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Financial Statement Analysis and Security Valuation Stephen H. Penman. Prepared by Peter D. Easton and Gregory A. Sommers Fisher College of Business The Ohio State University With contributions by Stephen H. Penman – Columbia University

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Financial statement analysis and security valuation stephen h penman

Financial Statement Analysisand Security ValuationStephen H. Penman

Prepared by

Peter D. Easton and Gregory A. Sommers

Fisher College of Business

The Ohio State University

With contributions by

Stephen H. Penman – Columbia University

Luis Palencia – University of Navarra, IESE Business School


Financial statement analysis and security valuation stephen h penman

Simple Forecasting and

Simple Valuation

Chapter 14


What you will learn in this chapter

Chapter 14

Page 455

What you will learn in this chapter

  • How simple forecasts can be made from financial statements

  • How simple forecasts give simple valuations

  • When simple forecasts and simple valuations work as reasonable approximations

  • How simple forecasting works as a tool in sensitivity analysis

  • How simple valuation models work in reverse engineering

  • How sensitivity analysis is done


Financial statement analysis and security valuation stephen h penman

Chapter 14

Page 456

Review: The Perfect Balance Sheet

With a perfect balance sheet, expected residual earnings are zero

MS, Inc.

Balance Sheet, December 31, Year 0

AssetsEquities

PriorPrior

Year 0YearYear 0Year

Marketable equity

securities (at market) 23.4 20.3Long-term debt (NFO) 7.7 7.0

Common shareholders’

equity (CSE) 15.7 13.3

NOA 23.4 20.3 23.4 20.3


Residual earnings components

Chapter 13

Page 424

Table 13.1

Residual Earnings Components


Simple forecasts forecasting from book values sf1

Chapter 14

Pages 456-457

Table 14.1

Simple Forecasts: Forecasting from Book Values (SF1)

Earnings

Component

Forecasts of

Earnings Components

Forecasts of Residual Earnings Components

Operating

Financing

Comprehensive

MS, Inc.

Pro Forma Income Statement, Year 1

Operating income:.1134 x 23.42.654

Interest expense:.10 x 7.7(.770)

Net income:.12 x 15.71.884


Sf1 valuation

Chapter 14

Page 457

SF1 Valuation


Review the imperfect balance sheet

Chapter 1

Page 459

Exhibit 14.1

Review: The Imperfect Balance Sheet


Simple forecasts forecasting from earnings and book values sf2

Chapter 14

Page 458

Table 14.2

Simple Forecasts: Forecasting from Earnings and Book Values (SF2)

Earnings

Component

Forecasts of

Earnings Components

Forecasts of Residual Earnings Components

Operating

Financing

Net

PPE, Inc.

Pro Forma Income Statement, Year 1

Operating income:9.8 + (.1134 x 4.5)10.310

Interest expense:0.7 + (.10 x 0.7) (.770)

Net income:9.1 + (? x 3.8) 9.540


Sf2 valuation

Chapter 14

Pages 459-460

SF2 Valuation


Sf2 valuation nike

Chapter 14

Page 461

Box 14.1

SF2 Valuation: Nike

Nike, Inc.

Required return for operations11.0%

Core operating income,– 1996$567 million

Net operating assets  1995$2,208 million

 1996$2,659 million

Core residual operating income– 1996: 567  (0.110 x 2,208)$324.1 million

SF2 forecast of operating income– 1997: 567 + (0.110 x 451)$616.6 million

SF2 forecast of ReOI– 1997$324.1 million

Value of common equity

$5,377 million

Value per share on 143.629 million shares$37.44

Value of operations

$5,605 million

$5,605 million

$5,605 million

Nike traded at $104 per share at the end of fiscal year, 1996.


Sf2 valuation reebok

Chapter 14

Page 461

Box 14.1

SF2 Valuation: Reebok

Reebok International Ltd.

Required return for operations10.1%

Core operating income,– 1996$174 million

Net operating assets  1995$1,220 million

 1996$1,135 million

Core residual operating income– 1996: 174  (0.101 x 1220)$50.8 million

SF2 forecast of operating income– 1997: 174 + (0.101 x[- 85])$165.4 million

SF2 forecast of ReOI– 1997$50.8 million

Value of common equity

$918 million

 Value of minority interest (at 14 times 1996 MI earnings)$210 million

 Value of common equity$708 million

 Value per share on 55.840 million shares$12.68

Value of operations

 $1,638 million

$1,638 million

$1,638 million

Reebok traded at $43 per share at the end of fiscal year, 1996.


