Training Session on StockPointer for Investment Advisors

Transcription

1 Training Session on StockPointer for Investment Advisors Leading to the StockPointer Certification EVA is a registered Trademark of Stern Stewart & Co. Copyright 2001 StockPointer 2000 Arthur Andersen All rights reserved. April 2006

2 Contents (1 of 2) Training Objectives Understanding your needs What is EVA? How does it work? Software Features SPiX Top-80 Backtesting Customer Base EVA Metric difficult to mask An Accounting Gap The EVA power Cost of Debt Cost of Equity 2

3 Contents (2 of 2) The EVA Rationale StockPointer s Achievement The EVA Value Drivers StockPointer Key Metrics Economic Performance Index (EPI) Price / Intrinsic Value (P/IV) Ratio Future Growth Value (FGV) The EVA Rationale Portfolio Assessment Competitive Analysis Interactive Case Study Definitions 3

4 Training Objectives Better understand the EVA valuation model used by StockPointer Become familiar with the StockPointer Analysis & Reports Learn how to generate & use the StockPointer reports Better understand the StockPointer software features 4

5 Understanding your needs To buy or sell a stock, you need to evaluate the company from different angles: Management Capabilities, Competitive Advantages, Market Positioning & Leadership, Growth Potential, Profitability, Capital Management. Several Valuation Models exist with their respective strengths and weaknesses (e.g. P/E, D 1 /(k g), FCFF, FCFE, PEG, ROE, P/S, P/BV, Dupont...) 5

6 What is EVA? EVA (Economic Value Added) is a measure that takes the Cost of Capital out of the Net Operating Profit, in order to have a real picture of the financial performance of a company, in face of its shareholders. EVA is an estimate of the true Economic Profit, or the amount by which NOPAT exceeds or falls short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk. ''EVA analysis is at the heart of understanding how companies create shareholder wealth. Most importantly, it helps investors measure and understand those factors that create or destroy value.' Steven Einhorn, Global Investment Research, Goldman, Sachs & Co. 6

7 What is StockPointer? StockPointer is a Web-based offering which provides valuation graphics and key metrics according to the EVA method in order to allow investments managers to rapidly detect stock investment opportunities. EVA is today s hottest financial idea and getting hotter Fortune magazine 7

8 How does StockPointer work? 5600 US Stocks 1200 Canadian Stocks Reports & Graphs SPiX Top 40 StockPointer Adjust. NOPAT & CAPITAL Intrinsic Value Economic Performance Market Performance Accounting Performance Financial reports + figures captured in the footnotes Reports Production Data Management Security & Access Internet Utilities & Administration Specific Analysis Formatting Validating Adjustments to NOPAT et CI Enrichment Transmitting File server 8

9 StockPointer Functions Login/Logout Individual Stock Basic Report SP-Report Portfolio Analyser PfScan Best Cad Stocks SPiX Best US Stocks SPiX Customize your own requests SP-Criteria + + PDF Printout Feature Excel Export Feature Intrinsic Value Scenario Building SP-WhatIf 9

10 SPiX-Top 40 Cad vs S&P / TSX 19%/yr 7%/yr 10

11 SPiX-Top 80 US vs S&P %/yr -1%/yr 11

12 Customer Base (Canada) StockPointer exists since 2002 Is currently a strategic tool for more than 200 investment professionals in Canada: 12

13 Customer Base (USA) provides independent research services, based on StockPointer valuation metrics to 9 of the 11 major US investment firms in the USA. 13

14 Enron: Difficult to mask EVA compared to Net Income and EPS 1 What a customer will like about his Advisor using StockPointer? Net income showed great Results while EVA showed not so great 1 Stern Stewart & Co. 14

15 An Accounting Gap Revenue - COGS $$$ go to vendors Gross Profit - SG&A Expenses $$$ go to employees EBIT - Interests $$$ go to lenders EBT - Taxes $$$ go to governments Net Earnings «An Income Statement is designed as if the capital funded by the shareholders was free!» 15

16 Bridging the gap An hypothetical company producing an EVA of $150, a NOPAT of $250 versus a Cost of Capital of 10% on a Invested Capital of $1000 Initial Revenue $1,500 - SG&A & Taxes $1,250 NOPAT $ Cost of Invested Capital $ 100 EVA (Economic Profit) $

17 EVA change explains market price more significantly than other typical measures 1 1 Stern Stewart & Co. 17

18 Cost of Debt 1 Cost of Debt = Interest / Debt 1 FORTUNE, March 6,

19 Cost of Equity 19

20 The EVA Rationale Shareholders Lenders Wealth Destruction Business Invested Capital (IC*) Wealth Creation Net Operating Pofit After Tax (NOPAT*) Weighted Average Cost of Capital (COC) 20

