SMF ratios

How to calculate DCF

First project FCF for first five years which is EBIT(1-tax rate) + d&A - change in working capital - capital expenditure. Then calculate terminal value using terminal multiple method or perpetuity method which is FCf in the fifth year (1+ g) / (WACC- g) WACC is the discount rate and growth rate is GDP/inflation rate Discount cash flows back to the starts cash flow year / (1 +WACC) to the power of the year

Sortino Ratio

For example, assume Mutual Fund X has an annualized return of 12% and a downside deviation of 10%. Mutual Fund Z has an annualized return of 10% and a downside deviation of 7%. The risk-free rate is 2.5%. The Sortino ratios for both funds would be calculated as: Mutual Fund X Sortino = (12% - 2.5%) / 10% = 0.95 Mutual Fund Z Sortino = (10% - 2.5%) / 7% = 1.07 Even though Mutual Fund X is returning 2% more on an annualized basis, it is not earning that return as efficiently as Mutual Fund Z, given their downside deviations. Based on this metric, Mutual Fund Z is the better investment choice. The Sortino ratio is a variation of the Sharpe ratio that differentiates harmful volatility from total overall volatility by using the asset's standard deviation of negative asset returns, called downside deviation. The Sortino ratio takes the asset's return and subtracts the risk-free rate, and then divides that amount by the asset's downside deviation. The ratio was named after Frank A. Sortino. Just like the Sharpe ratio, a higher Sortino ratio is better. When looking at two similar investments, a rational investor would prefer the one with the higher Sortino ratio because it means that the investment is earning more return per unit of bad risk that it takes on.

how to know which multiples to use and which companies to compare

Global Industry Classification Standard (GICS) recently developed by Morgan Stanley Capital International and Standard & Poor's. The appropriate selection of a relevant peer universe is critical for a Comps analysis, because it plays a significant role in the valuation of the target company. For example, a company could sometimes be compared across two different industries due to the nature of the business (e.g. an internet retail company). Similarly, some comparable companies might need to be ruled out or adjusted because it owns businesses across several different industry groups. Peer universe selection is therefore somewhat subjective. When doing a Comps valuation, the analyst can choose to use either trailing (historical) performance metrics, or future (forecast) performance metrics. (Note that many analyses will look at both historical and future metrics.) In general future metrics are preferred, but one needs to be careful with this. For example, projected EBITDA and projected Earnings/EPS are subject to all kinds of potential pitfalls associated with forecasting. The forecast numbers may end up being significantly off. Additionally, when performing a Comps analysis you may want to adjust the performance for various one-time charges and non-recurring items (such as a sale of assets, a one-time legal expense, or a restructuring charge). It is important that all companies in the analysis use "clean" numbers to provide an "apples-to-apples" comparison. This becomes especially difficult when using future performance metrics, as the non-recurring items may be as-yet unknown. P/S - used for new companies, growing fast but not much earnings yet P/Book - Financial companies,, balance sheets are primarily composed of liquid assets that often approximate market values Cash flow multiples- more difficult than earnings multiples to be manipulated

How to calculate WACC

WACC represents the blended cost to both debt holders and equity holders of a firm based on the cost of debt and cost of equity for that specific firm. (E/ P + D + E)(Ke) + (D/P+D+E)(Kd)(1-Tx) + (P/P+D+E)(Pe)

Why not use DCF for financial sector

We noted earlier that financial service firms are constrained by regulation in both where they invest their funds and how much they invest. If, as we have so far in this book, define reinvestment as necessary for future growth, there are problems associated with measuring reinvestment with financial service firms. Note that, we consider two items in reinvestment - net capital expenditures and working capital. Unfortunately, measuring either of these items at a financial service firm can be problematic. Consider net capital expenditures first. Unlike manufacturing firms that invest in plant, equipment and other fixed assets, financial service firms invest primarily in intangible assets such as brand name and human capital. Consequently, their investments for future growth often are categorized as operating expenses in accounting statements. Not surprisingly, the statement of cash flows to a bank show little or no capital expenditures and correspondingly low depreciation. With working capital, we run into a different problem. If we define working capital as the difference between current assets and current liabilities, a large proportion of a bank's balance sheet would fall into one or the other of these categories. Changes in this number can be both large and volatile and may have no relationship to reinvestment for future growth. As a result of this difficulty in measuring reinvestment, we run into two practical problems in valuing these firms. The first is that we cannot estimate cash flows without estimating reinvestment. In other words, if we cannot identify how much a company is reinvesting for future growth, we cannot identify cash flows either. The second is that estimating expected future growth becomes more difficult, if the reinvestment rate cannot be measured.

