1
Q
ETF’s reported tracking error
A
annualized standard deviation of the difference in daily returns between an ETF and its benchmark
2
Q
Where can information on a company’s return assumptions for pension assets be found?
A
Footnotes to the financial statements
3
Q
Two main definitions of cash flow
A
Free Cash Flow and Residual Income
4
Q
FCFF vs. FCFE
A
FCFE is after debt, FCFF is to entire firm, both are after capex and working capital
5
Q
Residual income
A
- accounting earnings in excess of the opportunity cost of generating those earnings
- BV + PV of expected future residual earnings
6
Q
Relative Valuation Model
A
- Estimates value of asset in comparison to other asset
- P/E
- CF/share
7
Q
When is FCF model appropriate
A
- Not dividend paying
- Dividend paying but not consistent
- Investor takes a control approach
8
Q
when is residual income model appropriate
A
- not paying dividends, and alternative to FCF model
- expected FCF are negative
9
Q
DDM Equation
A
D1 / (r-g)
10
Q
Share Repurchase Affect on Shareholder Wealth
A
Neutral (if done at market rates)
11
Q
Justified P/E
A
- Also known as fundamental P/E
- calculates P/E on the basis of fundamentals
12
Q
Dividend Payout Ratio
A
(1-b)
13
Q
Retention Rate
A
- “b”
- fraction of earnings reinvested in the company
14
Q
Forward Justified P/E
A
(1-b) / (r-g)
15
Q
Current Justified P/E
A
[(1-b) (1+g)] / (r-g)
16
Q
H Model
A
- D0 (1+G(L)) + D0H(G(s) - G(L)) / (r - G(L))
- G(L) = Long-term growth rate
- G(S) = Short-Term Growth Rate
- H = half life of high growth period
16
Q
Sustainable Growth Rate
A
- g = (b in the mature phase) * (ROE in the mature phase)
- b = retention rate
- (1-dividend payout rate)
- Net Income - Dividends/Net Income
17
Q
DuPont Decomposition
A
- ROE = net income/sales (profit margin) * sales/total assets (asset turnover) * total assets/SE (leverage)
- multiple by Net Income-Dividends/Net Income (1- b) to get sustainable growth rate
18
Q
Adjust Present Value (APV)
A
- Firm value is calculated by taking debt out of company and discounting by unlettered cost of equity
- Discounting unlettered FCFF by unlevered cost of equity
19
Q
Equity Value
A
Firm Value - Market value of debt
20
Q
FCFF from Net Income
A
Net Income + Net Non Cash Charges (NCC) + Interest Expense (1-tax rate) - Fixed Capital Investments - Investments in Working Capital
21
Q
FCFF from CFO
A
CFO + Interest Expense (1-tax rate) - Fixed Capital Investments
22
Q
IFRS vs. GAAP Treatment:
1. Interest Received
2. Interest Paid
3. Dividends Received
4. Dividends Paid
A
IFRS (GAAP)
1. Operating or Investing (operating)
2. Operating or financing (operating)
3. Operating or Investing (operating)
4. Operating or Financing (financing)
23
Q
FCFE from FCFF
A
FCFF - interest expense (1-tax rate) + net borrowings
24
FCFE From Net Income
NI + NCC - FCInv - WCInv + Net Borrowings
25
FCFE From CFO
CFO - FCInv + Net Borrowings
26
FCFF from EBIT
EBIT (1- tax) + Dep - FCInv - WCInv
27
FCFF From EBITDA
EBITDA (1- tax rate) + Dep (tax rate) - FCInv - WCInv
28
When would net income and FCFE be the same
New investments exactly equal depreciation and company is not investing in working capital or engaging in any new net borrowing
29
Preferred Dividends Effect on FCFF and FCFE
Add back dividends in FCFF and ignore in FCFE
30
Law of One Price
Two identical (same or equivalent future cash flows) assets should sell a the same price
31
Supporting Rationales for P/E
1. Earning power is chief driver of investment value
2. P/E widely recognized and used by investors
3. Differences in P/E's may be related to difference in long-run average returns on investments in those stocks
32
Potential Drawbacks to P/E
1. EPS can be 0, insignificantly small, or negative
2. The ongoing or recurring components of earnings that are most important in determining intrinsic value can be difficult to distinguish from transient components
3. EPS may be distorted from different accounting standards
33
Normalized P/E
- P/E based on longer-run expected average EPS (type of trailing P/E)
- Based on level of EPS that the business could be expected to achieve under mid-cyclical conditions
34
Molodovsky Effect
