Waseda Financial Investment Team 24 th October 2011.
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Waseda Financial Investment Team
24th October 2011
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Market Update Seesaw trading
◦Tue: Rose on news of 2T rescue fund◦Wed: Fall on Sakorzy statement that
debt talks were stuck◦Fri: Stocks rallied on hope that
weekend EU summit provide answers to debt crisis S&P futures up 1.1% DOLLAR FELL AGAINST YEN TO POSTWAR
LOW
Techs fell on thai floods
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Economic dataPhilly Fed Business outlook
◦ Business Activity +8.7 vs -10.0 (exp) & -17.5 prior◦ New orders +7.8 from -11.3◦ Shipments to +13.6 from -22.8
USD leading indicators—0.2%, 0.3%USD CPI 3.9% from 3.8%
◦ PPI Index ex food and energy 2.5% from 2.5%EUR Debt GDP ratio—85.4%, 85.1% CHF ZEW survey -54.5 vs -75.7
◦ CHF trade balance 1.85B vs 0.76BGerman ZEW -48.3 vs -43.3China Real GDP 9.1% vs 9.5%
China defaults?
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Company News20 companies announced spinoff
◦Abott lab, Kraft, Sara Lee, Conoco Phillips
Groupon’s IPO◦Valuation of 10.76Bn
Apple earnings miss expectations Goldman report loss (428m)
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Stock or Business?
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If you're an investor, you're looking on what the asset is going to do, if you're a speculator, you're commonly focusing on what the price of the object is going to do,
and that's not our game.
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“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
- Warren Buffet
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How to start?Buy a good
companyAt a good price
Qualitative
Quantitative
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I'll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty.
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Durable Competitive Advantage
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ExamplesSwitching costsBrandSpecial access to scarce
resources◦Eg Debeers in 20th C
Low cost ◦Eg Walmart
Network effect
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How to identify?Evaluate historical profitability
◦ROE, ROA, ROICStable market share?Drivers of profit
◦Easy to imitate?Competitive advantage periodIndustry’s competitive structure
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Southwest airlines Vs KO
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ExamplesCoca ColaPepsi ColaHersheysMcdonald
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Sectors without durable CAAirlineTechAuto industryPharmaceutical (?)
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Why important?Eliminate sectorsForecast
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Buying at the right priceForecastingValuation
◦Discounted Cash Flow◦ Asset-based valuation◦Comparables◦Residual Earnings◦Abnormal Earnings
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Discounted Cash FlowIntrinsic value= PV of all cash flows from
businessPV
◦$1 today. Interest rate= 5%◦ How much next year?
Savings account◦Interest rate 5%◦After Year 1, CF=$105◦Value of account?
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PV of bond
Year 1 Year 2 Year 3 Year 4
Cash Flow 100 100 100 100+1000
PV 100/1.05 100/1.05^2
100/1.05^3
(1100)/1.05^4
• Discount rate 5%• Redemption value $1000•Coupon $100
Price of bond= $1177.30
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Steps of DCF valuationForecast FCF to horizon
◦FCF= Cash from operations- Cash from Investment
Discount FCF to PVCalculate continuing value at horizon
with estimated growth rateDiscount CV to present Discounted CV+ Discounted FCFSubtract Net debtValue of Equity
No of shares= Price per share
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Step 1: Forecast FCF to horizonHorizon 2 Years
2000 2001Cash from Operations
3657 4097
Cash from Investment
947 1187
FCF 2710 2910
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Step 2: Discount FCF to PV 2000 2001Cash from Operations
3657 4097
Cash from Investment
947 1187
FCF 2710 2910Discount rate (1.09^t)
1.09 1.1881
PV of FCF2486.23
92449.28
9
Total PV4935.5273
13
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Step 3: Calculate CV from Year 3Assume FCF will grow at rate of
5%CV at Year 3= FCF of Year 2 *
1.05 Discount rate- 1.05
Discount CV to Year 1
2000 2001Cash from Operations 3657 4097Cash from Investment 947 1187FCF 2710 2910Discount rate (1.09^t) 1.09 1.1881PV of FCF 2486.239 2449.289Total PV 4935.527313Continuing Value 64293.83PV of CV 54114.83081
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Step 5: Value of equity 2000 2001Cash from Operations 3657 4097Cash from Investment 947 1187FCF 2710 2910Discount rate (1.09^t) 1.09 1.1881
PV of FCF 2486.239 2449.289Total PV 4935.527313Continuing Value 64293.83PV of CV 54114.83081Enterprise Value 59050.35812Book value of net debt 4435
Value of equity 54615.35812No of shares outstanding 2472
Value per share 22.09359147
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Sources of UncertaintyDiscount rateGrowth rate ForecastsCash from Operations/
Investments