SS 14

LOS 52.j: Explain asset-based valuation models and demonstrate the use of asset-based models to calculate equity value

-Asset based models are based on the idea that equity value is the market or fair value of assets minus the market value or fair value of liabilities. -tough to get market values of assets, so usually use balance sheet to determine value of assets and liabilities. can value them at depreciated values, inflation adjusted depreciation values, or estimated replacement values. -this is all tough for a firm with a lot of intangible assets -asset based model valuations are most reliable when the firm has primarily tangible short term assets, assets with ready market values or when firm will cease to operate and is being liquidated.

LOS 51.b: Compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system.

-Can group base don the products and services they offer. principal business activity -sector- similar industries -sensitivity to business cycles. cyclical and non cyclical -statistical methods, cluster analysis can be used. this method groups together based on highly correlated returns. the group formed will then have lower return correlations between groups. -limitations of statistical: ‣ historical correlations may not be the same as future correlations ‣ the groupings of firms may differ over time and across countries ‣ the grouping of firms is sometimes non-intuitive ‣ the method is susceptible to statistical error

The leading P/E ratio illustrates that the P/E ratio is a function of:

-D1/E1 = expected dividend payout ratio k= required rate of return on the stock g = expected constant growth rate of dividends

What are callable common shares?

-Give the firm the right to repurchase the stock at a pre-specified call price. Investors receive a fixed amount when the firm calls the stock -call feature benefits firm because when the stock's market price is greater than the call price, the firm can call the shares and reissue them later at a higher price. -calling the shares, similarly to repurchasing them, allows firm to reduce its dividend payments without changing its per share dividend

LOS 52.f: Identify companies for which the constant growth or a multistage dividend discount model is appropriate.

-Gordon uses single constant growth, so its good for stable and mature, noncyclical, dividend-paying firms. -for dividend firms with dividends growing rapidy, slowly or erratically, followed by constant, then use some form of the multistage growth model. -3 stage multi model for firms that have growth, transition and maturity phases. -when don't pay dividends, use valuation based on FCFE as long as growth rates of earnings can be estimated. otherwise can use price multiples instead.

Industry Concentration

-High industry concentration does not guarantee pricing power -absolute market share may not matter as much as a firm's market share relative to it competitors. -if industry products are undifferentiated and commodity-like, then consumers will switch to the lowest-priced producer. the more attention on price in an industry, the more competitive. industries with greater product differentiation in regard to features, reliability, and service after the sale will have greater pricing power. -if the industry is capital intensive, and therefore costly to enter or exit, overcapacity can result in intense price competition.

LOS 50.c: Distinguish between public and private equity securities

-Private equity is usually issued to institutional investors via private placements. smaller than public markets but grow rapidly -compared to public, private equity has the following characteristics: ‣ less liquidity because no public market for the shares exists ‣share price is negotiated between the firm and its investors, not determined in a market ‣ more limited firm financial disclosure because there is no government or exchange requirement to do so. ‣ lower reporting costs because of less onerous reporting requirements ‣ potentially weaker corporate governance because of reduced reporting requirements and less public scrutiny ‣ greater ability to focus on long-term prospects because there is no public pressure for short-term results ‣ potentially greater return for investors once the firm goes public

Porter has identified two important competitive strategies that can be employed by firms within an industry:

-a cost leadership (low-cost) strategy: firm seeks to have lowest costs of production in its indutry, offer lowest prices, and generate enough volume to make a superior return. can be used to grow share or protect share. predatory pricing: firm hopes to drive out competitors and later increase prices. although there are often laws prohibiting it, it can be hard to prove -or a differentiation strategy: products and services should be distinctive in terms of type, quality, or delivery. for success, cost of differentiation must be less than the price premium buyers place on product differentiation. the price premium should also be sustainable over time.

cyclical firm

-a cyclical firm is one whose earnings are highly dependent on the stage of the business cycle. these firms have high earnings volatility and high operating leverage. -products are often expensive, non-necessities whose purchase can be delayed until the economy improves. -examples: basic materials, consumer discretionary, energy, financial services, industrial and producer durables, and technology.