Observation that P/Es tend to be high on depressed EPS at the bottom of a business cycle and tend to be low on unusually high EPS at the top of a business cycle
35
Two methods to calculate normalized EPS
1) Method of historical EPS, in which EPS in calculated as average EPS over the most recent full cycle
2) Method of average return on equity, in which normalized EPS is calculated as the average ROE from the most recent full cycle, multiplied by the current book value per share (preferred)
36
Earnings Yield
- Same as inverse price ratio
- EPS/P
37
Calculating Benchmark Value of P/E
- Median of industry P/E's
- count NMF ones as 0
38
PEG
-P/E to growth
- P/E divided by expected earnings growth rate
- Low ratios better than high (less than 1 is very attractive)
39
Drawbacks of PEG
1. Assumes linear relationship between P/E and growth
2. PEG ratio does not factor in differences in risk
3. PEG does not account for differences in the duration of growth (long-term growth prospects may not be captured)
40
Yardeni Model
CEY = CBY - b *LTEG + Residual
- CEY = Current Earnings Yield of the market index
- CBY = Current Moody's Investor Service A rated corporate bond yield
- LTEG = consensus 5-year earnings growth rate forecast for the market index
41
P/E based off Yardeni Model
P/E = 1 / (CBY - b * LTEG)
42
Book value of equity
Shareholders equity - preferred equity
43
BV/S Multiple Advantage
1) Can be used even when EPS is negative
2) More stable than EPS
3) Better for valuing companies that have primarily liquid assets, like financial institutions
4) Can be used when company operations are not going to continue as a going concern
44
Drawbacks of P/S
1) Human capital is not valued correctly
2) Accounting methods can skew calculations
3) Reports assets and liabilities at fair value which not accurately reflect actual values
4) Share repurchases may skew numbers
45
Tangible Book Value/Share
- excludes goodwill
- takes fair value of assets and liabilities (take into consideration how different account measures calculates fair value)
46
Justified P/B
because b = g * ROE, P/B = (ROE - g) / (r - g)
47
P/B Based on Residual Income Valuation
1 + (Residual value of expected future earnings) / B(0), B(0) is initial book value
48
Advantages to use P/S
1) Sales are less easy to distort than earnings or book value
2) Sales are always positive (usually)
3) More stable
4) More appropriate to value mature, cyclical and 0-income companies
49
Drawbacks of P/S
1) May have high sales even when not operating profitably
2) Does not show debt
3) Does not incorporate different company structures
4) Different revenue recognition principles
50
Justified P/S
- [(E(1) / (S(1)) * (1-b)] / (r-g)
- g = growth = b * PM(0) * (Sales/Total Assets) * Total Assets/Shareholders Equity), PM(0) = profit margin
E1/S1 = Forecasted profit margin
Forecasted profit margin * dividend payout divided by discount factor
51
Trailing dividend yield
Divide current price over current dividend rate
52
Justified P/D
(r-g) / (1+g)
53
Enterprise Value
Market Value to Common Equity + Market Value of Preferred + Market Value of Debt - Cash
54
ROIC
- measures return on capital for all investors of a company
- EV/EBITDA because EBITDA flows to equity and debt holders
55
Market Value of Invested Capital
(Total Invested Capital - TIC), same as Enterprise Value but without the cash
56
Scaled Earnings Surprise
(Unexpected Earnings - Earnings consensus) / standard deviation of earnings
57
Equity charge
Equity Capital * Cost of Equity
58
Capital charge
Total cost of capital (equity + debt)
59
Economic Value Added
NOPAT * (C% * TC), NOPAT = net operating profit after tax, C = cost of capital, TC = total capital
NOPAT - if given EBIT, needs to add back capitalized expenses, like R&D
60
Residual Income Model
- also called discounted abnormal earnings model and Edwards-Bell-Ohlson model
- model that views stock valuation as the sum of book value per share and present value of the stock's future expected residual income per share
- B(0) + (E(t) - r*B(t-1) / [(1+r)^2)]
- you can check to make sure its correct by using DDM
- not only used to value stocks but also to look at corporate performance and determine exec compensation