P/S

Abbreviated as the P/S ratio or PSR, the price-to-sales ratio is also known as a "sales multiple" or "revenue multiple." if the forward p/s is less than current could be a sign of predicted increase in cash flows

IPO

An IPO is the first sale of stock in a previously private company to the public markets. This is known as "going public." The IPO process is incredibly complex and investment banks charge large fees to lead companies through it. Companies IPO for a number of reasons including raising capital, cashing out for the original owners and investors, and employee compensation. Some negatives for "going public" include sharing future profits with the public investors, loss of confidentiality, loss of control, IPO expenses to investment banks, legal liabilities, etc.

How a company raises stock price

Any type of positive news about the company could potentially raise the stock price. If the company repurchases stock, it lowers the shares outstanding, raises the EPS which will raise the stock price. A repurchase is also seen as a positive signal in the market. A company could also announce a change to its organizational structure like cost-cuts or consolidations or they could announce an accretive merger or acquisition that will increase their earnings per share. Any of these occurrences would most likely raise the company' s stock price.

Valuing a company using comparable technique

Average multiple from comparable companies (based on size, industry, etc), multiplied by the operating metric of the company you are valuing o Most common multiple is Enterprise Value/EBITDA o Others include Price/Earnings, PEG, EV/EBIT, Price/Book, EV/Sales o Different multiples may be more or less appropriate for specific industries o For example, if comparable company A is trading at an EV/EBITDA multiple of 6.0x, and the company you are valuing has EBITDA of $100 million, their EV would be valued at $600 million based on this valuation technique.

Why use DDM over DCF

CF how would you split between operating result and financial result for a bank? You can't. So how do you compute FCF? You can't. WACC: how do you compute cost of debt? They will have at least 100 different types of debt including 50 types of savings accounts and there is no way you can reasonably forecast how they would react to a change in target capital structure. Target capital structure: For banks, equity ratios are based on risk weighted assets rather than assets. So how do you set a target d/e ratio? You can't.

Cost of debt

Calculating cost of debt (Rd), on the other hand, is a relatively straightforward process. To determine the cost of debt, use the market rate that a company is currently paying on its debt. If the company is paying a rate other than the market rate, you can estimate an appropriate market rate and substitute it in your calculations instead.

Different types of cash flows - operations, financing, investing

Cash flow from operations is the cash generated from the normal operations of a company. The cash flow from investing is the change in cash due to outside occurrences such as the purchase or sale of Property, Plant and Equipment, or any other investments. Cash flow from financing involves the increase or decrease in cash due to the issuance or repurchase/repayment of equity and debt.

Free cash flow for the first 5 years

EBIT (1- tax rate) - capital expenditure - change in working capital + Depreciation + Amortisation

What kind of an investment would have a negative beta?

Gold reacts opposite to the market

Leverage ratio - debt/EBITDA

How many ebitda needed until you pay off debt, over 3 = dangerous territory

DCF

What is a 'Discounted Cash Flow (DCF)' Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity. DCF analyses use future free cash flow projections and discounts them, using a required annual rate, to arrive at present value estimates. A present value estimate is then used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one. Calculated as: DCF = [CF1/(1+r)1] + [CF2/(1+r)2] + ... + [CFn/(1+r)n] CF = Cash Flow r= discount rate (WACC) When it comes to assessing the future value of investments, it is common to use the weighted average cost of capital (WACC) as the discount rate and use 2% as the growth *LOOK AT EXAMPLE ON INVESTOPDEIA*

