CompanyValuation(JEM 132) CharlesUniversity,Prague

JiriNovak,IESUK 1
Lecture2
ValuationModelsI
JiriNovak
IES,UK
Recap
ImportanceofValuation
companyvaluationisusefulwhenevera
companyoritspartispurchasedorsold
reasonablevaluationofassetsiscrucialfor
2
healthyfinancialmarketsandtheentireeconomy
LimitationsofValuation
taskofcompanyvaluationistouncoverthe
uncertainfuture,whichischallengingand
alwaysquestionable
aimistostructuretheanalysiswellandrootit
properlyinexistinghistoricalevidence
l A h 1.3ValuationApproaches
ValuationApproaches
CostBased
whatwasthecosttodeveloptheasset?
(firmcanbeseenasportfolioofassets)
Revenue Based
4
RevenueBased
whatisthepresentvalueofrevenuestheasset
isexpectedtogenerate?
ComparableBased
whatisthepriceofcomparableassetsinliquid
markets?
ValuationApproaches
Simple
rough&dirtywaystoobtainapproximateidea
aboutcompanyvalueforquickorientation
indicatorsoffirmvaluemaybeobtained:
5
y
crosssection
timeseries
ValuationApproaches
ValuationMultiples(VM)
M/B andP/E ofcomparablecompaniestobe
multipliedbyEq =B orNI=E respectively
DividendGrowthModel(DG)
6
( )
extrapolatepastdividendpayoutsallowingfor
constantgrowth,discountthematcostofequity
CompanyValuation(JEM 132) CharlesUniversity,Prague
JiriNovak,IESUK 2
ValuationApproaches
Complex
sophisticatedvaluationmodelsarebasedon
forecasted(proforma) financialstatements,
fromwhichdiscounteditemsaretaken
7
valuationmodelischaracterizedbyforecasted
itemthatiseventuallydiscounted:
dividends
freecashflow
residualincome=economicvalueadded
ValuationApproaches
DiscountedDividendModel(DDM)
dividends(Dv) returntoownersontheir
investmentincompanyequity
DiscountedCashFlowModel(DCF)
8
freecashflow(FCF) valuegeneratedthrough
operatingactivitiesforownersandcreditors
ResidualIncomeModel(RIM)
economicvalueadded(EVA) residualvalueto
ownersaftersubtractingallcapitalcharges,
addedtobookvalueofequity
l l l 2.1ValuationMultiples
ValuationMultiples
Use
quickorientationabouttheapproximaterange
withinwhichthevalueislikelytolie
verifyingplausibilityofvalueestimateproduced
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bymoresophisticatedforecast
Method
obtainM/B, P/E,andEV/EBITA multipleof
comparablecompanies(i.e.closestcompetitors)
multiplythebenchmarkmultiplewiththe
correspondingaccountingitem(Eq,NI orEBITA)
oftheofthecompanyofinterest
ValuationMultiples
MarkettoBook
ratioofstockmarket value ofequity(marketcap)
dividedby(accounting)book value ofequity
PricetoEarnings
11
g
ratioofsharepricetoearningspershare
EVtoEBITA
ratioof:
enterprisevalue(marketvalueofequity&debt) to
operatingincome(earningsbeforeinterest,taxes
&amortization)
ValuationMultiples
Logic
basicideaisthatthereissomefixedrelationship
betweencompanyvalueandtheunderlying
accountingfundamentals(Eq,NI orEBITA)
B fi
12
Benefits
multiplesareoftenusedbecausetheyaresimple
tocomprehendandcommunicate
Shortcomings
relativevaluationgivessoundresultsonlywhen:
firmsarecomparable(uniqueadvantages)
marketvaluescomparableswithoutbias(fads)
CompanyValuation(JEM 132) CharlesUniversity,Prague
JiriNovak,IESUK 3
d d h d l 2.2DividendGrowthModel
As
1
=+ 30 RE
1
= 30
operating
FinancialCycle
$$$$$$$$$$$$$
$$$$$$$$$$$$$ assets
O
O
O
equity
E 100
O
O
14
p g
expenses
267
$$$$$$$$$$$$$
debt
Li
0
= 60
assets
As
0
= 160
revenues
Sl
1
= 320
earnings
NI
1
= 30
O
O
O
Eq
0
= 100
interestexp.
IE= 3
EBIT
1
O
taxes
Tx= 20 Whatistheultimate
wayofpayingreturn
tocompanyowners?
DividendGrowth
Method
pastdividendpayoutsareimplicitly
extrapolatedintothefutureanddiscountedto
presentvalueusingfixedcostofequity
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makesstrongassumptionsaboutdividend
payoutdynamicsandriskdynamics
Use
formaturecompanies(insteadystate)thatpay
stabledividendsregularly
pluginmethodinsophisticatedmodelsto
determinecontinuingvalueafterhorizon
DividendGrowth
GordonFormula
Considerations
0

d
V
r g
~perpetuitywithgrowth
16
o i e a io
V companyvalue
d initialdividendpayoutthatshouldbe
sustainableinthelongrun(withsomegrowth)
r discountfactorthatshouldreflectthe
riskinessofthecompanysequity
g dividendgrowthratethatissustainablein
averylongrun
DividendGrowth
ConceptualShortcomings
dividendscapturejustthedistribution ofwealth
totheownersfailingtouncovertheblackbox
ofvaluecreation

17
irrelevance theorembyMillerandModigliani
suggeststhatinaperfectworlddividendsdo
notaffectcompanyvalue(why?)