61
In residual income model, how to calculate book value per share for period 0 when given period -1
Book value in period -1 + EPS in period 0 - dividends in period 0
62
In residual income model, how to calculate equity charge
book value in period -1 (or beginning book value) * cost of equity = equity charge in period 0
63
In residual income model, how to calculate residual income per share
Forecasted EPS - equity charge per share
64
Clean Surplus Relationship
B(t) = B(t-1) + E(t) - D(t)
65
Excess Earnings Model
- B(0) + [ (ROE(t) - r) * B(t-1) ] / (1+r)^t
- ROE = EPS / beginning book value per share
- should yield the same result as residual income model and DDM
66
Tobin's Q
- Market value of debt and equity / replacement costs of equity
67
Single Stage Residual Income Model
B(0) + (ROE-r)/(r-g) * B(0)
68
Containing Residual Income Model
- B(0) + [ E(t) - r*B(t-1)) / (1+r)^t ] +
(P(T) - B(T) / (1+r)^T)
- (B(0) + [ (ROE(t) - r) *B(t-1)/(1+r)^t ] + (P(T) - B(T) / (1+r) ^ T)
- (P(T) - B(T) = premium over book value at time T
69
In a private company, personal use of assets by management will affect which part of the valuation ratio
Numerator
70
3 Major practice areas for private company valuation
1) transaction
2) litigation
3) compliance
71
Total discount on private company valuation
1 - (1-DLOM) * (1-DLOC)
- DLOC = (1- (1/(1+Control Premium)))
72
Alternatives to the CAPM for private company valuation
1) expanded capm = capm + small cap stock premium + company specific stock premium
2) build up approach = risk free rate + equity risk premium + small cap premium + company specific stock premium + industry risk premium
73
Reinvestment rate
- The rate of investment in working capital and long term assets necessary to maintain operations and support assumed growth
- g/WACC
74
Residual income valuation of a private company
Normalized income - (working capital * r(wc)) - (fixed assets * r(fa))
75
Firm value of a private company
Sum of the value of tangible assets and the residual value of excess earnings from intangible assets
76
Residual value of a private company
RI* (1+ g) / (r-g)
77
3 Ways to Value a Private Company
1) Income approach - CF based
2) Market Approach - multiples approach
3) Asset-Based Approach - sum of parts
78
Unlevered beta from levered beta
Levered Beta / (1+(1-t) * D/E)
79
Levered beta from unlettered beta
(1 + (1-t) * D/E) * Levered Beta
80
Finding the value of intangible assets in private company
1) Normalized earnings - working capital * rate(wc) - fixed assets * rate(fa)
2) Take that number and multiply by growth rate and divide by (intangible rate - g)
3) add that number to the sum of fixed assets and working capital
81
Total return under gordon growth model
Total return = dividend yield + cap gains yield
82
under gordon growth model, when stock is fairly valued, what is the expected return
required return or discount rate
83
PVGO
P0 - E1/r
84
growth component of the P/E for each stock
PVGO/E1
85
if stock is fairly priced in the market per GGM, what rate is the stock expected to increase at
g, or the expected growth rate in dividends
86
normalized earnings
earnings that a company can expect to earn under mid-cycle conditions
87
multi stage residual value per share including persistence factor (ROE fades over time)
B0 + sum [ E(t) - r*B(t-1) / (1+r)^t ] + [ E(t) - (r*B(t-1) / (1+r-w)(1+r)^(t-1)]
88
single stage residual income model
B0 + (ROE-r)/(r-g)*B0
89
CCM vs. EEM
CCM is basically single staged cash flow while EEM is used on small companies with significant intangibles
90
Capitalization Rate of Private Companies
WACC - Longterm growht rate
91
Best valuation approach for private company in a high growth stage
Income approach
92
Best valuation approach for private company that is mature
market-based
93
Best valuation approach for private company that is a start up
asset-based
94
MVA
Market value of the company - book value of total capital
95
When debt is borrowed, the impact on FCFE in that year
Higher
96
Persistence factor when residual income is 0
0
97
Tobin's q when assets are productive
higher
98
CFA Level 2
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