Minority Interest

noncontrolling interest (NCI), is ownership of less than 50% of a company's equity by an investor or another company. Minority interest shows up as a noncurrent liability on the balance sheet of companies with a majority interest in a company, representing the proportion of its subsidiaries owned by minority shareholders. In accounting terms, if a company owns a minority interest in another company but only has a minority passive position, for example it is unable to exert influence holding only less than 20% of the subsidiary's voting stock, then only dividends received from the minority interest are recorded from this investment. This is referred to as the cost method; the ownership stake is treated as an investment at cost and any dividends received are treated as dividend income. The alternative accounting method for a minority interest is referred to as the equity method, where the company has a minority active position, such as being able to exert influence by having greater than 20% but less than 50% of the voting shares. Both dividends and a percent of income are recorded on the company's books. Dividends are treated as a return of capital, decreasing the value of the investment on the balance sheet. The percentage of income the minority interest is entitled to from the company is added to the investment account on the balance sheet as it effectively increases its equity share in the company. The parent company with the majority interest owns greater than 50% but less than 100% of a subsidiary's voting shares and recognizes a minority interest on its financial statements. The parent company consolidates the financial results of the subsidiary with its own, and as a result, a proportional share of income shows up on the parent company's income statement attributable to the minority interest. Likewise, a proportional share of equity in the subsidiary company shows up on the parent's balance sheet attributable to the minority interest. The minority interest can be found in the noncurrent liability section or equity section of the parent company's balance sheet under U.S. GAAP rules. Under IFRS, however, the minority interest must be recorded in the equity section of the balance sheet. Example of Minority Interest ABC Corporation owns 90% of XYZ Inc., which is a $100 million company. ABC records a $10 million minority interest as a noncurrent liability to represent the 10% of XYZ Inc. it does not own. XYZ Inc. generates $10 million in net income, so ABC recognizes $1 million, or 10% of $10 million, of net income attributable to minority interest on its income statement. Correspondingly, ABC marks up the $10 million minority interest by $1 million on the balance sheet. The minority interest investors do not record anything unless they receive dividends, which are booked as income.

s&P 500

18.4

ROIC

A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. Return on invested capital gives a sense of how well a company is using its money to generate returns. Comparing a company's return on capital (ROIC) with its weighted average cost of capital (WACC) reveals whether invested capital is being used effectively. One way to calculate ROIC is: (Net income - dividends) / total capital

Credit Default Swap

A credit default swap is essentially insurance on a company's debt and is a way to insure that an investor will not be hurt in the event of a default.

DDM

A stock that grows too quickly will end up distorting the basic Gordon-growth DDM formula, possibly even creating a negative denominator and causing a stock's value to read negative. There are other DDM methods that help mitigate this issue. The dividend discount model (DDM) is a procedure for valuing the price of a stock by using the predicted dividends and discounting them back to the present value. If the value obtained from the DDM is higher than what the shares are currently trading at, then the stock is undervalued. Dividend per share/ (Discount rate - Dividend growth rate) For example, Company X paid a dividend of $1.80 per share this year. The company expects dividends to grow in perpetuity at 5% per year, and the company's cost of equity capital is 7%. The $1.80 divided is the dividend for this year and needs to be adjusted by the growth rate to find D(1), the estimated dividend for next year. This calculation is: D(1) = D(0) x (1 + g) = $1.80 x (1 + 5%) = $1.89. Next, using the GGM, Company X's price per share is found to be D(1) / (r - g) = $1.89 / ( 7% - 5%) = $94.50. While this method of DDM is widely used, it has two well-known shortcomings. The model assumes a constant dividend growth rate in perpetuity. This assumption is generally safe for very mature companies, but newer companies have fluctuating dividend growth rates in their beginning years. The second flaw of this DDM is that the output is very sensitive to the inputs. For example, in the Company X example above, if the dividend growth rate is lowered 10% to 4.5%, the resulting stock price is $75.24 (over a 20% reduction in the $94.50 price).

Cost of equity

Cost of equity (Re) can be a bit tricky to calculate, since share capital does not technically have an explicit value. When companies pay debt, the amount they pay has a predetermined associated interest rate that debt depends on size and duration of the debt, though the value is relatively fixed. On the other hand, unlike debt, equity has no concrete price that the company must pay. Yet, that doesn't mean there is no cost of equity. Since shareholders will expect to receive a certain return on their investment in a company, the equity holders' required rate of return is a cost from the company's perspective, since if the company fails to deliver this expected return, shareholders will simply sell off their shares, which leads to a decrease in share price and in the company's value. The cost of equity, then, is essentially the amount that a company must spend in order to maintain a share price that will satisfy its investors.

