AssetValuationEquityInvestments

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1、十三 Asset Valuation: Equity Investments1.A: An Introduction to Security Valuationa: Explain the top-down approach and its underlying logic to the security valuation process.Step 1 General economic influences: fiscal policy: tax cuts encourage spending and tax increases discourage spending. monetary p

2、olicy: a restrictive policy reduces the availability of funds and causes interest rates to rise putting upward pressures on costs. In addition to fiscal and monetary actions you must also consider the economic consequences of political changes around the globe. From a global portfolio perspective yo

3、u have to consider the economic events in other countries.Step 2 Industry influences: The next step in the valuation process is to identify those industries that will prosper or suffer during the time frame of your economic forecast. You should consider the cyclical nature of the industry under stud

4、y. Some industries are cyclical, some are contra cyclical and some are non-cyclical. Finally, your analysis should also account for foreign economic shifts. In general, an industrys prospects within the global business environment determine how well or poorly individual firms in the industry do.Step

5、 3 Company Analysis: After determining the industrys outlook you should compare the individual firms performance within the entire industry using financial ratios and cash flow values. Your goal is to identify the best company in a promising industry. This involves not only examining the firms past

6、performance, but also its future prospects.b: Calculate the value of a preferred stock, assuming a perpetual dividend.Valuation of preferred stock is easy since the dividend is fixed and the preferreds life is infinite (its a perpetuity) appears in the upper right hand corner. Again, the only proble

7、m is determining kP. Because of default risk factors, the preferreds discount rate (kP) should be above the firms bond rate (kB). But since dividends paid by one corporation to another corporation are 80% tax exempt, preferred yields are below the firms highest-grade bond yields.preferred value=D +D

8、 +.+D =D (1 +kp)1(1 + kp)2(1 + kp)kpExample: value the preferred of a company that pays a $5 annual dividend. The firms bonds are currently yielding 8.5% and preferred shares are selling to yield fifty basis points below the firms bond yield.Step 1: determine the discount rate. 8.5% - .5% = 8%Step 2

9、: value the preferred. D/kPc: Calculate the value of a common stock, using the dividend discount model (DDM) for both a one-year holding period and a multiple-year holding period.Example: what is the value of a stock that last year paid a $1 dividend, if you think: next years dividend will be 10% hi

10、gher; the stock will be selling for $25 at year end; the risk free rate of interest is 5%, the market return is 10% and the stocks beta is 1.2?Step 1: solve for the discount rate. ke = .05 + (1.2)(.1 - .05) = 11%.Step 2: find the PV of the future dividend. FV = D1 = $1(1.1) = $1.10; n = 1; i=11; PV=

11、 $.99.Step 3: find the PV of the future price: FV = $25, n = 1; i = 11; PV = $22.52.Step 4: sum steps 2 and 3. The current value based on the investors expectations is $.99 + $22.52 = $23.51.Modeling a stocks value with a multiple-year holding period just expands the one-year approach to forecasting

12、 two or three years worth of dividends and the terminal price of the stock at the end of the period.d: Calculate the value of a common stock, using the infinite period DDM.There is one multiperiod model that uses a different approach though.Stock Value = D0(1 + g)1+D0(1 + g)2+D0(1 + g)3+.+D0(1 + g)(

13、1 + ke)1(1 + ke)2(1 + ke)3(1 + ke) This is the infinite period model. The infinite period model assumes that the growth rate (g) in dividends between years is constant. So next years dividend D1 is just D0(1 + g) and the second years dividend is just D0 (1 + g)2. The equation using this assumption l

14、ooks like what appears above.This equation simplifies to the infinite period dividend discount model.Projected Stock Value P0=D0(1 + g)=D1ke- gke- gNote: this model is also called the constant growth DDM in the literature.e: Calculate the value of a common stock for a company experiencing temporary

15、supernormal growth.The infinite period DDM doesnt work with growth companies. Growth companies are firms that currently have the ability to earn rates of return on investments that are currently above their required rates of return. The infinite period DDM assumes the dividend stream grows at a cons

16、tant rate forever while growth companies have high growth rates in the early years that level out at some future time. The high early or supernormal growth rates will also generally exceed the required rate of return. Since the assumptions (constant g and kg) dont hold, the infinite period DDM canno

