02 Valuation Models i Cvl
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Transcript of 02 Valuation Models i Cvl
Company Valuation (JEM 132) Charles University, Prague
© Jiri Novak, IES UK 1
Lecture 2
Valuation Models I
Jiri Novak
IES, UK
Recap
Importance of Valuation
company valuation is useful whenever a company or its part is purchased or sold
reasonable valuation of assets is crucial for
‐ 2 ‐
healthy financial markets and the entire economy
Limitations of Valuation
task of company valuation is to uncover the uncertain future, which is challenging and always questionable
aim is to structure the analysis well and root it properly in existing historical evidence
l A h1.3 Valuation Approaches
Valuation Approaches
Cost Based
what was the cost to develop the asset?(firm can be seen as portfolio of assets)
Revenue Based
‐ 4 ‐
Revenue Based what is the present value of revenues the asset is expected to generate?
Comparable Based what is the price of comparable assets in liquid markets?
Valuation Approaches
Simple
“rough & dirty” ways to obtain approximate idea about company value for quick orientation
indicators of firm value may be obtained:
‐ 5 ‐
y
– cross‐section
– time‐series
Valuation Approaches
Valuation Multiples (VM) M/B and P/E of comparable companies to be multiplied by Eq = B or NI = E respectively
Dividend Growth Model (DG)
‐ 6 ‐
( )
extrapolate past dividend payouts allowing for constant growth, discount them at cost of equity
Company Valuation (JEM 132) Charles University, Prague
© Jiri Novak, IES UK 2
Valuation Approaches
Complex
sophisticated valuation models are based on forecasted (pro forma) financial statements, from which discounted items are taken
‐ 7 ‐
valuation model is characterized by forecasted item that is eventually discounted:
– dividends
– free cash flow
– residual income = economic value added
Valuation Approaches
Discounted Dividend Model (DDM) dividends (Dv) – return to owners on their investment in company equity
Discounted Cash Flow Model (DCF)
‐ 8 ‐
free cash flow (FCF) – value generated through operating activities for owners and creditors
Residual Income Model (RIM) economic value added (EVA) – residual value to owners after subtracting all capital charges, added to book value of equity
l l l2.1 Valuation Multiples
Valuation Multiples
Use
quick orientation about the approximate range within which the value is likely to lie
verifying plausibility of value estimate produced
‐ 10 ‐
by more sophisticated forecast
Method
obtain M/B, P/E, and EV/EBITAmultiple of comparable companies (i.e. closest competitors)
multiply the benchmark multiple with the corresponding accounting item (Eq, NI or EBITA) of the of the company of interest
Valuation Multiples
Market‐to‐Book
ratio of stock market value of equity (market cap) divided by (accounting) book value of equity
Price‐to‐Earnings
‐ 11 ‐
g
ratio of share price to earnings per share
EV‐to‐EBITA ratio of:
– enterprise value (market value of equity & debt) to
– operating income (earnings before interest, taxes & amortization)
Valuation Multiples
Logic basic idea is that there is some fixed relationship between company value and the underlying accounting fundamentals (Eq, NI or EBITA)
B fi
‐ 12 ‐
Benefits multiples are often used because they are simple to comprehend and communicate
Shortcomings relative valuation gives sound results only when:
– firms are comparable (unique advantages)
– market values comparables without bias (fads)
Company Valuation (JEM 132) Charles University, Prague
© Jiri Novak, IES UK 3
d d h d l2.2 Dividend Growth Model
As1 = + € 30 RE1 = € 30
operating
Financial Cycle
$$$$$$$$$$$$$
$$$$$$$$$$$$$assets
equity E € 100
‐ 14 ‐
p gexpenses
€ 267
$$$$$$$$$$$$$
debt
Li0 = € 60
assets
As0 = € 160
revenues
Sl1 = € 320
earningsNI1 = € 30
Eq0 = € 100
interest exp.IE = € 3
EBIT1
taxesTx = € 20 What is the ultimate
way of paying return to company owners?
Dividend Growth
Method
past dividend payouts are implicitly extrapolated into the future and discounted to present value using fixed cost of equity
‐ 15 ‐
makes strong assumptions about dividend payout dynamics and risk dynamics
Use for mature companies (in steady state) that pay stable dividends regularly
plug‐in method in sophisticated models to determine continuing value “after horizon”
Dividend Growth
Gordon Formula
Considerations
0 d
Vr g
~ perpetuity with growth
‐ 16 ‐
o i e a io
V… company value
d… initial dividend payout that should be sustainable in the long‐run (with some growth)
r… discount factor that should reflect the riskiness of the company’s equity
g… dividend growth rate that is sustainable in a very long run
Dividend Growth
Conceptual Shortcomings
dividends capture just the distribution of wealth to the owners failing to uncover the “black box” of value creation
‐ 17 ‐
irrelevance theorem by Miller and Modigliani suggests that in a perfect world dividends do not affect company value (why?)