Enterprise value

Enterprise value is the value of a firm as a whole, to both debt and equity holders. In order to calculate enterprise value you take the market value of equity (AKA the company' s market cap), add the debt, add the value of the outstanding preferred stock, add the value of any minority interests the company owns and then subtract the cash the company currently holds. There are a few reasons for subtracting cash from Enterprise Value. First off, cash is already accounted for within the market value of equity. You also subtract cash because you can either use that cash to pay off some of the debt, or pay yourself a dividend, effectively reducing the purchase price of the company.

Operating leverage

Operating leverage is the relationship between a company' s fixed and variable costs. A company whose costs are mostly fixed has a high level of operating leverage. Because businesses with higher operating leverage do not proportionately increase expenses as they increase sales, those companies may bring in more revenue than other companies. However, businesses with high operating leverage are also more affected by poor corporate decisions and other factors that may result in revenue decreases.

Different indexes

S&P 500- 500 stocks based on market cap Dow Jones- 20 stocks, based on price system Nasdaq- those 4000 stocks that trade on Nasdaq stock market, mainly tech, based on market cap

3 components of statements of cash flows

cash from operations, cash from financing , cash from investing

20-22 p/e ratio

consumer discretionary, consumer staples, energy, IT

Leverage ratio - interest coverage ratio EBIT/interest expense

does company have enough capital to pay interest expenses should aim for 3:1

15 p/e ratio

financials(around 18 or 19), healthcare, telecom and utilities

How would a $10 increase in depreciation in year 4 affect the DCF valuation of a company?

it would decrease EBIT by 10(1-tax rate) if there was a 40% tax rate then the EBIT would decrease by 6 but FCF would increase when you add back depreciation so that would increase by 10. Therefore valulation will increase by present value of that 4

PEG

though a broad rule of thumb is that a PEG ratio below one is desirable. If a company has a low p/e ratio and then a peg ratio of above 1 it probably does not have a high enough growth rate to justify a low p/e. The price/earnings to growth ratio (PEG ratio) is a stock's price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock's value while taking the company's earnings growth into account, and is considered to provide a more complete picture than the P/E ratio. pe/ratio / earnings per share growth rate low peg ratio may be undervalued if they have high p/e ratio and high growth rate they will have a lower peg ratio so the high p/e ratio is justified

P/E ratio

valuing a company that measures its current share price relative to its per-share earnings. Sometimes known as the price multiple or the earnings multiple. Market Value per Share / Earnings per Share What is the 'Price-Earnings Ratio - P/E Ratio' The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio is also sometimes known as the price multiple or the earnings multiple. The P/E ratio can be calculated as: Market Value per Share / Earnings per Share In essence, the price-earnings ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company's earnings. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. A low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends. When a company has no earnings or is posting losses, in both cases P/E will be expressed as "N/A." Though it is possible to calculate a negative P/E, this is not the common convention.

FCF- free cash flow?

Operating cash flow - capital expenditures

Enterprise Multiple (EV/EBITDA)

*takes into account debt *EV = (market capitalization) + (value of debt) + (minority interest) + (preferred shares) - (cash and cash equivalents). *EBITDA = earnings before interest tax depreciation and amortisation *undervalued - low *low is good for mergers and acquisitions *forward higher than current - decline in future earnings

Beta

A beta of 1 indicates that the security's price moves with the market. A beta of less than 1 means that the security is theoretically less volatile than the market. A beta of greater than 1 indicates that the security's price is theoretically more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Conversely, if an ETF's beta is 0.65, it is theoretically 35% less volatile than the market. Therefore, the fund's excess return is expected to underperform the benchmark by 35% in up markets and outperform by 35% during down markets. Many utilities stocks have a beta of less than 1. Conversely, most high-tech, Nasdaq-based stocks have a beta of greater than 1, offering the possibility of a higher rate of return, but also posing more risk. For example, as of May 31, 2016, the PowerShares QQQ, an ETF tracking the Nasdaq-100 Index, has a trailing 15-year beta of 1.27 when measured against the S&P 500 Index, which is a commonly used equity market benchmark. What is 'Beta' Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns. Beta is also known as the beta coefficient. Calculating 'Beta' Beta is calculated using regression analysis. Beta represents the tendency of a security's returns to respond to swings in the market. A security's beta is calculated by dividing the covariance the security's returns and the benchmark's returns by the variance of the benchmark's returns over a specified period. Using Beta A security's beta should only be used when a security has a high R-squared value in relation to the benchmark. The R-squared measures the percentage of a security's historical price movements that could be explained by movements in a benchmark index. A beta of 1.2 means that an investment will theoretically be 20% more volatile than the market. If the market goes up 10%, that investment should go up 12%.