The P/E ratio we have defined here will increase with

-a higher dividend payout rate -a higher growth rate -a lower required rate of return

What is private investment in public equity (PIPE)

-a public firm that needs capital quickly sells private equity to investors. -the firm may have growth opportunities, be in distress, or have large amounts of debt -the investors can often buy the stock at a sizeable discount to its market price.

Advantages and disadvantages of price multiple valuations based on fundamentals:

-advantages ‣ they are based on theoretically sound valuation models ‣ they correspond to widely accepted value metrics -disadvantages ‣ price multiples based on fundamentals will be very sensitive to the inputs (especially the k-g denomiator)

Advantages and disadvantages of asset based models

-advantages ‣ they can provide floor values ‣ they are most reliable when the firm has primarily tangible short term assets, assets with ready market values, or when the firm is being liquidated ‣ they are increasingly useful for valuing public firms that report fair values. -disadvantages ‣ market values are often difficult to obtain ‣ market values are usually different than book values ‣ they are inaccurate when a firm has a high proportion of intangible assets or future cash flows not reflected in asset values ‣ assets can be difficult to value during periods of hyperinflaton.

LOS 50.g: Distinguish between the market value and book value of equity securities

-primary goal of firm management is to increase the book value of the firm's equity and thereby increase the market value of its equity. -the book value of equity: is the value of the firm's assets on the balance sheet minus its liabilities. it increases when the firm has positive net income and retained earnings that flow into the equity account. -market value of equity: total value of a firm's outstanding equity shares based on market prices and reflects the expectations of invstors about the firm's future performance.

Advantages and disadvantages of comparable valuation using price multiples

-advantages: ‣ evidence that some price multiples are useful for predicting stocks returns ‣ price multiples are widely used by analysts ‣ price multiples are readily available ‣ can be used in time series and cross-sectional comparisons ‣ EV/EBITDA multiples are useful when comparing firm values independent of capital structure or when earnings are negative and the P/E ratio cannot be used. -disadvantages ‣ lagging price multiples reflect the past ‣ price multiples may not be comparable across firms if firms have different size, products and growth ‣ price multiples for cyclical firms are vlatile ‣ stock may appear overvalued by comparable method but undervalued by a fundamental method or vice versa ‣ diff accounting methods can result in price multiples that are not comparable across firms, especially internationally ‣ a negative denominator is meaningless ratio

Advantages and disadvantages of discounted cash flow models

-advantages: based on fundamental concept of discounted present value widely accepted -disadvantages: ‣ inputs must be estimated ‣ value estimates are very sensitive to input values

Market Share Stability

-an analyst should examine whether firm's market shares in an industry have been stable over time. -market shares that are highly variable likely indicate a highly competitive industry in which firms have little pricing power. More stable market shares likely indicate less intense competition in the industry -factors that affect market share stability include barriers to entry, introductions of new products and innovations, and the switching costs that customers face when changing from one firm's products to another. Switching costs, such as the time and expense of learning to use a competitors' product, tend to be higher for specialized or differentiated products. High switching costs contribute to market share stability and pricing power.

Gordon, the stock's value is determined by the relationship between the investor's required rate of return on equity, ke, and the projected growth rate of dividends, gc:

-as the difference between ke and gc widens, the value of the stock falls. -as the difference narros, the value of the stock rises -small changes in the difference between ke and gc can cause large changes in the stock's value

What are convertible preference shares?

-convertible preference shares can be exchanged for common stock at a conversion ratio determined when the shares are originally issued. It has the following advantages: ‣ the preferred dividend is higher than a common dividend ‣ if the firm is profitable, the investor can share in the profits by converting his shares into common stock ‣ the conversion option becomes more valuable when the common stock price increases ‣ preferred shares have less risk than common shares because the dividend is stable and they have priority over common stock in receiving dividends and in the event of liquidation of the firm ‣ often used for risky venture capital and private equity firms

What are cumulative and non-cumulative preference shares?

