Growth in CSE
= [CSE(EP) - CSE(BP)]/CSE(BP) x100%
CSE(EP)
= CSE(BP) + CE - Div
AE
= (ROCE - re) x CSE (BP)
or
= CE - r*CSE(BP)
Growth in AE
= [(AE previous - AE current)/ AE previous] x 100%
ROCE (yr, FIFO)
= [CE/CSE (BP)] x 100%
Conservative Accounting
= carrying value of net assets is lower than otherwise. Thus, conservative acc. yields higher intrinsic P/B ratios. This is also observed in the results above.
= result in reduced earning & lower book value’
Examples:
- expensing R&D expenses vs capitalizing
- accelerated depn & amortization methods
- overestimates of liabilities and expenses
- underestimates of revenue and income
- higher provision for doubtful debts: lower earnings & lower acc. receivable
Calculate the value of the company equity using PVAE model
CE
- Div
= Retained
CSE(EP) E(CE) E(AE) Discount PV rate = PV
Accounting - based meaures
- comprehensive earnings (CE) $
- Return on Common Equity (ROCE/ROE) %
- Abnormal Return on Common Equity (AROCE) %
- Abnormal Earnings (AE) $
Market - based measures
- Stock Return (SR) $
- Stock Rate of Return (SRR) %
- Stock Abnormal Rate of Return (SARR) %
- Stock Abnormal Return (SAR) $
Accounting-based measure: Comprehensive Earnings (CE)
= change equity - net payout to owners (d)
CE current = CSE current - CSE beginnning + Net div. (d)
Note: change equity = closing CSE - Opening CSE
and Net Payout to owners (d) = Dividends paid + shares buy back - shares issued
Accounting-based measure: ROCE = ROE
Based on opening book value:
ROCE = CE current/ CSE(BP) X 100%
Based on average book value:
CE/[1/2(CSE(BP) + CSE(EP))]
Accounting-based measure: Abnormal ROCE %
= ROCE - re
where re = Rf + Be(Rm - Rf)
Accounting-based measure: Abnormal Earning
= CE - (re X CSE(BP))
Alternatively:
AE = AROCE x CSE (BP)
= (ROCE - re) x CSE(BP)
where
AE > 0 if ROCE > re creating economic value
AE< 0 if ROCE < re destroying economic value
AE = 0 if ROCE = re firm earns a normal rate of return
Reason for -ve & -ve AE
+ve - firm may be in an attractive industry & its strategic position may enable it to generate returns on (ROCE) common equity in excess of its cost of equity (re) in the SR.
-ve - the firm might be at some competitive disadvantage in the SR, leading to subnormal AE. Alternatively, firm may be very skilled ( or underskilled) in financial engineering & may be able to generate supernormal (or subnormal) economic profits.
Market-based measures: Stock Return (SR)
= change MV + d
where
change MV = MV(EP) - MV(BP)
d = CE + CSE(BP) - CSE(EP)
CE = CSE(EP) - CSE(BP) + d
SR = CE + (MV - CSE) current - (MV - CSE) beginning
= CE + change (price to book premium)
Market-based measure: Stock Rate of Return (SRR)
- = (change MV + d) / MV(BP) x 100%
- = SR/MV(BP) x 100%
= CE + [(MV - CSE) end - (MV-CSE) beginning] / MV beginning
= [(ROCE x CSE(BP)) x change (PB premium)] / MV(BP)
= ROCE x (CSE(BP)/MV(BP)) + (changePB premium/MV(BP)) - = (change share price + div per share) / share price = SRR for each share
special case: current premium of MV is nil.
no premium MV = CSE(EP), change (PB premium) = zero
(i) where PB premium is constant zero : CSE(BP) = MV(BP)
SRR = ROCE
(ii) where PB premium is constant positive (MV(BP) - CSE(BP) > 0) :
CSE(BP) < MV(BP)
SRR < ROCE
(iii) where PB premium is constant negative (MV(BP)>CSE(BP) :
CSE(BP) > MV(BP)
SRR > ROCE
Market-based measure: Stock Abnormal Rate of Return %
= SRR - re
where re - calculate by CAPM
Market-based measure: Stock Abnormal Return $
= SR - (re x MV(BP))
where re = normal return
ABM vs MBM
ABM
- historical cost data
- accrued acc. (non-cash flows)
- prudence acc. choices
- assets vs expenses contentions
ABM are backwards-looking: usefulness & relevance are questionable.
But offers comparability, consistency & stability.
MBM
- assumptions based.
- driven by market opinions which may be fad-driven.
- measures highly volatile (extreme swings)
MBM is difficult to interpret (from bullish vs bearish)
bullish = characterized by rising share prices./ confident/positive/optimizing
bearish = characterized by or associated with falling share prices.
But forward bias.
PVAE Model
V E beginning = CSE beginning + PVAE
CSE beginning -> where ROCE = rE = return on BV = return on equity
~ BV = Equity MV
PVAE -> Excess above ROCE = returns beyond BV x rE
~ rE benchmark against ROCE to determine value beyond BV or conversely below BV.
Note: V E beginning there is symbol top of V is E and below of V is O
PVAE model & PB Premium
PB beginning = V E beginning /CSE beginning
V E beginning = CSE beginning + PVAE beginning
(i) where PVAE beginning < equivalent 0,
~ V E beginning < equivalent CSE beginning and PB premium < equivalent 0 or -ve.
(ii) where PVAE beginning > 0,
~ V E beginning > CSE beginning and PB premium > 0 or +ve