Company's capital structure

A company' s capital structure is made up of debt and equity, but there are different levels of each. Debt can be broken down into senior, mezzanine and subordinated, with senior being paid off first in the event of bankruptcy, then mezzanine, then subordinated. Since senior is paid off first, it will have a lower interest rate. Equity can also be broken down into preferred stock and common stock. Preferred stock is like a combination of debt and equity in that it has the opportunity for some appreciation in value, but more importantly pays out a consistent dividend, that is not tied to the market price of the stock. Common stock is the final piece of the capital structure, and is the stock that is traded on the exchanges. In the event of bankruptcy, the common stockholders will have the last right to assets in the event of liquidation, and therefore are bearing the highest level of risk. Due to this they will demand the highest return on their investment.

WACC

A firm's WACC is the overall required return for a firm. Because of this, company directors will often use WACC internally in order to make decisions, like determining the economic feasibility of mergers and other expansionary opportunities. WACC is the discount rate that should be used for cash flows with risk that is similar to that of the overall firm. Formula for Weighted Average Cost Of Capital (WACC) Where: Re = cost of equity A firm's WACC is the overall required return for a firm. Because of this, company directors will often use WACC internally in order to make decisions, like determining the economic feasibility of mergers and other expansionary opportunities. WACC is the discount rate that should be used for cash flows with risk that is similar to that of the overall firm. Suppose that lenders requires a 10% return on the money they have lent to a firm, and suppose that shareholders require a minimum of a 20% return on their investments in order to retain their holdings in the firm. On average, then, projects funded from the company's pool of money will have to return 15% to satisfy debt and equity holders. The 15% is the WACC. If the only money in the pool was $50 in debt holders' contributions and $50 in shareholders' investments, and the company invested $100 in a project, to meet the lenders' and shareholders' return expectations, the project would need to generate returns of $5 each year for the lenders and $10 a year for the company's shareholders. This would require a total return of $15 a year, or a 15% WACC. For example, suppose that a company yields returns of 20% and has a WACC of 11%. This means the company is yielding 9% returns on every dollar the company invests. In other words, for each dollar spent, the company is creating nine cents of value. On the other hand, if the company's return is less than WACC, the company is losing value. If a company has returns of 11% and a WACC of 17%, the company is losing six cents for every dollar spent, indicating that potential investors would be best off putting their money elsewhere.

Why might there be multiple valuations for a single company

Each method of valuation will each give a different value of a given company. The reason for these differences is due to different assumptions, different multiples, or different comparable companies and/or transactions. Generally, the precedent transaction methodology and discounted cash flow methodology will give a higher valuation than the comparable companies analysis or market valuation. This is because a prior transaction will include a "control premium" over the company' s market value to entice shareholders to sell, and will account for the "synergies" that may occur when the two companies become one. The DCF will also normally produce a higher valuation than the comparable companies due to the fact that when an analyst makes their projections and assumptions for a company' s future cash flows, they are usually somewhat optimistic.

Goodwill

Goodwill is an intangible asset found on a company' s balance sheet. Goodwill may include things like intellectual property rights, a brand name, etc. Usually goodwill is acquired when purchasing a firm, in that the acquirer pays a higher amount for the firm than the book value of its assets. If an event occurs that diminishes the value of these intangible assets, the assets must be "written down" in a process much like depreciation. Goodwill is then subtracted as a non-cash expense and therefore reduces net income.

how would you calculate discount rate for all equity model

If a firm is all equity, then you would use CAPM to calculate the cost of equity, and that would be the discount rate.

What happens to FCF if working capital increases

Intuitively, you can think of working capital as the net dollars tied up to run the business. As more cash is tied up (either in Account Receivable, Inventory, etc.), there will be less free cash flow generated. Since you subtract the Change in Net Working Capital in the calculation of Free Cash Flow, if Net Working Capital increases, your Free Cash Flow will decrease.

Net working capital

Net Working Capital is equal to Current Assets minus Current Liabilities. It is a measure of how able a company is able to pay off its short term liabilities with its short term assets. A positive number means they can cover their short term liabilities with their short term assets. If the number is negative, the company may run into trouble paying off their creditors which could result in bankruptcy if their cash reserves are low enough.