-cumulative preference shares are usually promised fixed dividends, and any dividends that are not paid must be made up efore common shareholders can receive dividends. -non-cumulative preference shares do not accumulate over time when they are not paid, but dividends for any period must be paid before common shareholders can receive dividends.

Non-cyclical industries can be further separated into defensive (stable) or growth industries

-defensive industries are those that are least affected by the stage of the business cycle and include utilities, consumer staples (such as food producers) and basic services (such as drug stores) -growth industries have demand so strong they are largely unaffected by the stage of the business cycle.

What are american depository receipts (ADRs)?

-denominated in U.S. dollars and trade in the United States -the security on which the ADR is based is the American Depository Share (ADS), which trades in the firm's domestic market.

What are depository receipts (DRs)?

-depository receipts (Drs) represent ownership in a foreign firm and are traded in the markets of other countries in local market currencies. -a bank deposits shares of the foreign firm and then issues receipts representing ownership of a specific number of the foreign shares -the depository bank acts as a custodian and manages dividends, stock splits, and other events. -value of DR is affected by exchange rate changes, as well as firm fundamentals, economic events, and any other factors that affect the value of any stock -if firm is involved with the issue, the depository receipt is a sponsored DR; otherwise it is an unsponsored DR. a sponsored DR provides the investor voting rights and is usually subject to greater disclosure requirements. In an unsponsored DR, the depositor bank retains the voting rights

What are the steps in using the multistage model?

-determine the discount rate, Ke -project the size and duration of the high initial dividend growth rate, g* -estimate dividends during the high-growth period -estimate the constant growth rate at the end of the high-growth period, gc -estimate the first dividend that will grow at the constant rate -use the constant growth value to calculate the stock value at the end of the high-growth period -add the PVs of all dividends to the PV of the terminal value of the stock. -common mistake: calculate the future value P3 and forget to discount it back to presernt or to discount over the number of periods until the constant growth dividend is paid rather than using correct number of period

what is direct investing?

-direct investing in the securities of foreign companies simply refers to buying a foreign firm's securities in foreign markets. some obstacles to direct foreign investment are that: ‣ the investment and return are dominated in a foreign currency ‣ the foreign stock exchange may be illiquid ‣ the reporting requirements of foreign stock exchanges may be less strict, impeding analysis ‣ investors must be familiar with the regulations and procedures of each market in which they invest.

Non-cyclical firm

-produces goods and services for which demand is relatively stable over the business cycle. -health care, utilities, telecommunications, and consumer staples.

What are putable common shares?

-putable common shares give the shareholder the right to sell the shares back to the firm at specific price. -a put option benefits the shareholder because it effectively places a floor under the share value. -shareholders pay for the put uption because other things equal, putable shares are sold for higher prices than non putable shares and raise more capital for the firm when they are issued

LOS 52.b: Describe major categories of equity valuation models

-discounted cash flow models - stock's value is estimated as the present value of cash distributed to shareholders (dividend discount models) or the present value of cash available to shareholders after the firm meets its necessary capital expenditures and working capital expenses (free cash flow to equity models) -multiplier models: 2 types: 1 is ratio of stock price to such fundamentals as earnings, sales, book value, or cash flow per share. second type is based on ratio of enterprise value to either EBITDA or revenue. enterprise value is the market value of all a firm's outstanding securities minus cash and shortterm investments. common stock value can be estimated by subtracting the value of liabilities and preferred stock from an estimate of enterprise value. -asset-based models: intrinsic value of common stock is estimated as total asset value minus liabilities and preferred stock.

The assumptions of the gordon growth model are

-dividends are the appropriate measure of shareholder wealth -the constant dividend growth rate, gc, and required return on stock, ke, are never expected to change -ke must be greater than gc. if not, the math will not work. -LOOK FOR FOREVER, INFINETLY, INDEFINETLY, FOR THE FORESEEABLE FUTURE FOR GORDON GROWTH MODEL -LOOK FOR JUST PAID OR RECENTLY PAID FOR DO.. WILL PAY OR EXPECTED TO PAY IS D1

LOS 52.i: Explain the use of enterprise value multiples in equity valuation and demonstrate the use of enterprise value multiples to estimate equity value.