Dividend Growth
Technical Limitations
d … companies pay less and less dividends and rather repurchase their stocks (due to taxes); current dividend payouts may underestimate th i di id d ti it
‐ 18 ‐
their dividend generating capacity
g… only one growth rate can be used for entire future; growth may have predictable pattern
g << r… else the model “explodes”
r … model “black boxes” financial statements; certain dividend payouts may imply changes in fLev, hence in r
Company Valuation (JEM 132) Charles University, Prague
© Jiri Novak, IES UK 4
Dividend Growth
60,0%
70,0%
80,0%
Dividend Payout Ratio
‐ 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
Pay
ou
t ra
tio
Dividend Growth
5,0%
6,0%
Dividend Yield
‐ 20 ‐
0,0%
1,0%
2,0%
3,0%
4,0%
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Div
iden
d y
ield
d d d d l2.3 Discounted Dividend Model
Comprehensive Valuation
Use (DDM, DCF) very versatile, sophisticated method applicable for any company
provided that one keeps basic accounting relationships it provides a lot of flexibility
‐ 22 ‐
relationships it provides a lot of flexibility
Method first, analyze the company’s historical performance, compute financial ratios
second, forecast future financial statements based on historical financial performance
third, discount forecasted dividends (DDM) or free cash flows (DCF) to present value
Comprehensive Valuation
t+1 t+2 t+3 T
financial ratios forecasted ratios
t‐3 t‐2 t‐1
‐ 23 ‐
t+1 t+2 t+3 T
context
t‐3 t‐2 t‐1
accounting figures
$
forecasted accounting
discounting
operating
Discounted Dividends
working capitalWC0 = € 64
g(NS) = ?
FLV = 0.6
equity EQ € 100
WCT = 5
XAT = 3.33
‐ 24 ‐
operating expenses after taxes
€ 284
debt
ND0 = € 60operating revenues
NS1 = € 320
earningsNI1 = € 30
PM =
11.25%
IR1 = 10%
EQ0 = € 100
interest exp.IEat = € 6
NOI1 = € 36
Dv1 = EQ0 + NI1 – EQ1
fixed assetsFA0 = € 96
ATO decomposed:
XAT – fixed asset turnoverWCT – working capital turnover
Company Valuation (JEM 132) Charles University, Prague
© Jiri Novak, IES UK 5
Discounted Dividends
Financing Assumptions
dividends obtained from pro forma statements by assuming some after tax cost of debt and explicitly model credit side of BS by either:
‐ 25 ‐
– dividend policy assumption – assumes certain part of FCF are paid out as dividends with residual implications for financial leverage, or
– financial leverage assumption – assumes company maintains certain financial leverage leaving dividend policy residual
Discounted Dividends
Value Creation vs. Distribution
DDM based on value distribution, which should be value irrelevant (assuming no frictions)
DCF based on value creation, i.e. individual value
‐ 26 ‐
drivers that may yield abnormal profitability
that is why some prefer DCF over DDM (despite of their theoretical equivalence)
Discounted Dividends
Operating vs. Financing
DDM mixes effect of operating & financing, hence makes forecasting more difficult (why?)
profitability comparison is harder across
‐ 27 ‐
companies with different capital structure
DDM recommended use to value banks where capital structure is part of operations
Discounted Dividends
‐ 28 ‐
E1.8 Extra
Dividend Irrelevance
Dividend Irrelevance Theorem
Miller, Modigliani showed that in a perfect world dividend payout is irrelevant to firm value
dividends would be residual – they would
‐ 30 ‐
depend on existing investment opportunities so so would be be very volatile
Paradox discounted dividend modelV = [divt / (1+ ke)
t ]
how it is possible that dividend payout is irrelevant to company value?
Company Valuation (JEM 132) Charles University, Prague
© Jiri Novak, IES UK 6
Dividend Irrelevance
Dividend Irrelevance Paradox
if shares are fairly priced NPV of $1 invested in any company is equal to $1
investors are indifferent between:
‐ 31 ‐
– receiving $1 dividend & investing it elsewhere
– retaining $1 in the firm & increasing future div
P = DPS
time
share price
dividends paid out
Dividend Irrelevance
Dividend Irrelevance Paradox
$1 in current dividend == sacrificing future dividends of NPV=$1 == decrease in P of $1
‐ 32 ‐
sum of dividends the company pays throughout its existence remains unchanged – dividend policy determines only when they occur