21 StockPointer s Achievement To provide systematic and reliable metrics to assess how company executives manage the capital in the best interest of the shareholders 21

22 The EVA Value Drivers 1 Stern Stewart & Co. 22

23 StockPointer Key Metrics To assess whether a company manages its capital adequately, StockPointer uses: Economic Performance Index To asses whether a stock is overvalued/undervalued, StockPointer uses: Price / Intrinsic Value 23

24 Economic Performance Index Economic Performance Index? 24

25 Economic Performance Index Economic Performance Index = ROC/COC A Performance Index 1 means that the Return on Capital (ROC) generated by the company exceeds the Return expected by the Shareholders i.e. Return on Capital (ROC) is equal or greater than Cost of Capital (COC). 25

26 Case 1 Company «A» has a Capital of $100 m, Sales are at $100 m, Net Income is $15 m and Cost of Capital is 12% Company «B» has a Capital of $200 m, Sales are at $100 m, Net Income is $15 m and Cost of Capital is 12% Which one would you invest in? 26

27 Case 1 (Cont d) Company «A» has a Capital of $100 m, Sales are at $100 m, Net Income is $15 m and Cost of Capital is 12%: Sales Margin =15% ($15 m / $100 m = 15%). Return on Capital = 15% ($15,000,000 / $100,000,000 ) Performance Index = 1.25 (ROC / COC = 15% / 12%) Company «B» has a Capital of $200 m, Sales are at $100 m, Net Income is $15 m and Cost of Capital is 12%: Sales Margin =15%. Return on Capital = 7.5% ($15,000,000 / $200,000,000 ) Performance Index =.625 (ROC / COC = 7.5% / 12%) 27

28 Price / IV Ratio PRICE / INTRINSIC VALUE Ratio? 28

29 Price / IV Ratio (Cont d) In general, Price / IV ratio should be above 0.4 and below 2.5 Hence, a stock with an Intrinsic Value of $10 estimated by StockPointer could be an interesting buy if its priced was between $4 and $25 Below $4, there could be a problem that the analysis of the reported figures does not tell us Above $25, the stock is definitely overvalued 29

30 FGV = Risk factor related to the growth embedded in stock price Enterprise Value of Future Growth Value (FGV) Current Operations Value 30

31 To good to be true 31

32 The EVA Rationale The lenders and the shareholders fund the development of a business These fund providers require specific returns on their respective funds according to how comparable risks get rewarded in the financial markets EVA measures the economic capacity of a business to generate sufficient after tax profit to yield the returns required by the fund providers in accordance with to the capital markets EVA ( Economic Profit ) Accounting Profit* since the latter does not consider the return required by the shareholders on their invested capital Hence there is wealth creation for the shareholders when a business produces an EVA > 0 Market Price = f (Wealth Creation) StockPointer proposes two practical and universal metrics in order to detect the businesses that: create wealth for the shareholders; and, are not overvalued by the market. * «Until a business returns a profit that is greater than its cost of capital, it operates at a loss... Until then it does not create wealth; it destroys it.» Peter Drucker in a Harvard Business Review article 32

33 The EVA Rationale (Cont d) Key Concepts Weighted Average Cost of Capital funded by the lenders and the shareholders (COC) Business Economic Model Lenders Shareholders Invested Capital (IC*) Profit available to reward cost of the supplied capital EBIT X (1-t) = NOPAT Economic Profit (EVA) = After-Tax Operating Profit Cost of Capital Economic Profit Accounting Profit EVA Integration of the Financial Statements in one meaningful metric Wealth Creation for the Shareholders when EVA > 0 Share Market Price = f ( Wealth Creation) Intrinsic Value Present value of the EVA Two metrics: Return generated on the Capital versus the Cost of Capital required (EPI) Share Market Price versus Share Intrinsic Value Net Operating Profit After Tax (NOPAT*) (1) ROC = NOPAT / IC Weighted Average Cost of Capital (COC) (2) EVA$ = NOPAT - (COC * IC) (3) EVA% = ROC - COC Intrinsic Value of a Business TIV = IC + Σ (EVA$ t / (1+WACC) t ) Intrinsic Value of the Equity (IV) Economic Performance Index (>1) EPI = ROC / COC Price / Intrinsic Value Ratio (>0,4 and < 2,5) Price / IV Ratio * Adjusted to reflect more accurately the economic reality of a Business and avoid potential accounting distortions 33

