EQUITY VALUATION:

APPLICATIONS AND PROCESSES

Presenter
Venue
Date
 VALUATION

Examining
Values of
Comparable
Assets
Estimating Estimating
Proceeds Variables
from Related to
Immediate Future
Liquidation Returns

Value
Estimate
INTRINSIC VALUE

Asset Value Given a

Complete Understanding of an
Assets Characteristics

True or Real Value

Not Always Equal

to Market Price
ESTIMATED VALUE AND MARKET PRICE

Intrinsic
Undervalued: value >
market price

Intrinsic
Fairly valued: value =
market price

Intrinsic
Overvalued: value <
market price
 ASSET MISPRICING

Efficient Market Theory:

Intrinsic value = Market price

VE P = (V P) + (VE V)

Sources of perceived mispricing

Market error
Analyst error
 USES OF EQUITY VALUATION

Is the stock under- or

Stock Selection
overvalued?

Inferring Market What does the security price say

Expectations about expectations?

Evaluating What is the effect on firm value

Corporate Events from a merger?

Fairness Is the value paid for the firm

Opinions fair?
 USES OF EQUITY VALUATION

Evaluating What is the effect on firm value

Business
Strategies of a new strategy?
Communicating How is firm value being
with Analysts and
Shareholders affected?

Appraising Private What is the value of a private

Businesses firm?

What is the value of equity

Compensation
compensation?
 THE VALUATION PROCESS

1. Understanding the Business

Industry and competitive analysis Financial statement analysis

2. Forecasting Company Performance

Forecast sales, earnings, dividends, and financial position

3. Selecting the Appropriate Valuation Model

Base selection on company characteristics

 THE VALUATION PROCESS

4. Using Forecasts in a Valuation

Use judgment in valuation application

5. Applying the Valuation Conclusions

Investment Strategic
Valuation opinions
recommendations decisions
 VALUATION MODELS

Absolute Valuation Relative Valuation

Models
Present value models
Dividend discount models
Free cash flow to equity
Free cash flow to the firm
Residual income
Asset-based models
Models
Price ratios
Price-to-earnings ratio
Price-to-book-value ratio
Price-to-cash-flow ratio
Enterprise value multiples
 PRESENT VALUE MODELS

Value of an investment = present

value of expected future benefits

Future benefits Future benefits

= dividends = free cash flow

Dt FCFEt
V0 V0
t 1 (1 r ) t
t 1 (1 r ) t
CHOOSING A VALUATION MODEL

What are the What is the

characteristics of availability and
the company? quality of data?

What is the
purpose of the
valuation?
OTHER VALUATION MODEL ISSUES

Sum-of-the-Parts Valuation

Sensitivity Analysis

Situational Adjustments
 ANALYST ROLES

Sell-Side Buy-Side
Analysts Analysts

Corporate Independent
Analysts Analysts
CHOICE OF DISCOUNTED CASH FLOW
MODELS

15
ADVANTAGES AND DISADVANTAGES
Theoretically appealing and provide
Present a direct computation of intrinsic value
Input uncertainty can lead to poor
value models estimates of value

Ratios are easy to compute and

Multiplier analysis is easily understood
Problems with selecting a peer group
models or comps

Consistent with the notion that a

Asset-based business is worth the sum of its parts
Difficulties determining market value
valuation and the value of intangible assets
 CHOICE OF DISCOUNTED CASH FLOW
MODELS

Rapidly increasing
Transition ROE = r
earnings Earnings and
Heavy reinvestment Earnings growth dividends growth
Small or no dividends slows matures
Capital reinvestment Gordon growth model
slows useful
FCFE and dividends

Growth increasing
Maturity