-enterprise value (EV) measure total company value. EV can be viewed as what is would cost to acquire the firm: ‣ EV = market value of common & preferred stock + market value of debt - cash and short-term investments ‣ cash and ST inv are subtracted because an acquirer's cost for a firm would be decesed by the amount of the target's liquid assets. ‣ enterprise value is appropriate when an analyst wants to compare the values of firms that have significant differences in capital structure. ‣ EBITDA is most common denominator for EV multiples... numerator represents total company value, it should be compared to earnings of both debt and equity owners. ‣ an advantage of using EBITDA instead of net income is that EBITDA is usually positive even when earnings are not. when NI is negative, value multiples based on earnings are meaningless. ‣ a disadvantage of using EBITDA is that is often includes non-cash revenues and expenses

LOS 50.f: Explain the role of equity securities in the financing of a company's assets

-equity capital is used for the purchase of long-term assets, equipment, research and development, and expansion into new businesses or geographic areas. -equity securities provide the firm with "currency" that can be used to buy other companies or that can be offered to employees as incentive compensation. -provides liquidity

A thorough industry analysis should include the following elements:

-evaluate the relationships between macroeconomic variables and industry trends using information from industry groups, firms in the industry, competitors, suppliers, and customers. -estimate industry variables using different approaches and scenarios -compare with other analysts' forecasts of industry variables to confirm the validity of the analysis and potentially find industries that are misvalued as a result of consensus forecasts. -determine the relative valuation of different industries -compare the valuations of industries across time to determine the volatility of their performance over the long run and during different phases of the business cycle. -analyze industry prospects based on strategic groups, which are groups of firms that are distinct from the rest of the industry due to the delivery or complexity of their products or barriers to entry. -classify industries by life cycle stage (embryonic, growth, shakeout, mature, or declining) -position the industry on the experience curve, which shows the cost per unit relative to output. the curve declines because of increases in productivity and economies of scale, especially in industries with high fixed costs. -consider the forces that affect industries, which include demographic, macroeconomic, governmental, social, and technological influences. -examine the forces that determine competition within an industry

A company analysis should include the following elements:

-firm overview, including information on operations, governance, and strengths and weaknesses -industry characteristics -product demand -product costs -pricing environment -financial ratios, with comparisons to other firms and over time -projected financial statements and firm valuation

Investors' Required Return and the Cost of Equity

-firms cost of equity: the expected equilibrium total return (including dividends) on its shares in the market. -at any point in time, a decrease in share price will increase the expected return on the shares and an increase in share price will decrease expected returns. -an increase (decrease) in the required return used to discount future cash flows will decrease (increase) intrinsic value -investors also estimate the expected returns on equity shars and compare this to the minimum return the will accept for bearing the risk inherent in a particular stock -if an investor estimates the expected return on a stock to be greater than her minimum required rate of return on the shares, given their risk, then the shares are an attractive investment. -investors can have different required rates of return for a given risk, different estimates of a firm's future cash flows, and different estimates of the risk of a firm's equity shares. A firm's cost of equity can be interpreted as the minimum rate of return required by investors (in the aggregate) to compensate them for the risk of the firm's equity shares.

In the shakeout stage, industry growth and profitability are slowing due to strong competition. The characteristics of this stage are as follows:

-growth has slowed: demand reaches saturation level with few new customers to be found -intense competition: industry growth has slowed, so firm growth must come at the expense of competitors -increasing industry overcapacity: firm investment exceeds increases in demand -declining profitability: due to overcapacity -increased cost cutting: firms restructure to survive and attempt to build brand loyalty -increased failures: weaker firms liquidate or are acquired.

What are preference or preferred stock?