DividendGrowth
TechnicalLimitations
dcompaniespaylessandlessdividendsand
ratherrepurchasetheirstocks(duetotaxes);
currentdividendpayoutsmayunderestimate
th i di id d ti it
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theirdividendgeneratingcapacity
g onlyonegrowthratecanbeusedforentire
future;growthmayhavepredictablepattern
g <<relsethemodelexplodes
rmodelblackboxesfinancialstatements;
certaindividendpayoutsmayimplychangesin
fLev,henceinr
CompanyValuation(JEM 132) CharlesUniversity,Prague
JiriNovak,IESUK 4
DividendGrowth
60,0%
70,0%
80,0%
DividendPayoutRatio
19
0,0%
10,0%
20,0%
30,0%
40,0%
50,0%
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
P
a
y
o
u
t ra
tio
DividendGrowth
5,0%
6,0%
DividendYield
20
0,0%
1,0%
2,0%
3,0%
4,0%
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
D
iv
id
e
n
d
y
ie
ld
d d d d l 2.3DiscountedDividendModel
ComprehensiveValuation
Use(DDM,DCF)
veryversatile,sophisticatedmethod
applicableforanycompany
providedthatonekeepsbasicaccounting
relationships it provides a lot of flexibility
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relationshipsitprovidesalotofflexibility
Method
first,analyzethecompanyshistorical
performance,computefinancialratios
second,forecastfuturefinancialstatements
basedonhistoricalfinancialperformance
third,discountforecasteddividends(DDM)or
freecashflows(DCF)topresentvalue
ComprehensiveValuation
t+1 t+2 t+3 T
Ofinancialratios
Oforecastedratios
t3 t2 t1
23
t+1 t+2 t+3 T
Ocontext
t3 t2 t1
Oaccountingfigures
$
Oforecastedaccounting
Odiscounting
operating
DiscountedDividends
workingcapital
WC
0
= 64
O
g(NS)=?
O
FLV =0.6
equity
EQ 100
OWCT =5
O
XAT =3.33
24
operating
expenses
aftertaxes
284
debt
ND
0
= 60
operating
revenues
NS
1
= 320
earnings
NI
1
= 30
O
PM =
11.25%
O
IR
1
=10%
O
O
EQ
0
= 100
interestexp.
IEat = 6
NOI
1
= 36
Dv
1
=EQ
0
+NI
1
EQ
1
O
fixedassets
FA
0
= 96
ATO decomposed:
XAT fixedassetturnover
WCT workingcapitalturnover
CompanyValuation(JEM 132) CharlesUniversity,Prague
JiriNovak,IESUK 5
DiscountedDividends
FinancingAssumptions
dividendsobtainedfromproforma statements
byassumingsomeaftertaxcostofdebtand
explicitlymodelcreditsideofBSbyeither:
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dividendpolicyassumption assumescertain
partofFCFarepaidoutasdividendswith
residualimplicationsforfinancialleverage,or
financialleverageassumption assumes
companymaintainscertainfinancialleverage
leavingdividendpolicyresidual
DiscountedDividends
ValueCreationvs.Distribution
DDMbasedonvalue distribution,whichshould
bevalueirrelevant(assumingnofrictions)
DCFbasedonvaluecreation,i.e.individualvalue
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driversthatmayyieldabnormalprofitability
thatiswhysomepreferDCFoverDDM
(despiteoftheirtheoreticalequivalence)
DiscountedDividends
Operatingvs.Financing
DDMmixeseffectofoperating &financing,
hencemakesforecastingmoredifficult(why?)
profitabilitycomparisonisharderacross
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companieswithdifferentcapitalstructure
DDMrecommendedusetovaluebankswhere
capitalstructureispartofoperations
DiscountedDividends
28

E 1.8Extra
DividendIrrelevance
DividendIrrelevanceTheorem
Miller,Modiglianishowedthatinaperfect
worlddividendpayoutisirrelevanttofirmvalue
dividendswouldberesidual theywould
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dependonexistinginvestmentopportunitiesso
sowouldbebeveryvolatile
Paradox
discounteddividendmodel
V = [div
t
/(1+k
e
)
t
]
howitispossiblethatdividendpayoutis
irrelevanttocompanyvalue?
CompanyValuation(JEM 132) CharlesUniversity,Prague
JiriNovak,IESUK 6
DividendIrrelevance
DividendIrrelevanceParadox
ifsharesarefairlypricedNPVof$1investedin
anycompanyisequalto$1
investorsareindifferentbetween:
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receiving$1dividend&investingitelsewhere
retaining$1inthefirm&increasingfuturediv
P = DPS
time
share
price
dividends paid out

DividendIrrelevance
DividendIrrelevanceParadox
$1incurrentdividend=
=sacrificingfuturedividendsofNPV=$1=
=decreaseinP of$1
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sumofdividendsthecompanypaysthroughout
itsexistenceremainsunchanged dividend
policydeterminesonlywhentheyoccur