Simple forecasts forecasting from current accounting rates of return sf3

Chapter 14

Pages 462-463

Table 14.3

Simple Forecasts: Forecasting from Current Accounting rates of Return (SF3)

Earnings

Component

Forecasts of

Earnings Components

Forecasts of Residual Earnings Components

Operating

Financing

Net

For PPE, Inc. the current RNOA, NBC and ROCE (with beginning of year amounts in the denominator) are 14.02%, 10.00% and 14.47% respectively

PPE, Inc.

Pro Forma Income Statement, Year 1

Operating income:.1402 x 74.410.431

Interest expense:.10 x 7.7 .770

Earnings: ? x 66.7 9.661


Sf3 forecasting an adjustment for leverage

Chapter 14

Page 463

SF3 Forecasting:An Adjustment for Leverage

For PPE, Inc.,


Valuation with constant rnoa

Chapter 14

Pages 463-464

Valuation with Constant RNOA

If RNOA1 = RNOA0

If RNOA is constant for all periods,


Sf3 valuation nike

Chapter 14

Page 466

Box 14.2

SF3 Valuation: Nike

Nike, Inc.

Cost of capital for operations11%

Core RNOA, 1996 (on average NOA)23.3%

Forecasted growth rate for net operating assets7%

Net operating assets1996$2,659 million

 SF3 forecast of operating income1997: 2,659 x 23.3%$619.5 million

SF3 forecast of ReOI1997$327.1 million

Value of common equity

$10,607 million

Value per share on 143.629 million shares$73.85

Value of operations

$10,835 million

$10,835 million

$10,835 million


Sf3 valuation reebok

Chapter 14

Page 466

Box 14.2

SF3 Valuation: Reebok

Reebok International Ltd.

Required return for operations10.1%

Core RNOA, 1996 (on average NOA)14.8%

Forecasted growth rate for net operating assets7.0%

Net operating assets1996$1,135 million

SF3 forecast of operating income1997: 1,135 x 14.8%$168.0 million

SF3 forecast of ReOI 1997$53.4 million

Value of common equity

$2,136 million

Value of minority interest (at 14 times 1996 MI earnings)210 million

$1,926 million

Value per share on 55.840 million shares$34.49

Value of operations

$2,856 million

$2,856 million

$2,856 million


Simple forecasts and simple valuations

Chapter 14

Page 465

Table 14.4

Simple Forecasts and Simple Valuations


Simple valuation ppe inc

SF2:

Simple Valuation: PPE, Inc.

SF1:

SF3:


Simple forecasts of growth in noa

Chapter 14

Page 467

Simple Forecasts ofGrowth in NOA

If ATO is constant,

Forecast growth in NOA with forecasted sales growth rate


Price to book ratios roce 1968 85

Price-to-Book Ratios & ROCE 1968-85

ROCEROCEP/B

Group (%)

1 43.33.43

2 28.72.57

3 23.82.20

4 21.01.89

5 19.11.65

6 17.71.45

7 16.51.36

8 15.41.25

9 14.41.16

10 13.51.10

11 12.61.06

12 11.71.00

13 10.6 .97

14 9.5 .91

15 8.3 .84

16 6.8 .80

17 4.9 .78

18 2.2 .75

19 -3.2 .74

20-22.51.01

Based on all NYSE, AMEX and NASDAQ firms. The grouping is done each year; the numbers reported are averages from the analysis for all years.

Chapter 14

Page 469

Table 14.5


Unlevered p b on rnoa

Chapter 14

Page 470

Figure 14.1

Unlevered P/B on RNOA


Residual operating income patterns 1965 96

Chapter 14

Page 471

Figure 14.2(a)

Residual Operating Income Patterns: 1965-96


Return on net operating assets patterns 1965 96

Chapter 14

Page 471

Figure 14.2(b)

Return on Net Operating Assets Patterns: 1965-96


Growth in net operating assets patterns 1965 96

Chapter 14

Page 471

Figure 14.2(c)

Growth in Net Operating Assets Patterns: 1965-96


Simple forecasting as an analytical device sensitivity analysis

Chapter 14

Page 473

Simple Forecasting as an Analytical Device: Sensitivity Analysis

“As If” Questions

  • Effect of changes in RNOA on forecasts and values

  • Effect of changes in PM and ATO

  • Effect of changes in investment (growth in NOA)

  • Effect of leverage on forecasts of net income


The valuation grid nike

Chapter 14

Page 474

The Valuation Grid: Nike

What values are implied by different combinations of RNOA and growth in NOA?


Market forecast pairs nike

Chapter 14

Page 474

Market Forecast Pairs: Nike

What combination of RNOA and growth in NOA justify the market price?

Market Forecast Pairs

Nike, Inc., 1996

Price = $104

__________________________________

RNOA Growth in NOA

__________________________________

15%10.15%

169.94

179.72

189.51

199.30

209.09

218.87

228.66

238.45

248.24

258.02

267.81

277.60

287.39

297.17

306.96


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