Valuation

Question 1

Why is it important to look at both ROIC and growth?

Answer 1

“Growth is only good when the incremental investment to achieve this growth earns a higher return on invested capital (ROIC) than the company’s cost of capital (WACC)”
- ONly looking at earnings and growth is a bad proxy for value creation.

Question 2

What is the difference of book value, market value and intrisic value?

Answer 2

Different types of value:
- Book value - what is on the books.
- This is the liquidation floor
- USable for debt holders.
- Market value - What it is being traded for right now
- Relevant during merger, acquisition and divestitures. Estimate share price. Short-term investor.
- Intrinsic value (fundamental value)- the value of an asset based on its future economic benefit to the owner
- To estimate value to a specific buyer, long-term share price, long-term investor

Question 3

Difference of equity and enterprise value?

Answer 3

• Equity value, can be same as market value
• Enterprise value = All equity + net debt value. (Simplified)

Question 4

What is a DCF?

Answer 4

Intrinsic value = The value of an asset based on its future economic benefit to the owner. It can for example be the cash flows in the future.

Three elements:
1. Future cash flows, e.g. FCFF - Free cash flows to the firm.
2. Terminal value TV
3. Discount rate

Question 5

How to assess management?

Answer 5

• Incentove drive all human behavior. Understanding what drives them
• Look at conference call transceipt at conference etc.
• Listen to them, can they retain talent, can they form great teams? Are they trustworthy.
• Are they a A-leader, which will recruit other A-leaders?

Question 6

FCFE formula?

Answer 6

Net income
+ D&A
- CHANGE NWC
- CAPEX &acquisition
+ (debt issuance - dept paid)
=FCFE

Question 7

Fcff formula?

Answer 7

EBIT (1-t)
+ D&A
- CHANGE NWC
- CAPEX & acquisition
=FCFF

Question 8

Why shouldn’t stock-based conpensation be added back to FCFF? (Basically increasing cash flow)

Answer 8

Stock-based compensation is not added back, it is not a non-cash expense like D&A -> Therefore it should be removed from FCF caluclation (not added back)

3. “The stock-based compensation may not represent cash but it is so only because the company has used a barter system to evade the cash flow effect. Put differently, if the company had issued the options and restricted stock (that it was planning to give employees) to the market and then used the cash proceeds to pay employees, we would have treated it as a cash expense… We have to hold equity compensation to a different standard than we do non-cash expenses like depreciation, and be less cavalier about adding them back. / Damodaran

Question 9

Should you just take a EBIT or earnings as a standard point for DCF?

Answer 9

No.

(2) Free cash flow in valuation: Base year (what to look for)
1. Unusual or extraordinary items - take out!
2. Normalized vs actual numbers (FCF is extremely volatile - so use normalized to not show too big difference
1. Change in WC replaced by % of revnues instead
2. Acquisition
3. Stock-based compensation and Acquisition
1. It is a in-kind expense (not-cash) , you give shares instead of paying cash.
2. It should not be added to FCF for a DCF, and instead should treat itas if it were a cash expense
4. Also include stock-basecd acquisitions in Cash acquisitions.
4. Taxes
1. Use average over a long period-
5. Accounting inconsistencies
1. For example capitalized R&D vs treating is as a operating expense - this alters the perception of the business.
2. You should capitalize R&D for companies that fit it.