers reported are averages from the analysis for all years.
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14-21
Unlevered P/B on RNOA
McGraw-Hill/Irwin
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Chapter 14
Page 470
Figure 14.1
14-22
Chapter 14
Page 471
Figure 14.2(a)
Residual Operating Income
Patterns: 1965-96
0.25
0.2
Residual Operating Income (ReOI)
0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
I
0
I
1
I
2
I
3
I
4
I
5
Year Relative To Current Year
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14-23
Chapter 14
Page 471
Figure 14.2(b)
Return on Net Operating Assets
Patterns: 1965-96
40%
Return on Net Operating Assets (RNOA)
35%
30%
25%
20%
15%
10%
5%
0
-5%
-10%
I
0
I
1
I
2
I
3
I
4
I
5
Year Relative To Current Year
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14-24
Growth in Net Operating Assets
Patterns: 1965-96
Chapter 14
Page 471
Figure 14.2(c)
60%
50%
Growth in Net Operating Assets
40%
30%
20%
10%
0
-10%
-20%
I
0
I
1
I
2
I
3
I
4
I
5
Year Relative To Current Year
McGraw-Hill/Irwin
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14-25
Simple Forecasting as an Analytical
Device: Sensitivity Analysis
Chapter 14
Page 473
“As If” Questions
– Effect of changes in RNOA on forecasts and
values
– Effect of changes in PM and ATO
– Effect of changes in investment (growth in
NOA)
– Effect of leverage on forecasts of net income
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14-26
Chapter 14
Page 474
The Valuation Grid: Nike
What values are implied by different combinations of
RNOA and growth in NOA?
Valuation Grid for Nike, Inc., 1996
Required return for operations: 11%
RNOA
15%
20%
23.3%
25%
0%
23.66
32.07
37.63
40.49
4%
27.50
40.73
49.46
53.95
7%
35.44
58.58
73.85
81.72
8.39%
45.30
80.76
116.23
9%
53.95
110.23
104.00
104.00
000
130.78
Growth
In NOA
McGraw-Hill/Irwin
146.52
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14-27
Market Forecast Pairs: Nike
Chapter 14
Page 474
What combination of RNOA and growth in NOA justify the market price?
Market Forecast Pairs
Nike, Inc., 1996
Price = $104
__________________________________
RNOA
Growth in NOA
__________________________________
15%
10.15%
16
9.94
17
9.72
18
9.51
19
9.30
20
9.09
21
8.87
22
8.66
23
8.45
24
8.24
25
8.02
26
7.81
27
7.60
28
7.39
29
7.17
30
6.96
McGraw-Hill/Irwin
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