17、t be used to value growth companies.A more realistic approach to supernormal growth companies and companies that dont pay dividends is to combine the multiperiod model with the infinite period model.In the temporary supernormal growth model you must:1. Project the size and duration of the supernorma

18、l dividend growth rate, (g supernormal) 2. Forecast what the normal growth rate will be at the end of the supernormal growth period, (g future normal) 3. Determine the discount rate, ke f: Show how to use the DDM to develop an earnings multiplier model and explain the factors in the DDM that affect

19、a stocks price-to-earnings (P/E) ratio.Example: A firm has an expected dividend payout ratio of 60%, a required rate of return of 11%, and an expected dividend growth rate of 5%. What is the firms expected P/E ratio? If you expect next years earnings (E1) to be $3.50, what is the value of the stock

20、today?Step 1: estimate the P/E ratio: .6/(.11 - .05) = 10Step 2: calculate the value estimate: (E1)(P/E estimateNote 1: the main determinant of the size of the P/E ratio is the difference between k and g.Note 2: the relevant P/E ratio you should study is the expected (P0/E1) ratio not the historical

21、 (P0/E0) ratioNote 3: the P/E ratio is just a restatement of the DDM. So anything that influences stock prices through the DDM will also have the same effect on the P/E ratio.g: Explain the relationship among the nominal risk-free rate, the risk-free rate, and the expected rate of inflation.Nominal

22、risk free rate = (1 + real risk-free rate)(1 + expected inflation) - 1Example: the real rate is 4 percent and the expected inflation rate is 3 percent.The nominal risk-free rate = (1.04)(1.03) 1 = 1.0712 1 = 7.12%.The nominal rate is frequently estimated by summing the real rate and the inflation ex

23、pectation.Estimate of the nominal risk-free rate = 4% + 3% = 7%h: Discuss the risk factors to be assessed in determining a country risk premium for use in estimating the required return for foreign securities. Business risk is a function of the variability of economic activity within a country and t

24、he average operating leverage used by firms within the country. Firms in different countries assume significantly different financial risk. Countries with small or inactive capital markets offer significant liquidity risk. The uncertainty in exchange rates causes exchange rate risk. Finally, country

25、 risk arises from unexpected economic and political events. i: Estimate the dividend growth rate, given the components of return on equity and incorporating the retention rate.Note: Why does g equal (RR)(ROE) for a stable but expanding company? Assume ROE is constant and that new funds come solely f

26、rom earnings retention. What is the firms growth rate given that the firm earns 10% on equity of $100 and pays out 40% of earnings in dividends?Earnings in period 1: (.10)($100) = $10. Dividend in period 1: (.40)( $10) = $ 4.Retention in period 1: ($10)(1-.4) = $ 6 so Earnings in period 2: (.10)($10

27、0) + (.10)($6) = $10.60.Dividend in period 2: (.40)($10.60) = $4.24.Analysis of growth: earnings growth = ($10.60 - $10)/$10 = 6% and dividend growth = ($4.24 - $4)/$4 = 6%.Analysis of stock price: assume k = 10%.Price at the beginning of period 1 = D1/(k - g) = $4/(.10 - .06) = $100.Price at the be

28、ginning of period 2 = D2/(k - g) = $4.24/(.10 - .06) = $106The stocks price will grow at a 6 percent rate just like earnings and dividends.What caused this growth? Earnings on the new retained earnings. Growth = (ROE)(Retention rate) = (.1)(1 - .4) = 6%.j: Describe a process for developing estimated

29、 inputs to be used in the DDM, including the required rate of return and expected growth rate of dividends.Estimating the inputs: the valuation models are dominated by the inputs k and g, so it is important that you understand how they are estimated and what they mean.The required rate of return (k)

30、 is influenced by:1. The economys real risk-free rate, which is determined by the supply and demand for capital in the country. 2. The expected rate of inflation in the country, which will cause investors to demand higher nominal rates of interest to compensate for their potential loss of purchasing

31、 power. 3. The risk premium is associated with the uncertainty of the returns expected from the investment. Since different investments have different patterns of return and different guarantees, the risk premiums differ. The required rate of return is a combination of the nominal real rate of retur

