Transcript Intro to valuation

Class Business
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Upcoming Debate
Valuation Assignment
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Free-Cash Flow Valuation of Target (TGT)
Graded portions
– Pro forma projections (Wednesday, 5/25)
– Valuation and Investment recommendation
(Tuesday, 5/31)
– 7 minute presentation on valuations (Tuesday, 5/31)
Valuation Assignment
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Download Financial Data From SEC website
Construct Forecasts of Financial Statements
Use Forecasts of FS to construct forecasts of freecash flows
Construct Intrinsic Value based on free-cash flows
Recommend Investment decision based on Valuation
Integration
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Economics/Strategy
– Constructing reasonable forecasts
Accounting
– Constructing consistent forecasts
Finance
– Valuation
Intrinsic Value vs. Market Price
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Intrinsic Value (V0)
– The value you believe the security to be based on
your analysis.
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Market Value (P)
– The observed market price at which the security is
traded.
Valuation Methods:
Other Methods
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Book Value
– The net worth of common equity according to a
firm’s balance sheet.
Liquidation Value
– Net amount that can be realized by selling the
assets of a firm and paying off the debt.
Replacement Cost
– Costs to replace a firm’s assets.
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Tobin’s q: Ratio of market value of a firm to
replacement cost.
Discount Models: General Model
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V0 = Value of Stock
CFt = Cash flow at period ‘t’
k = required return
Dividend Discount Models
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V0 = Value of Stock
Dt = Dividend at period ‘t’
k = required return
Expected Dividends
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How do we get the D’s?
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Forecast total future dividends, Dt (or actually earnings, Et)
above that which is needed to maintain productive capacity
(earnings net of depreciation or NOD)
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Sound Economic Motivation
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Accounts for Macroeconomic conditions
Accounts for Industry dynamics
Accounts for firm-specific economies
Follows Accounting consistencies
This approach falls under the general category of
Fundamental Analysis
Framework of Analysis
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Fundamental Analysis
Approach to Fundamental Analysis
1. Domestic and global economic analysis
2. Industry analysis
3. Company analysis
Why use the top-down approach?
Global Economic
Considerations
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Performance in countries and regions is highly
variable
Political risk
Exchange rate risk
– Sales
– Profits
– Stock returns
Domestic Considerations
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Gross domestic product
Unemployment rates
Interest rates & inflation
Consumer sentiment
Federal Government Policy
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Fiscal Policy - government spending and taxing
actions
– Direct policy
– Slowly implemented
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Monetary Policy - manipulation of the money
supply to influence economic activity
– Initial & feedback effects
Tools of monetary policy
– Open market operations
– Discount rate
– Reserve requirements
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Economy Shocks
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Demand shock - an event that affects demand
for goods and services in the economy
– Tax rate cut
– Increases in government spending
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Supply shock - an event that influences
production capacity or production costs
– Commodity price changes
– Educational level of economic participants
Business Cycles
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Business Cycle
– Peak
– Trough
Industry relationship to business cycles
– Cyclical
– Defensive
NBER Cyclical Indicators:
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Leading Indicators - tend to rise and fall in advance of the
economy
– Avg. weekly hours of production workers
– Stock Prices
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Coincident Indicators - indicators that tend to change
directly with the economy
– Industrial production
– Manufacturing and trade sales
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Lagging Indicators - indicators that tend to follow the lag
economic performance
– Ratio of trade inventories to sales
– Ratio of consumer installment credit outstanding to
personal income
Industry Analysis
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Sensitivity to business cycles
Factors affecting sensitivity of earnings to business
cycles
– Sensitivity of sales of the firm’s product to the
business cycles
– Operating leverage
– Financial leverage
Industry life cycles