-have features of both common stock and debt -preferred dividends are not a contractual obligation, share do not mature and the sahres can have put or call features. -like debt, preferred shares typically make fixed periodic payments to investors and do not usually have voting rights.

Ease of Entry

-high barriers to entry benefit existing industry firms because they prevent new competitors from competing for market share. -in industries with low barriers to entry, firms have little pricing power. -high barriers to entry do not mean firm pricing power is high. industries with high barriers to entry may have strong competition among existing firms.

The following summary describes how these two factors influence the competitive environment in an industry: (rivalry and threat of new entrants)

-higher barriers to entry reduce competition -greater concentration (smaller number of firms control a large part of the market) reduces competition, whereas market fragmentation (a large number of firms, each with a small market share) increases competition -unused capacity in an industry, especially if prolonged results in intense price competition. for example, underutilized capacity in the auto industry has resulted in very competitive pricing -stability in market share reduces competition. For example, loyalty of a firm's customers tends to stabilize market share and profits -more price sensitivity in customer buying decisions results in greater competition -greater maturity of an industry results in slowing growth

LOS 52.g: Explain the rationale for using price multiples to value equity and distinguish between multiples based on comparables versus multiple based on fundamentals.

-in a price multiple approach, an analyst compares a stock's price multiple to a benchmark value based on an index, industry group of firms, or a peer group of firms within an industry. -con of price multiple: they reflect only the past because historical data is often used in the denominator ... so many use forward values in denominator (sales, book value, earnings etc.) -price multiples based on comparables: comparing price multiple of a firm to others based on market prices -price multiples based on fundamentals: tells us what a multiple should be based on some valuation model and therefore are not dependent on the current market prices of other companies to establish value.

Dividend displacement of earnings

-in practice, above is not always true. -an increase in dividend payout ratio will reduce the firm's sustainable growth rate. higher dividends will increase firm value, a lower growth rate will decrease firm value. this is known as dividend displacement of earnings. -the net affect on firm value of increasing the dividend payout ratio is ambiguous. -thus, firms cannot continually increase their P/Es or market values by increasing the dividend payout ratio. otherwise everyone would have 100% payout ratios

Leveraged buyout vs. management buyout

-leveraged buyout (LBO) investors buy all of a firm's equity using debt financing (leverage) -if buyers are the firm's current management, the LBO is referred to as a management buyout (MBO). Firms in LBOs usually have cash flow that is adequate to service the issued debt or have undervalued assets that can be sold to pay down the debt over time.

To illustrate the long list of factors to be considered in industry analysis, we use the following strategic analysis of the candy/ confections industry

-major firms: cadbury, hershey, mars, and nestle -barriers to entry and success: very high. low capital and technological barriers, but consumers have strong brand loyalty. -industry concentration: very concentrated. largest four firms dominate global market share -influence of industry capacity on pricing: none. pricing is determined by strength of brand not production capacity. -industry stability: very stable. market hare changes slowly -life cycle: very mature. growth is driven by population changes -competition: low. lack of unbranded candy makers in market reduces competition -demographic influences: not applicable -government influence: low. industry is largely unregulated, but regulation arising from concerns about obesity is possible -social influence: not applicable -technological influence: very low. limited impact from technology -business cycle sensitivity: non-cyclical and defensive. demand for candy is very stable.

Price-to-book ratio (market to book)

-market value of a firm's equity divided by the book value of its equity -the more optimistic investors are about the firm's future growth, the greater its price-to-book ratio -it is used as a measure of relative value -if low price to book, value stocks, and high price to book are considered growth stocks.

Multistage dividend growth models

-may temporarily have a growth rate that exceeds the required rate of return on the firm's equity, but can't keep that up indefinetly. it will attract competition and growth rate will fall. -to value this though, add the present values of dividends expected during the high-grwoth period to the present value of constant growth value of the firm at the end of high-growth period. this is the multistage dividend discount model

What are common shares?