32、n and the risk premium. The risk premium can be determined by reference to a risk premium curve or by using the capital asset pricing model:k=Rnominal risk free rate+Prisk premium or k=Rnominal risk free rate+(beta)(Rmarket-Rnominal risk free rate)Expected growth rate of dividends: assuming past inv

33、estments are stable and earnings are calculated to allow for maintenance of past earnings power, then the firms earnings growth rate (g) can be defined as the firms earnings plowback or retention rate (RR) times the return on the equity (ROE) portion of new investments.1.B: Stock-Market Analysisa: C

34、alculate the earnings per share (EPS) of a stock market series.EPS = (per share sales estimate)(EBDIT %) - D - I(1 - T)Example: sales estimate is $90 per share; EBDIT is 20% of sales; depreciation is $8 per share: interest expense is $5 per share: and the tax rate is 34%.b: Calculate the expected P/

35、E ratio (earnings multiplier) of a stock market series, using the series expected dividend payout ratio, required rate of return, and expected growth rate of dividends.The basic DDM model looks at the stream of expected returns, their timing and the required rate of return. If you assume g and k are

36、 constant and that the stock pays dividends the basic model simplifies into the infinite period (or constant growth) model to below.Stock value = stock price =D0 (1 + g)=D1ke - gke - gNote: if the market is efficient the stocks price will equal the stocks value. The basic infinite period DDM can be

37、converted to an expected P / E ratio by dividing both sides of the equation by the expected earnings, E1 in the model below:Note: P0 is the price of the stock right now.Note: P0 / E0 is called the historical earnings multiplier.Note: the P/E ratio varies between stocks and industries.P0 =D1 / E1 E1

38、ke - g c: Estimate the value of, and explain the level of and changes in the earnings multiplier of a stock market series.A two-part valuation procedure of a stock market series or index:1. Estimate the future earnings per share for the stock market series. (EFuture) 2. Estimate a future earnings mu

39、ltiplier for the stock market series. (P/EFuture) Note: empirical evidence shows that the earnings multiplier is a more volatile variable than earnings.After you estimate the future earnings per share (E) and future earnings multiplier (P/E) you multiply them together to get an estimate of what the

40、stock market series will be worth at the end of the period.End of period index value = (Efuture)(P/EFuture)d: Calculate the expected rate of return for a stock market series.Example: you forecast that next period g will be 9%, k will be 12%, the dividend payout will be 40%, and the indexs earnings w

41、ill be $300. Thus you feel that the cash dividend of the index will be $120 next period. The index is currently at 3,600. What will the return on the index be for the period based on your projections?Step 2: calculate the expected value of the index at year-end.(P/E)(E) = (13.333)(300)= $4,000.Step

42、3: calculate the expected return. 120 + (4000 3600)/3600 = .1444 = 14.44%e: Explain how the top-down approach can be used to analyze the valuation of world stock markets.The procedure used here for analyzing a U.S. market index can be used to analyze any market index. The expected return should be c

43、alculated for all non-U.S. markets, especially the major world markets.Market index PE ratios will vary across national borders because of different economic outlooks, GDP, capital investments, industrial production, inflation, and interest rates.1.C: Industry Analysisa: Describe the process for est

44、imating earnings per share (EPS) for an industry and estimate the EPS for an industry.Step 1. Forecasting sales per share. The three techniques used to forecast sales are: a. industry life cycle analysis, b. input-output analysis, and c. studying industry relationships.Step 2. Analyze the competitio

45、n within the industry. The earnings forecast should be preceded with an analyses of the competitive structure for the industry. A review of the competitive nature of the industry is necessary because the profitability of a specific firm in an industry is heavily influenced the competitive environmen

46、t in which it must do business and the profitability of the industry as a whole.Step 3. Forecasting the industry profit margin: (a) this step requires the analyst to estimate the industry gross profit margin using economic variables related to the industry. Multiplying the projected EBDIT profit mar

47、gin times the industry sales per share estimate yields an estimate of the industrys earnings per share before depreciation, interest and taxes, (b) using time series analysis the analyst can then forecast the industrys depreciation per share (D), interest expense per share (I) and tax rate (T).Step

48、4. Putting it all together (estimating earnings per share). The analysts can now forecast industry earnings per share using the following formula:Estimated EPS = (sales per share estimate)(EBDIT %) - D - I(1 - T)b: Describe the industry life cycle and identify an industrys stage in its life cycle.1.

