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Fin 4201/8001

Fin 4201/8001. Topic 4a: Valuing Companies The adventure continues…. The Project. Next few classes, little reading = time to get organized Sources – usual suspects Analyze with tenets, spread sheet w/ forecasts, ratios…. Play from your strengths. Another look. Abstract

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Fin 4201/8001

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  1. Fin 4201/8001 Topic 4a: Valuing Companies The adventure continues….

  2. The Project • Next few classes, little reading = time to get organized • Sources – usual suspects • Analyze with tenets, spread sheet w/ forecasts, ratios…. • Play from your strengths

  3. Another look • Abstract • Introduce firm and environment • Operations • Industry

  4. Another look • Ratio analysis • Buffett’s tenets • Equity Valuation • Recommendation • References, Tables, Charts,…

  5. Valuation • Objective: Investment decision • Price < Estimated value = BUY • Three step approach (Top-down) • Analysis of economies and markets • Analysis of Industry • Analysis of individual firm

  6. Valuation (The softer side) • Most of the 12 tenets • Macro economic implications • Corporate governance and the market for corporate control • Buffett = cost < value • How do you know? Valuation • Our focus ≈ ROIC, NOPLAT, and DCF

  7. Return On Invested Capital = Profit/capital • ROIC is after tax profit divided by (working capital + PPE) • Scorecard vs. some benchmark • Goal ≠ maximize • But can’t just look at $ either – Capital costs money (growth for growths sake) • ROIC > Opportunity cost of capital • Ultimate = stock performance or value creation

  8. NOPLAT = Net Operating Profit Less Adjusted Taxes • ≈ Owner earnings • Look at example in a couple of slides

  9. DCF – Discounted Cash Flow • Returns depend on market expectations • The great equalizer • Goal = Maximize PV of cash or economic profit • Ultimate measure is stock performance • Problems • Predict future (Buffett KISS and stable) • Earnings can be manipulated

  10. Historical Analysis • Need to understand past to be able to predict the future • Reorganize statements to reflect economic vs. accounting performance • Measure and analyze ROIC = ability to create value • Assess financial health and capital structure for short and long term

  11. Historical Analysis • ROIC = NOPLAT / Invested capital • Reorg Balance Sheet to create invested capital • Reorg Income statement to get NOPLAT • How much cash can be taken out? • FCF = NOPLAT + noncash Op exp – invested capital

  12. ROIC = NOPLAT / Invested Capital • Invested capital = Balance sheet = Debt + Equity? • Debt equivalents = unfunded retirement liabilities, restructuring reserves,… • Equity equivalents = deferred taxes…

  13. Non op assets not included in capital Operating liabilities netted against operating assets

  14. ROIC = NOPLAT / Invested Capital • Now to Income statement = NOPLAT • Interest expense not subtracted • Exclude non operating income • Adjust taxes to reflect exclusions • What you have is basically an all equity, operations only firm

  15. Interest = payout to investor, not expense If not in capital = not in NOPLAT Taxes calc’d on operating profits

  16. ROIC = NOPLAT / Invested Capital • Now what about Free Cash Flow? • Basically the same as tenet #8 in Topic 3 ≈ FCF = NOPLAT + Non cash opexpense – investment in capital • Intangibles and goodwill – usually exclude • Other Long Term assets • Hidden Assets – leases, R&D • Cash if large ≠ operating

  17. Interest = payout to investor, not expense CF from non-op treated separate Taxes calc’d on operating profits

  18. Forecasting • Models = try to reduce to simple numbers • Make realistic assumptions on sales and costs • Look for the “drivers” • Two-stage growth model

  19. The Forecast • Analyze historicals • Aggregate items or add more lines • CNBC, Yahoo, Edgar, Compustat (WRDS),… • Start with IS • Revenue forecast consistent with historical and economy-wide growth

  20. The Forecast • Forecast rest of income statement consistent with “drivers” • COGS – function of sales adjusted for competition and/or productivity • Depreciation = % of revenue or % of PPE or historical equipment purchase • Interest exp or income tied to asset or liability that generates it • Taxes – look to historical or just plug 39% • Forecast Balance sheet, invested capital, and non-op assets • E.g. working capital tied to COGS or PPE tied to revenue or depreciation

  21. The Forecast • Forecast investor funds • Retained earnings = old RE + NI - dividends • Other equity accounts • Calculate ROIC and FCF to generate value • Can use WACC or do like Buffett (long treasury rate) • Other issues

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