Chapter 15
Company Analysis and Stock
Valuation
Abdullah Al Mamun
ID-33068
Analysis of Growth Companies
Growth Companies: Generating Returns above Required Rate of Return.
Earnings higher the required rate of return are pure profits.
How long can they earn these excess profits?
Is the stock properly valued?
Analysis of Growth Companies
Growth Companies: A growth company is any company whose business
generates significant positive cash flows or earnings, which increase at
significantly faster rates than the overall economy.
Growth Stocks: a growth stock is a stock of a company that generates
substantial and sustainable positive cash flow and whose revenues and
earnings are expected to increase at a faster rate than the average company
within the same industry
Analysis of Growth Companies
Alternative growth models
No growth Firm:
E = r X Assets = Dividends
E 1 b E E
V k
k k v
Analysis of Growth Companies
Long-run growth models
assumes some earnings are reinvested.
Simple growth model
bEmk bEm
2
(Gross Present Value of Growth Investment s)
k k
bEm bE
( Net Present Value of Growth Investment s)
k k
E bEm bE E 1 b bEm
v v
k k k k k
Analysis of Growth Companies
Expansion Model:
Firm retains earnings to reinvest, but receives a rate of return on its
investment equal to its cost of capital
m = 1 so r = k
E E 1 b bE E
V
k k k k
Analysis of Growth Companies
Negative Growth Model: The negative
growth model applies to a firm that retains
earnings (b>0) and reinvests these funds in
projects that generate rate of return below
the firm’s cost of capital (r<k or m<1).
Savikun Nahar Mukta
ID-30005
The Capital Gain Component
bEm/k
b Percentage of earnings retained for reinvestment
m relates the firm’s rate of return on investments and the firm’s required
rate of return (cost of capital)
1 = cost of capital
>1 is growth company
Time period for superior investments
Dynamic True Growth Model
Firm invests a constant percentage of current earnings in projects that generate rates of
return above the firm’s required rate of return
D1
V
kg
Measures of Value-Added
Economic Value-Added (EVA)
Compare net operating profit less adjusted taxes (NOPLAT) to the firm’s total cost of capital
in dollar terms, including the cost of equity
EVA return on capital
EVA/Capital
Alternative measure of EVA
Compare return on capital to cost of capital
Measures of Value-Added
Market Value-Added (MVA)
Measure of external performance
How the market has evaluated the firm’s performance in terms of market value of debt and
market value of equity compared to the capital invested in the firm
Relationships between EVA and MVA
mixed results
Measures of Value-Added
The Franchise Factor
Breaks P/E into two components
P/E based on ongoing business (base P/E)
Franchise P/E the market assigns to the expected value of new and
profitable business opportunities
Franchise P/E = Observed P/E - Base P/E
Incremental Franchise P/E = Franchise Factor X Growth Factor
Rk
G
rk
Faisal Mahmud
ID - 38035
Growth Duration
Evaluate the high P/E ratio by relating P/E ratio to the firm’s rate and
duration of growth
P/E is function of
Expected rate of growth of earnings per share
Stock’s required rate of return
Firm’s dividend-payout ratio
Growth Duration
E’(t)=E(0) (1+G)^t
N(t)= N(0) (1+D)^t
E’(t)=E’(t) N(t)=E(0)[(1+G)^t(1+D)}]^t
E(t)=E’(0) (1+G+D)^t
(0) (1G g D g )
t
p g
(0) E g
p d
(0)
E (0) (1G a D a)
a
t
Intra-Industry Analysis
Directly compare two firms in the same industry
An alternative use of T to determine a reasonable P/E ratio
Factors to consider
A major difference in the risk involved
Inaccurate growth estimates
Stock with a low P/E relative to its growth rate is undervalued
Stock with high P/E and a low growth rate is overvalued
Site visits and the art of
the interview
Focus on management’s plans, strategies, and concerns
Restrictions on nonpublic information
“what if” questions can help gauge sensitivity of revenues, cost, and earnings
Management may indicate appropriateness of earnings estimates
Discuss the industry’s major issues
Review the planning process
Talk to more than just the top managers
Md Mehedi Hassan
Id: 39050
When to Sell
Holding a stock too long may lead to lower returns than expected
If stocks decline right after purchase, is that a further buying
opportunity or an indication of incorrect analysis?
Continuously monitor key assumptions
Evaluate closely when market value approaches estimated
intrinsic value
Know why you bought it and watch for that to change
Efficient Market
Efficient Market is a market where there are large
numbers of rational profit maximizers actively
competing, with each trying to predict future market
values of individual securities, and where important
current information is almost freely available to all
participants
Efficient Market
Securities prices always fully reflect all available, relevant information about
the security.
Efficient Market
All Available Information:
Weak Form : Past price related information
Semi Strong Form : Past price, news etc..
Strong Form : All information including inside information.
Efficient Markets
Opportunities are mostly among less well-known companies
To outperform the market you must find disparities between stock values and
market prices - and you must be correct
Concentrate on identifying what is wrong with the market consensus and what
earning surprises may exist
Influences on Analysts
Investment bankers may push for favorable
evaluations
Corporate officers may try to convince analysts
Analyst must maintain independence and have
confidence in his or her analysis
Global Company and Stock
Analysis
Factors to Consider:
Availability of Data
Differential Accounting Conventions
Currency Differences (Exchange Rate Risk)
Political (Country) Risk
Transaction Costs
Valuation Differences
The End
