valuation is an art
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Equity Valuation in the context of Bangladesh
Ali Imam
AnalystBRAC EPL Stock Brokerage Ltd.
June 30, 2012
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Valuation
Is an art
Is always biased- find the direction and extent
Is a forward looking exercise
Value is what you get (price is what you pay)
Does not indicate when it will be realized
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Basic Principles
Both buyer and seller wants to win
Everything has an opportunity cost for everyone
Cash is the king
Relative perspective
Tools
Macro-economic Data
Industry Data Financial Statement
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Rights of different stakeholders of a company
Lenders lend fund to earn interest income on investment Government provides public services to collect tax revenue from corporations
Shareholders invest in current share price to earn future dividend and capital gain
Enterprise value is the operating value of the entity (market cap excluding cash &
investments) Market Cap of Equity = No of Shares x Current Share Price
Market Cap of Debt = Book Value of Debt
Enterprise Value = Market cap of Equity + Market Cap of Debt Cash & Investment
Stakeholders Contribution of Stakeholders Payoff to Stakeholders
Customer Revenues Product/ services
Supplier Raw material Cost of Sales
Employees Human resource Wage & salaries
Lenders Interest debt Interest payment
Government Public facilities Tax
Sponsors Financial & entrepreneurial capital Net profit and dividend
Minority Shareholders Share price Net profit and dividend
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Understanding the Income Statement
Personal Income Statement
Salary
- Food
- House Rent
- Conveyance- Allocation of Fixed asset cost
- Interest Expense
+ Income from Assets
Taxable Income
- Income Tax
Savings
Summary of revenue and expenses for a particular period
Think about your personal accounts-
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Personal Income Statement
Salary
- Food
- House Rent
- Conveyance- Allocation of Fixed asset cost
- Interest Expense
+ Income from Assets
Taxable Income
- Income Tax
Savings
Corporate Income Statement
Revenue
- Raw material cost
- Labor cost
- Overhead- Allocation of Fixed asset cost (Depreciation)
- Interest Expense
+ Income from Assets
Taxable Income
- Tax Exp
Net Income
Understanding the Income Statement
Summary of revenue and expenses for a particular period
Revenue and expense recognition is governed by accounting standards and assumptions
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Personal Balance Sheet
+ House-hold Assets
+ Jewelery
+ Bank deposit
+ Cash
Total Assets
- Bank Loan
Net Worth
Understanding the Balance Sheet
List of assets and liabilities on a particular date- a snapshot
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Personal Balance Sheet
+ House-hold Assets
+ Jewelery
+ Bank deposit
+ Cash
Total Assets
- Bank Loan
Net Worth
Corporate Balance Sheet
Plant, Property & Equipment
Account Receivables
Investments
Cash
Total Assets
- Payables
- Interest Bearing Debt
Shareholders Equity
Understanding the Balance Sheet
List of assets and liabilities on a particular date- a snapshot
Liabilities and Shareholders Equity represent Sources of Capital while Assets represent
Utilization of Capital Assets and liabilities are recognized at historical cost value
Shareholders Equity = Share Capital + Net Profit for the year Cash Dividend for the year
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What drives value- think of an asset that never offers cash-returns
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What drives value- think of an asset that never offers cash-returns
So, cash-flow is the main value driver
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What drives value- think of an asset that never offers cash-returns
Cash-flow Statement
+ Cash Revenue
- Cash Expenses
Net Cash-flow from Operation
+ Asset Sales Proceed- Asset Purchase
Net Investing Cash-flows
- Debt Repayment
- Dividend Payment
Financing Cash-flows
So, cash-flow is the main value driver
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What drives value- think of an asset that never offers cash-returns
Cash-flow Statement
+ Cash Revenue
- Cash Expenses
Net Cash-flow from Operation
+ Asset Sales Proceed- Asset Purchase
Net Investing Cash-flows
- Debt Repayment
- Dividend Payment
Financing Cash-flows
So, cash-flow is the main value driver But which type of cash-flows?
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What drives value- think of an asset that never offers cash-returns
Cash-flow Statement
+ Cash Revenue
- Cash Expenses
Net Cash-flow from Operation
+ Asset Sales Proceed- Asset Purchase
Net Investing Cash-flows
- Debt Repayment
- Dividend Payment
Financing Cash-flows
So, cash-flow is the main value driver But which type of cash-flows?