-most common form of equity and represent an ownership interest -common shareholders have a residual claim on firm assets if the firm is liquidated and govern the corporation through voting rights -able to vote for the board of directors, on merger decisions, and on the selection of auditors. can vote by proxy- have someone else vote for them

In the decline stage, industry growth is negative. The characteristics of this stage are as follows:

-negative growth: due to development of substitute products, societal changes, or global competition -declining prices: competition is intense and there are price wars due to overcapacity. -consolidation: failing firms exit or merge

Free Cash Flow to equity (FCFE)

-often used in discounted cash flow models instead of dividends because it represents the potential amount of cash that could be paid out to common shareholders. FCFE reflects the firm's capacity to pay dividends. also good for firms that do not pay dividends. -cash remaining after a firm meets all of its debt obligations and provides for the capital expenditures necessary to maintain existing assets and to purchase the new assets needed to support the assumed growth of the firm. -other words: cash available to firm's equity holders after a firm meets all of the other obligations. -for a period calculated as ‣ FCFE = NI +dep - increase in working capital - fixed capital investment (FCInv) - debt principal repayments + new debt issues ‣ or FCFE = Cash flow from operations - FCInv + net borrowing ‣ net borrowing is the increase in debt during the period

Price multiples used for valuation:

-price-earnings (P/e) ratio: firm's stock price divided by earnings per share and is widely used by analysts and cited in the press -price-sales (P/S) ratio: The P/S ratio is a firm's stock price divided by sales per share -price-book value (P/B) ratio: the P/B ratio is a firm's stock price divided by book value of equity per share. -price-cash flow (P/CF) ratio: the P/CF ratio is a firm's stock price divided by cash flow per share, where cash flow may be defined as operating cash flow or free cash flow

In the growth stage, industry growth is rapid. The characteristics of this stage are as follows:

-rapid growth: new consumers discover the product -limited competitive pressures: the threat of new firms coming into the market peaks during the growth phase, but rapid growth allows firms to grow without competing on price -falling prices: economies of scale are reached and distribution channels increase -increasing profitability: due to economies of scale

The strategic analysis framework developed by michael porter delineates five forces that determine industry competition

-rivalry among existing competitors: rivalry increases when many firms of relatively equal size compete within an industry. slow growth leads to competition as firms fight for market share, and high fixed costs lead to price decreases as firms try to operate at full capacity. Example: high fixed costs in the auto industry from capital investments and labor contracts force firms to produce a large number of vehicles that they can only sell at low margins. industries with products that are undifferentiated or have barriers (are costly) to exit tend to have high levels of competition. -threat of new entrants: industries with barriers entry will find it easier to maintain premium pricing -threat of substitute products: limit the prices firms can charge by increasing the elasticity of demand. the more differentiated the products are within an industry, the less price competition there will be. For example, microsoft is one of the few suppliers of operating system software and thus has pricing power.

In the embyonic stage, the industry has just started. The characteristics of this stage are as follows:

-slow growth: customers are unfamiliar with the product -high prices: the volume necessary for economies of scale has not been reached -large investment required: to develop the product -high risk of failure: most embryonic firms fail

In the mature stage, there is little industry forth and firms begin to consolidate. The characteristics of this stage are as follows:

-slow growth: market is saturated and demand is only for replacement -consolidation: market evolves to an oligopoly -high barriers to entry: surviving firms have brand loyalty and low cost structures -stable pricing: firms try to avoid price wars, although periodic price wars may occur during recessions -superior firms gain market share: the firms with better products may grow faster than the industry average

What is a statutory voting system and cumulative voting system?

-statutory: each share held is assigned one vote in the election of each member of the board of directors -cumulative: shareholders can allocate their votes to one or more candidates as they choose.makes it so minority shareholder can have more proportional representation on the board. someone with 30% of firms shares could choose three of ten directors with cumulative voting but could elect no directors under statutory voting.

What is a justified P/E

-the P/E above, baed on fundamentals, is a justified p/e -it is justified, because assuming we have the correct inputs for D1, E1, K and g, then the equation above will provide a P/E ratio that is based on the present value of the future cash flows.