34 A new Function : PfScan To perform Portfolio analysis 34

35 A new Function : PfScan using a standard Portfolio from a customer 35

36 Competitive Analysis 36

37 Competitive Analysis (Cont d) 37

38 Interactive Case Study How to interpret an EVA report Does the business create value? (EPI > 1) Identify risk factors? Volatility of the Intrinsic Value and Share Market Price Evolution of the Economic Performance Spread The importance of the Future Growth Value to deliver to justify the current Enterprise Value The magnitude of the debt (financial leverage) Identify key events that cause significant changes in the pattern of the key EVA metrics Determine heavy and trendy gaps between conventional accounting measures (e.g. EPS) and EVA metrics (e.g. EVA) The pattern of the Free Cash Flow related to comparable businesses 38

39 Interactive Case Study How to use the Top X list (in addition to identify good investment prospects) Analyze the constitution of the Top 80 by economic sectors to detect trends for assets allocation (ex. 30 / 80 from from the energy sector compared to 27 / 80 for the prior month) Compare the constitution of the Canadian Top 80 and the American Top 80 to detect valuation trend differences between the markets (Currently 50% of the Canadian Top 80 are overvalued compared to only 2.5% of the American Top 80 which are overvalued) 39

40 Interactive Case Study Why to use a specific research To detect the most performing businesses of a particular industry meeting it own criteria while still undervalued Select businesses that meet its own criteria picked among a variety of proposed criteria classified according to three axis: Economic Performance, Market Performance and Accounting Performance 40

41 Interactive Case Study Analysis Criteria: Is the business currently over/undervalued (0.4 < Price/Intrinsic Value Ratio < 2.5) Volatility of the Intrinsic Value. Market Price Pattern versus Intrinsic Value Pattern. What is the traction and correlation between both patterns? Does the Return on Capital meet your minimum objective for investment (e.g. ROC > +/- 12 %) Is the Cost of Capital too low according to our current understanding of the business Volatility and Sustainability of a Business Model = f(economic Performance Spread Pattern) Level of Wealth Creation measured by the EPI (must be > 1) What constitute the Intrinsic Value: The Earnings Power of a business as opposed to the value of the brick & mortar Is there unreasonable expected future growth necessary to justify the current market Enterprise Value? Do EVA and EVA/Share current changes send signs of potential Market Price changes? Does the Share Price already reflect those changes? Is there a significant gap between the EPS/Net Income pattern and the EVA pattern? Is debt magnitude a risk factor? An ascending dividend pattern is usually good sign of business prosperity 41

42 Definitions Concept EVA (in $) NOPAT (en $) IC (en $) COC (en %) Definition Economic Value Added is a method developed initially by Stern & Stewart, a renowned finance consulting firm based in New York, mostly used at the beginning to assess the profitability of investments projects and to design performance-based compensation programs for executives. EVA = Economic Profit = NOPAT (ROC * IC) Net Operating Profit After Tax is calculated as following: Revenue COGS SG&A Expenses Applicable Taxes. The financial charges are not deducted at this level yet included in the Cost of Capital. Invested Capital is the funds invested in the business i.e. essentially the sum of all the assets whose the purchase was funded by the creditors and the shareholders. Cost of Capital is the Weighted Cost of Capital considering on one hand the cost of the debt and the cost of equity and on the other hand the capital structure (Debt versus Equity). The Cost of Equity is determined according to the Capital Asset Pricing Model that rewards the systematic risk of a business measured by its Beta. 42

43 Definitions (Cont d) Concept ROC (in %) EVA% (in %) IV (in $) EPI (>1) Price / Intrinsic Value Ratio Return on Capital is the return generated by a business that uses invested capital to acquire assets required to generate profits ROC = NOPAT / IC Is defined as the Economic Performance Spread. A favourable EVA% implies that the business has competitive advantages and a sustainable business model. EVA% = ROC COC Intrinsic Value is the economic value of a business composed of Invested Capital and the present value of the future Economic Profits (EVA$) discounted at the COC and estimated according to its historic performance based on the last twelve months. Economic Performance Index = ROC / COC Price / IV Définition (0,4 < IV < 2,5) 43

44 Definitions (Cont d) Concept COV (in $) EV (in $) FGV (in $) Current Operation Value is the present value of the future NOPAT discounted at the COC and according to the performance based on the last twelve months and without any growth assumed. Enterprise Value is the market value of the outstanding shares + the value of the debt. EV = Market Value of the outstanding shares + Value of the Debt Future Growth Value is the present value of the future growth expected by the stock market that is included in the current stock market price. FGV = EV COV Définition 44

45 Back-up slides 2000 Arthur Andersen All rights reserved.

46 A standard EVA report from StockPointer - Part 1 46

47 A standard EVA report from StockPointer - Part 2 47

48 A standard EVA report from StockPointer - Part 3 48

49 A standard EVA report from StockPointer - Part 4 49

50 A standard EVA report from StockPointer - Part 5 50