Operating cash-flow is the primary
value driver
Investments are the most importantusage of operating cash-flows
Residual is available for distribution
among the investors of corporation
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What drives value- think of an asset that never offers cash-returns
Cash-flow Statement
+ Cash Revenue
- Cash Expenses
Net Cash-flow from Operation
+ Asset Sales Proceed- Asset Purchase
Net Investing Cash-flows
- Debt Repayment
- Dividend Payment
Financing Cash-flows
So, cash-flow is the main value driver But which type of cash-flows?
Operating cash-flow is the primary
value driver
Investments are the most importantusage of operating cash-flows
Residual is available for distribution
among the investors of corporation
Free CF= Operating CF Investments = Distributable CF to investors
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Discounted Cash Flow (DCF) valuation
Cash Flow Cash Flow Cash Flow Cash Flow Continuing Value
Discounted at opportunity cost
Enterprise Value
Net Debt
Equity Value
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Discounted Cash Flow (DCF) valuation
Cash Flow Cash Flow Cash Flow Cash Flow Continuing Value
Discounted at opportunity cost
Enterprise Value
Net Debt
Equity Value
Present Value =
Fair Value Estimate =
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Relative Valuation
Return/ Yield
Output/Input Ratio
The higher, the better for investors
Example: Interest Rate, Dividend Yield
Trading Multiple
Input/Output Ratio
The lower, the better for investors
Example: PE Ratio, P/ BV Ratio
Comparing valuation ratios of Company X with- Its own historical average
Valuation ratios of company Y
Valuation ratios of the sector where X belongs
Valuation ratios of the broader market
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Who is entitled to what?
Income Statement Investors' Claim Investors' Investment
Multiple
/Yield
Revenue FCF for all stakeholders Total Value of the FIrm P/S
- Raw material cost
- Other Direct Cost
Gross Profit
- Admin Exp
- Selling Exp
EBITDA FCF for Lender, Govt & Shareholders Enterprise Value EV/ EBITDA-Depn & Amort
EBIT FCF for Lender, Govt & Shareholders Enterprise Value EV/ EBIT
- Interest Expense
+ Income from Assets
EBT FCF for Govt
- Tax Exp
Net Income FCF for Shareholders Market Capitalization of Equity P/EEPS FCF for Individual Shareholder Share Price P/E
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Price to Earning Ratio (P/E)
Definition:
Trailing P/E= Current Share price/Trailing 12 months earnings per share Forward P/E= Current Share price/Next 12 months earnings per share
Meaning and implication:
It indicates number of years will it take for return OF capital (not return ON capital)
Generally, the lower the P/E, the cheaper the stock
Companies with better earnings growth outlook should have higher P/E multiple
Pros & Cons:
Intuitive measure, readily available across stocks, practically applicable
Cant capture effect of earnings growth
Weak indicator when earnings quality is poor and unsustainable
Analytical Challenges:
Use fully-diluted earnings per share after record date
Adjust earnings for non-recurring items
Dont use P/E for evaluating asset-based companies (banks, MF etc.)
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Price to Book Value (P/BV)
Definition:
P/BV= Current Share price/Book Value Per Share Book value per share= (Total Assets- Total Debt)/ Number of outstanding shares
Meaning and implication:
It indicates how market values an asset relative to its accounting value
Generally, the lower the P/BV, the cheaper the asset
Companies that can generate higher ROE should have higher P/BV
Pros & Cons:
Book value does not consider important assets like human resource, brand value, etc.