Preference shares

Preference shares, more commonly referred to as preferred stock, are shares of a company's stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, the shareholders with preferred stock are entitled to be paid from company assets first. Most preference shares have a fixed dividend, while common stocks generally do not. Preferred stock shareholders also typically do not hold any voting rights, but common shareholders usually do.

R-squared

R-squared is a statistical measure that represents the percentage of a fund or security's movements that can be explained by movements in a benchmark index. For example, an R-squared for a fixed-income security versus the Barclays Aggregate Index identifies the security's proportion of variance that is predictable from the variance of the Barclays Aggregate Index. The same can be applied to an equity security versus the Standard and Poor's 500 or any other relevant index.

Leverage ratio - Debt to capital

Shows how company is financing operations all long term and short term obligations over shareholder's equity + debt Higher the ratio the more debt company uses to finance operations

Spreading comps

Spreading comps is the process of calculating relevant multiples from a number of different comparable companies and summarizing them for easy analysis/comparison.

Sharpe ratio

The Sharpe ratio has become the most widely used method for calculating risk-adjusted return; however, it can be inaccurate when applied to portfolios or assets that do not have a normal distribution of expected returns. Many assets have a high degree of kurtosis ('fat tails') or negative skewness. Sharpe ratio = (Mean portfolio return − Risk-free rate)/Standard deviation of portfolio return The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return. The Sharpe ratio can also help explain whether a portfolio's excess returns are due to smart investment decisions or a result of too much risk. Although one portfolio or fund can enjoy higher returns than its peers, it is only a good investment if those higher returns do not come with an excess of additional risk. A variation of the Sharpe ratio is the Sortino ratio, which removes the effects of upward price movements on standard deviation to measure only return against downward price volatility and uses the semivariance in the denominator.

Levered vs unlevered Beta

The levered beta will be the beta you get from a website like yahoo finance. By unlevering the beta, you are removing the financial effects from leverage (debt in the capital structure). This unlevered beta shows you how much risk a firm' s equity has compared to the market. Comparing unlevered betas allows an investor to see how much risk they will be taking by investing in a company' s equity (ie buying stock in the public market). When you have a Company A that doesn' t have a beta, you can find comparable Company B, take their levered beta, unlever it, and then relever it using the Company A' s capital structure to come up with their beta.

What is market risk premium

The market risk premium is the required return that investors require for investing in stocks over investing in "risk free" securities. It is calculated as the average return on the market (around 12-13%)- the risk free rate (current yield on a 10 year treasury)

Leverage ratio - Debt to equity

The portion of debt and equity uses to finance assets company's total liabilities over shareholder's equity high ratio - aggressive financing through debt The financial industry, for example, typically has a higher debt-to-equity ratio. This is due to the fact that banks and other financial institutions borrow money to lend money, which results in a higher debt-to-equity ratio. Other industries that are highly capital intensive, such as services, utilities and the industrial goods sector, also tend to have higher debt-to-equity ratios.

P/B

The price-to-book ratio (P/B Ratio) is 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". Calculated as: P/B Ratio = Market Price per Share / Book Value per Share where Book Value per Share = (Total Assets - Total Liabilities) / Number of shares outstanding A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware that this varies by industry. This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately. Due to accounting conventions on treatment of certain costs, the market value of equity is typically higher than the book value of a company, producing a P/B ratio above 1. Under certain circumstances of financial distress, bankruptcy or expected plunges in earnings power, a company's P/B ratio can dive below 1. Because accounting principles do not recognize brand value and other intangible assets, unless they are derived through acquisitions, all costs associated with creating intangible assets are expensed immediately. For example, research and development (R&D) costs must be expensed, reducing a company's book value. However, these R&D outlays can create unique production processes for a company, or result in patents that can bring royalty revenues going forward. While accounting principles favor a conservative approach in capitalizing costs, market participants may raise the stock price as a result of such R&D efforts, resulting in wide differences between the market and book values of equity. Also, P/B ratios can be less useful for services and information technology companies with little tangible assets on their balance sheets.

Would a public or private comapny be priced higher?

The public company will be priced higher for a few reasons. The main reason is the liquidity premium an investor would be willing to pay for the ability to quickly and easily trade their stock on the public exchanges. A second reason would be a sort of "transparency premium" an investor would pay since the public company is required to file their financial documents publicly.