LOS 50.e: Compare the risk and return characteristics of types of equity securities

-the risk of equity securities is most commonly measured as the standard deviation of returns -preferred stock is less risky than common stock because preferred stock pays a known, fixed dividend to investors that is a large part of the return, whereas common dividends are viable and can vary with earnings. -cumulative preferred shares have less risk than non-cumulative preferred shares because they retain the right to receive any missed dividends before any common stock dividends can be paid -putable are less risky and callable are more risky

Sustainable Growth Rate

-the sustainable growth rate is the rate at which equity, earnings, and dividends can continue to grow indefinitely assuming that ROE is constant, the dividend payout ratio is constant, and no new equity is sold -sustainable growth = (1 - dividend payout ratio) x ROE -1 - div payout is retention rate - proportion of NI that is not paid out as dividends and goes to retained earnings, thus increasing equity.

Capacity

-undercapacity, a situation in which demand exceeds supply at current prices, results in pricing power. -overcapacity, with supply greater than demand at current prices, will result in downward pressure on price. -capacity is fixed in the short run and variable in the long run.

LOS 51.a: Explain the uses of industry analysis and the relation of industry analysis to company analysis

-understanding a firm's business environment can provide insight about the firm's potential growth, competition, and risks. -for a credit analyst, industry conditions can provide important information about whether a firm will be able to meet its obligations during the next recession. -active management- can identify industries that are undervalued or overvalued in order to weight them appropriately -some use industry rotation - overweighting or underweighting industries based on the current phase of the business cycle.

The following are steps an analyst would use to form a peer group:

-use commercial classification providers to determine which firms are in the same industry -examine firms annual reports to see if they identify key competitors -examine competitors annual reports to see if other competitors are named -use industry trade publications to identify competitors -confirm that comparable firms have similar sources of sales and earnings, have similar sources of demand, and are in similar geographic markets. -adjust financial statements of non- financial companies for any financing subsidiary data they include

What else can an analyst do with the gordon model?

-use it to determine how much of the estimated stock value is due to dividend growth -to do this, assume the growth rate is zero and calculate a value. then subtract this value from the stock value estimated using a positive growth rate.

Multiples based on comparables

-use multiples to evaluate whether an asset is valued properly relative to a benchmark. -common benchmarks: stock's historical average or similar stocks and industry averages. -law of one price: two identical assets should sell at the same price, or in this case, two comparable assets should have approximately the same multiple. -if cyclical, p/s may be better because p/e is volatile -disadvantages of using price multiples based on comparables: ‣ a stock may appear ovevalued by the comparable method but undervalued by the fundamental method or vice versa ‣ different accounting methods can result in price multiples that are not comparable across firms, especially internationally and ‣ price multiples for cyclical firms may be greatly affected by economic conditions at a given point in time.

What is venture capital?

-venture capital refers to the capital provided to firms early in their life cycle to fund their development and growth -venture capital financing at various staged of a firm's development is referred to as seed or start up, early stage, or mezzanine financing. -venture capital investments are illiquid and investors often have to commit funds for three to ten years before they can cash out (exit) their investment. -investors hope to profit when they can sell their shares after (or as part of) an initial public offering or to an established firm.

There are several things to consider in deciding whether to invest on differences between market prices and estimated intrinsic values

1. the larger the percentage difference between market prices and estimated values, the more likely the investor is to take a position based on the estimate of intrinsic value. small differences between market prices and estimates of intrinsic values are to be expected 2. the more confident the investor is about the appropriateness of the valuation model used, the more likely the investor is to take an investment position in a stock that is identified as overvalued or undervalued. 3. the more confident the investor is about the estimated inputs the more likely to take an investment position in a stock that is identified as over or undervalued. 4. even if we assume that market prices sometimes deviate from intrinsic values, market prices must be treated as fairly reliable indications of intrinsic value. investors must consider why a stock is mispriced in the market. investors may be more confident about estimates of value that differ from market prices when few analysts follow a particular security. 5. finally, to take a position in a stock identified as mispriced in the market, an investor must believe that the market price will actually move toward its estimated intrinsic value and that it will do so to a significant extent within the investment time horizon.