Should be used for companies which has significant marketable assets on balance sheet such
as banks
Analytical Challenges:
Assess the quality of asset revaluation
Assess implications of off-balance sheet assets & debt
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Enterprise Value to EBITDA (EV/EBITDA)
Definition:
EV/EBITDA= (MCAP of Equity + MCAP of Debt Cash & Investments)/ EBITDA EBITDA= Net Profit + Tax + Interest Expenses + Depn & Amort
Meaning and implication:
It indicates number of years it will take to recoup investments done by all investor-groups
Generally, lower EV/EBITDA indicates cheap valuation
Generally, companies with better revenue growth, higher EBITDA margin and lower debt
have higher EV/EBITDA
Pros & Cons:
EBITDA is a better proxy of cash flow
Good indicator for investment intensive industries
Auto-adjusts for differential tax status, depreciation policy and capital structure
Analytical Challenges: Difficult to calculate- more information need
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Dividend Yield (D/P)
Definition:
Dividend Yield= Cash Dividend Per Share/ Current Share price
Meaning and implication:
It indicates the rate of return based on the dividend income only
Generally, investors prefer high dividend yield specially during economic downturn
High dividend yield also means lack of growth opportunity
Pros & Cons: Practically applicable, simple and intuitive
Captures only one source of return- dividend, does not consider capital gain
Analytical Challenges:
Stock dividend is effectively no dividend
High dividend yield investments may not be positively viewed specially when growth outlook
is weak
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Sample Valuation Case
Valuation of ABC Corp 2012E 2013E 2014E 2015E
Pretax Earning 41,469 43,901 47,953
+ Depreciation & Amortization 15,718 17,352 19,183
+ Net Financial Expenses 309 825 182
- Cash Income Tax Paid (19,768) (16,824) (17,916)- Working Capital Investments 1,317 1,115 2,403
CFO 39,046 46,369 51,804
- Capex (22,068) (15,700) (16,887)
+ Divestment of Other Assets - - -
CFI (22,068) (15,700) (16,887)
Free Cash Flow 16,978 30,669 34,917
Normalized CF 39,826
Terminal Value 384,564
PV of FCF 14,693 23,202 277,473
Enterprise Value 315,368
+ Cash & Investments 22,225
- Interest Bearing Debt 20,221
Equity Value 317,372
Number of Share 1,000Per Share Value 317
Weighted Avg Cost of Capital 15.6 15.0% 14.8%
EV/ EBITDA 5.5 x 5.1 x 4.7 x
P/E 12.8 x 11.9 x 10.8 x
P/B 8.1 x 7.4 x 6.7 x
Yield 7.0% 7.5% 8.4%
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CompaniesP/E P/BV EV/EBITDA Dividend Yield ROE Earnings Growth
2011A 2012E 2011A 2012E 2011A 2012E 2011A 2012E 2011A 2012E 2011A 2012E
Cement
A Cement 20.2 16.1 3.1 2.2 13.1 9.1 2.1% 2.5% 16% 14% -17% -4%
Consumer
B Cons Co Ltd 21.6 16.2 5.0 3.4 15.9 10.2 3.2% 3.7% 26% 22% 0% 3%
ABC Instant Food 14.5 11.3 6.3 5.5 6.4 5.4 6.7% 8.4% 42% 51% -11% 25%
Fuel & Power
Electricity Dist Co 13.5 10.9 4.4 3.5 8.6 6.7 5.7% 7.3% 34% 33% 6% 8%
Gas Dist Co 8.2 8.2 2.7 1.9 5.1 4.2 3.7% 5.3% 37% 25% 25% -17%
Pharmaceuticals
R&D Pharma 16.7 9.0 1.4 0.9 9.2 5.5 N/A 2.6% 9% 11% 36% 35%
Gnenric Pharma 15.4 12.1 3.3 2.6 9.2 7.8 1.4% 1.7% 24% 24% 31% 29%
Telecom
Dhaka Telecom 12.5 14.2 6.0 6.7 5.0 5.1 12.5% 9.1% 43% 48% 72% 3%
Tannery
Leather Footwear 15.5 10.9 4.9 2.9 7.6 4.6 1.4% 1.7% 31% 30% 8% 10%
Brand Footwear 13.0 9.2 4.7 3.2 8.7 6.0 5.0% 7.3% 41% 38% 17% 13%
Valuation Multiple Comparisons
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Current Valuation of the Market
Valuations become attractive after 44%
market correction from the peak
Current market PE is 13.0x against the
long-term average PE of 17.2x
Current market dividend yield is 3.7%,
more than long term average of 3.3%
On average, earnings of listed
companies grew by more than 20%
annually during last 10 years0.00%
1.50%
3.00%
4.50%
6.00%
7.50%
9.00%
0.00x
6.00x
12.00x
18.00x
24.00x
30.00x
36.00x
DividendYield
MarketP/E
Market P/E Yield
Source: DSE, BRAC EPL Research
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Thanks
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