P/CF

The ratio takes into consideration a stock's operating cash flow (OCF) which adds non-cash earnings, such as depreciation and amortization, to net income. It is especially useful for valuing stocks that have positive cash flow but are not profitable because of large non-cash charges. share price/cash flow per share The price-to-cash-flow ratio measures how much cash a company generates relative to its stock price, rather than what it records in earnings relative to stock price as measured by the price-earnings ratio. The price-to-cash-flow ratio is said to be a better investment valuation indicator than the price-earnings ratio, due to the fact that cash flows cannot be manipulated easily, as opposed to earnings, which are affected by depreciation and other non-cash items. For example, consider a company with a share price of $10 and 100 million shares outstanding. The company has net income of $125 million in a given year, and operating cash flow (OCF) of $200 million. Its cash flow per share is, therefore, $200 million / 100 million shares = $2. The company's earnings per share (EPS) can be calculated as $125 million / 100 million shares = $1.25. The company, therefore, has a price-to-cash-flow ratio of share price of $10 / cash flow per share of $2 = 5, and a price-earnings ratio of $10 / $1.25 = 8. This means that the company's investors are willing to pay $5 for every dollar of cash flows. The Price-to-Free Cash Flow ratio, which takes into account free cash flow (FCF) - or cash flow minus capital expenditures - is a more rigorous measure than the price-to-cash-flow ratio The optimal level of this ratio depends on the sector in which a company operates, and its stage of maturity. A new and rapidly growing technology company, for instance, may trade at a much higher ratio than a utility that has been in business for decades. This is because although the technology company may only be marginally profitable, investors will be willing to give it a higher valuation because of its growth prospects. The utility, on the other hand, has stable cash flows but few growth prospects, and as a result trades at a lower valuation.

In the CAPM model where do you find the risk free rate

The risk free rate is usually the current yield on the 10 year government treasury which can be found on the front page of The Wall Street Journal, on Yahoo! Finance, etc. This is considered "risk free" because the US Government is considered to be a risk-free borrower. CAPM is return on equity or cost of equity of a company required return

When should a company issue stock rather than debt to fund its operations?

There are a number of reasons a company may issue stock rather than debt to fund its operations. First, if it believes its stock price is inflated, it can issue stock and receive a high price for the shares. If the projects for which the money is being raised may not generate predictable cash flows in the immediate future, the company may have a difficult time paying the consistent coupon payments required by the issuance of debt. The company could also choose to issue stock if they want to adjust the debt/equity ratio of their capital structure.

how to analyse financial companies

Three of the most common valuation metrics used by analysts evaluating financial firms are price/earnings to growth (PEG) ratio, price to book (P/B) ratio and return on investment capital (ROIC). Of these, the P/B ratio is possibly the valuation method most commonly used by analysts. The average P/B ratio for the financial services sector is approximately 1.8, a bit below the market average.

What to do with excess cash on balance sheet

While at first you may think having a lot of cash on hand would be a good thing, especially in this economy, there is an opportunity cost to holding cash on the balance sheet. A company should have enough cash to protect itself from bankruptcy in a downturn, but above that level the cash should be used in one way or another. The main ways a company could use its cash would be to either reinvest into the firm (whether it be equipment, employees, marketing, etc) or the company could pay out the excess earnings/cash in the form of a dividend to its equity holders. A growing company will tend to reinvest rather than paying a dividend. Other ways the cash could be spent would include paying off debt, repurchasing equity, or buying out a competitor/supplier/distributor.

Precedent transactions

With this valuation technique you need to find historical transactions that are similar to the transaction in question. This includes the size of the company, the industry they are in, the economic situation, etc. Once you have found transactions that are comparable, look at how those companies were valued. What were the EV/EBITDA and EV/Sales multiples paid? Calculate a valuation multiple based on the sale prices in those transactions, and apply the multiple to the appropriate metric of the company in question.

CAPM

risk free turn + Beta(expected market return - risk free return) The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The risk-free rate is customarily the yield on government bonds like U.S. Treasuries. Find out which online brokers offer stock valuations in our new brokerage review center. The other half of the CAPM formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf): the return of the market in excess of the risk-free rate. Beta reflects how risky an asset is compared to overall market risk and is a function of the volatility of the asset and the market as well as the correlation between the two. For stocks, the market is usually represented as the S&P 500 but can be represented by more robust indexes as well. The CAPM model says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken. T