49、 Pioneering phase: during the start up phase the industry experiences modest sales growth and very small or negative profit margins. The market is small and firms incur major developmental costs. 2. Rapid accelerating growth phase: during this stage markets develop for the industrys products and dem

50、and grows rapidly. There is limited competition among the few firms in the industry, and profit margins will be very high. High sales growth and profit margins. 3. Mature growth phase: here, sales growth is still above normal, but growth is no longer accelerating. Competition increases and profit ma

51、rgins begin to decline. The number of competitors increases and profit margins move toward normal levels. 4. Stabilization and market maturity phase: this is the longest phase. Industry growth rates will approach the growth rate of the aggregate economy. Competition produces tight profit margins and

52、 ROEs become competitive (normal). 5. Deceleration of growth and decline: here demand shifts away from the industry. Growth of substitute products causes declining profit margins. c: Describe the basic forces that determine industry competition.Rivalry among the existing competitors: Rivalry increas

53、es when many firms of relatively equal size compete within an industry. Slow growth leads to competition when firms fight for market share, and high fixed costs leads to price cutting as firms try to operate at full capacity. Threat of new entrants: Look for things that discourage new entrants like

54、barriers to entry and economies of scale. Why? New entrants represent increased competition. Threat of substitute products: Substitute products limit the profit potential of an industry. Why? They limit the prices firms can charge. The more commodity like the product, the greater the competition and

55、 the lower the profit margin. Bargaining power of buyers: The ability of buyers to bargain for lower prices or higher quality when purchasing between competing firms within an industry influences the selling firms profitability. Bargaining power of suppliers: The ability of suppliers to raise prices

56、 or lower quality influences industry profitability. Suppliers are more powerful if there are just a few of them and if they are more concentrated than firms in the industry to which they sell. d: Describe two techniques for estimating an earnings multiplier for an industry and estimate the earnings

57、 multiplier for an industry.Macroanalysis of an industry multiplier assumes there is a relationship between the markets k and g and the industrys k and g. This technique adjusts the industry multiplier upwards or downwards based on the projected market multiple.Microanalysis of an industry multiplie

58、r can take a direction of change approach where industry variables are studied and then used to adjust the existing industry multiple upward or downward. The preferred approach though is the specific multiplier estimate method since it generates an actual point estimate of the multiplier. The specif

59、ic multiplier approach estimates the industry dividend payout ratio (D/E), required rate of return (k) and growth rate. Estimate the dividend payout ratio (D/E) based on past industry trends and current economic events. Estimate the required rate of return (k) for the industry. The risk free rate an

60、d inflation forecasts will come from the general economic forecast. The industry risk premium can be developed using either:1. The fundamental approach where the industrys business risk, financial risk, liquidity risk, exchange rate risk and country risk are considered. 2. The portfolio theory appro

61、ach where the industrys beta is determined by regression analysis and put into the CAPM. The industrys expected growth rate is estimated using the sustainable growth g = (retention rate)(ROE) framework. Coupling the general economic forecast with the relevant industry analysis, ROE should be project

62、ed by combining the industrys estimated profit margin, total asset turnover and financial leverage.e: Discuss factors that should be considered when conducting global industry analysis.Because so many firms are active in foreign markets and because the proportion of foreign sales is growing for so m

63、any firms, you must expand industry analysis to include the effects of foreign firms on global trade and industry returns. Differences in accounting treatments and the impact of exchanges rate fluctuations must be carefully considered in a global industry analysis.1.D: Company Analysis and Stock Sel

64、ectiona: Describe and estimate the expected earnings per share (EPS) and earnings multiplier for a company.There are four steps in estimating the value of a company:1. Estimating a companys earnings per share (EPS). 2. Estimating a companys earnings multiplier (P/E). 3. Estimating the future value o

65、f the firms stock. 4. Making the investment decision. EPS = (Sales per share)(EBITDA%) - D - I (1 - T)There are two methods for estimating a companys earnings multiplier: 1) macroanalysis and, 2) microanalysis.P/E = (D/E1) / (k - g)b: Describe and compute price/book value, price/cash flow, and price/sales ratios.Price/book value ratio (P/BV