Estimating the required return for equity

CAPM provides an estimate of the required rate of return for a security as a function of its systematic risk, risk free rate, and expected return on the market

energy firms are involved in:

• energy exploration, refining, production, energy equipment, energy services

LOS 51.i: Describe the principles of strategic analysis of an industry

Strategic analysis ‣ examines how an industry's competitive environment influences a firm's strategy.

telecommunications firms include wired and wireless service providers.

Utilities includes electric, gas, and water utilities.

consumer staples firms are less cyclical and sell goods and services in industries such as:

• food, beverage, tobacco, personal care products

Basket of listed depository receipts (BLDR)

an exchange-traded fund (ETC) that is a collection of DRs. EETF shares trade in markets just like common stocks

Gordon Growth Model (constant growth model)

assumes annual growth rate of dividends is constant

LOS 51.k: Describe the elements that should be covered in a thorough company analysis

company analysis: analyze firm's financial condition, products and services, and competitive strategy. competitive strategy is how a firm responds to the opportunities and threats of the external environment. the strategy may be defensive or offensive

Multiples based on Fundamentals

divide both sides of gordon model by next years projected earnings

LOS 50.b: Describe differences in voting rights and other ownership characteristics among different equity classes

have different classes of common stock

What are global depositor receipts (GDRs)

issued outside the united states and the issuer's home country. Most GDRs are traded on the London and Luxembourg exchanges. usually denominated in U.S. dollars. GDRs are not subject to the capital flow restrictions imposed by governments and thus offer the firm and the investor greater opportunities for foreign investment.

LOS 51.d: Explain the relation of "peer group" as used in equity valuation, to a company's industry classification

peer group is a set of similar companies an analyst will use for valuation comparisons. similar business activities, demand drivers, cost structure drivers, and availability of capital.

Government Classifications

some gov't bodies also classify firms. they do so to organize the economic data they public.

What is a potential problem with using enterprise value?

the market value of a firm's debt is often not available. in this case, use the market values of similar bonds or can use the book values. but book values may not be a good estimate of market value if firm and market conditions have changed significantly since the bonds were issued

Estimating the growth rate in dividends

three methods ‣ use historical growth in dividends for the firm ‣ use the median industry dividend growth rate ‣ estimate the sustainable growth rate

Global registered shares (GRS)

traded in different currencies on stock exchanges around the world

What are the three main types of private equity investments?

venture capital, leveraged buyouts, and private investments in public equity

consumer discretionary firms are cyclical and sell goods and services in industries such as:

• automotive • apparel • hotels and restaurants

financial services firms include firms involved in:

• banking • insurance • real estate • asset management • brokerage

basic materials and processing firms product

• building materials • chemicals • paper and forest products • containers and packaging • metals, minerals, and mining

technology firms sell or produce:

• computers • software • semiconductors • communications equipment • internet services • electronic entertainment • consulting and services

industrial and producer durables firms product capital goods for commercial services industries including

• heavy machinery and equipment • aerospace • defense • transportation • commercial services and supplies

LOS 51.f: Describe demographic, governmental, social, and technological influences on industry growth, profitability, and risk

• macroeconomic factors: can be cyclical or structural trends, most notably economic output as measured by GDP or some other measure. education level is one. • technology: • demographic factors: age distribution and population size • governments: taxes and regulation.tobacco is heavily taxed. • social influences: how people work, play, spend their money, and conduct their lives.

health care includes:

• pharmaceuticals • biotech • medical devices • health care equipment • medical supplies • health care services

Industry classification systems (commercial classifications)

‣ basic materials and processing firms product ‣ consumer discretionary firms are cyclical and sell goods and services in industries ‣ consumer staples firms are less cyclical and sell goods and services in industries ‣ energy firms ‣ financial services firms ‣ health care ‣ industrial and producer durables firms product capital goods for commercial services industries ‣ technology firms ‣ telecommunications firms include wired and wireless service providers.