Concepts of Value. Book Value Market value Liquidation Value

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Hollie Lambert
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1 Book Value Market value Liquidation Value Concepts of Value Fair Market Value ( FMV ) & Intrinsic Value a thorough appreciation of the Company, its Value Proposition, and its future prospects in a competitive market Market Value (most recent transaction) Investment Value (cash on cash returns) Strategic Value (positioning and power)

2 Analytical Perspectives 1. Proprietary modeling: always evolving. 2. Fundamental Analysis: parametric analysis. 3. Technical Analysis: using reliable patterns reflecting supply & demand and basic human behavior. 4. Speculation: I ve got a feeling.

3 Financial Markets Management 183 Economics 173A Equity Valuation Updated 5/13/18

4 The Valuation Approaches & Methods 1. Cost: De Novo or M&A 2. Income: Revenues, Earnings, Cash flows 3. Market = Comparable Companies (or mean comparable stocks?)

5 Stock Picking Top down Macroeconomic Analysis Sector Selection Industry Analysis Market Perspective Company Selection Security Analysis Technical Analysis

6 Stock picking Looking for Intrinsic Value The Company s Value Proposition Its Business Model. Determinants of Sales. Inherent Risks.

7 Fundamental Calculations: Cash Flows and RADR s a) Financial Ratio Analysis: a sense of the Company s expense structure. b) Forecast Earnings or Cash Flow, or Inflows ofsome sort: use a DCF to model the magnitude and timing of CF s c) Risk assessment: Conclude an RADR d) Discount e) Compare: Market Method Guideline companies

8 Nordstrom Performance Earnings per Share (EPS) 5 year Growth: negaive 8.7% for Nordstrom while its peer group, multiline retail, is > 35% EPS $ Price to Earnings (P/E): Nordstrom's ratio is 19 The average price to earnings ratio of the multiline retail industry is 29. Debt to Equity : Nordstrom s D/E is %, above the multiline retail industry average of 81.91%. Free Cash Flow per Share Growth : lower than competitors. FCF means the Company is able to pay down debt, buy back stock or pay dividends, invest money into the business, or. Profit Margins : Nordstrom s NPM is 3.21% today. The multiline retail average is 7.92%.

9 Nordstrom Returns Calculate the AHPR for Nordstrom Stock over the last 12 months. Here is the data: Price $ /13/18 $ /15/17 Dividends $ /24/17 $ /24/17 $ /24/17 $ / 2/18

10 Nordstrom Returns Collect all proceeds (numerator) and divide by the initial investment (denominator): -1 = = I m using subscripts to indicate initial investment at time=0

11 Nordstrom 1 year Return 22.7%

12 Nordstrom Returns If you assume that this annual return is repeatable, then what one year target price does this imply for Nordstrom stock? Assume no dividend growth. 22.7% = Solve for P 2

13 Nordstrom Target Price 22.7% = x = 2 2 =

14 Check the Calculation Insert the Target Price into the AHPR formulation:?

15 Stock Prices and Growth The price of a stock can be parsed into two prices: a price for fixed cash flows (dividends) and a price for growth in those cash flows. In the previous example, we calculated P 2, the future price of Nordstrom stock, assuming no change (no growth) in future dividends. What if, instead, we assumed 10 percent growth in dividends? In this case, we need a short lesson on Capitalization of Cash flows.

16 Asset Prices The financial value of any asset is the present value of its expected future cash flows discounted at an appropriate RADR. If we assume perpetual fixed cash flows, then the basic quantitative model is: 0

17 Asset Prices This equation below is an infinite series, that converges to: = V 0 This is called capitalizing a cash flow at r%

18 Asset Prices with Growing Cash Flows If the Cash flow in question is expected to grow by g% per year perpetually, then a modification is required: 0 which converges to: g g = V 0 This is called capitalizing a cash flow at a net discount rate ( NDR )

19 Calculate the Value ( V 0 ) of a $1.48 annual cash flow w/ and w/out 10% growth using 15% as the RADR. V g $32.60 And, if g = 0 V ng $ 9.87 Thus the value of pure growth is $22.73 or 70% of the asset s $32.60 Value

20 Intrinsic Valuation Methods Gordon s constant growth model V 0 where D0 1 g k g D 0 D 1 is is the D k 1 g the current dividend the dividend to be paid next year g is the expected dividend growth rate k is the discount factor according to riskiness the stock The model assumes that the dividend stream is perpetual and that the long term growth rate is constant. of

21 Intrinsic Valuation Methods Advantages of DDM Simplicity Disadvantages of DDM Apply only to dividend paying stocks. Risk is not an explicit variable; it is implied. Estimates of the discount rate and the growth rate may be in error. Small changes in the discount rate and the growth rate produce large differences in valuation. Models do not reflect the value of underutilized assets.

22 Discount Rates (looking for the RADR) Build up Method a) Risk free Rate + b) Equity risk premium + c) Company risk premium P/E implied C.A.P.M. a) Risk free Rate + b) Non systematic risk premium

Financial Markets Management 183 Economics 173A. Equity Valuation. Updated 5/13/17

Financial Markets Management 183 Economics 173A Equity Valuation Updated 5/13/17 Perspective and Objective 1. Diversification: Risk reduction. 2. Speculation: I ve got a feeling. 3. Long term: Buy & Hold.