1 / 58

Financial Valuation of companies

Financial Valuation of companies. Financial Valuation of companies. Objectives of the course: Unterstand the commonly used techniques in valuation of companies Be able to estimate a spread of values of a company Pr Dr Dominique Thévenin Associate Professor Grenoble Ecole de Management

mckenzie-kemp
Download Presentation

Financial Valuation of companies

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Financial Valuation of companies

  2. Financial Valuation of companies • Objectives of the course: • Unterstand the commonly used techniques in valuation of companies • Be able to estimate a spread of values of a company • Pr Dr Dominique Thévenin Associate Professor Grenoble Ecole de Management Dominique.thevenin@grenoble-em.com

  3. Summary • 1. Asset Pricing: general rules • 2. Patrimonial valuation methods • 3. Analogy valuation methods • 4. Discounted methods • 5. WACC issues and statistical approach of CAPM • 6. Specific cases: techno companies, convertible bonds

  4. Summary • Course documents • Slides, • Exercices and small cases, • Cases • Required tools • Simple calculator, or PC Excel • Linear regression, statistics • Boursorama, yahoo finance, google finance • Bloomberg, www.infancials.com, • Course Book • Bryley & Meyers ( en) • Vernimen (Fr)

  5. 1. General rules about asset pricing Financial ressources investment operations

  6. 1.1 Overview on interest rates • Interest rate • Expected inflation • Report of consumption • Time (liquidity) • Risk premium • Short horizon interest rate • Decided by Central Banks • In the context of monetary policy • Long Horizon interest rate • Market rate cointegrated with short rates 2% (2010 €)3% ( pastaverage) 1-2% (5-15 years)0% - 4 -6% 1% € 2007-2010,0,25% yen, $, 2010

  7. 1.2. Overview: asset pricing • Value of an asset = transaction price = price • that the owner estimates to be enough. • that the investor should pay when buying this asset, • P° • What you pay = what you get • = sum of the future cash flows that you receive as long as you hold this asset • = Discounted future cash flows • Certain or safe cash flows: bonds • P°= present value of future cash flows @ right risk rate

  8. Overview: asset pricing • Uncertain cash flows: • Speculative pricing : discounted expectedcash flows • Interest rate = adjusted to the risk of the asset • P° moves in response to rates fluctuations and cash flow revisions • Real assets • P° sensitive to expected selling price, rents, and interest rates • Stocks • P° sensitive to dividends, profits, selling price and interest rates

  9. Overview of asset pricing: bonds valuation • The bondholder receives fixed subsequent payoffs. • Exemple : 500 € in fine bond @ 3%, maturity 10 years. • What is the value of this bond if market rate is ? • 5% • 8% • 12% • 2% • 1%

  10. 1.3 Valuation of a company • Firm = set of assets holded by shareholders • Shares are assets themselves • Value of a company = value of all of its assets • = Debt Value + Equity value • Creditors = money suppliers = stakeholders. Thus the good issue is the value of Equities. • Equity Value = Assets value – Debt Value • Direct valuation: valuate equities from dividends or profits • Indirect valuation: valuate assets and substract the debt

  11. Valuation of a company • Assets oh the company = set of • projects, investments in process, (no growth situation) • growth opportunities ( few are disclosed) • Value of the assets = • PV of the future cash flows of all the projects • + PV of growth opportunities • Discounted at the weighted cost of capital

  12. Main methods to valuate • Book value, or patrimony approach • Financial statements provide information about patrimony • information about past profitability • Information about competitors • Analogy approach • Duplicate the valuation from similar firms • Financial or discounted approach • The value of an asset or a security = present value of expected cash flows = sum of discounted expected cash flows. ( part 3)

  13. 2. Book value approach • A1: value of equities = book value of equities • Simple: just read it in the financial statements ! • Assets are valuated according rules and regulations. • Continental Europe focuses on safety principle, • with historical costs: does not reflect their market value. Far from reality. • Distinguish some liabilities from equities is not trivial • Convertible bonds ? • Options on stocks ? • Consolidated datas are not always safe • IFRS regulation improves the valuation of listed companies

  14. 2.1. Book value approach • A2: net reevaluated assets : • Valuate every asset in the balance sheet at its market value • Are all assets liquid ? • Are all assets profitable ? (useless assets) • Does every asset fully reflect future earnings ? • Brands, licences, specific assets ? • Some elements do not exist in assets and financial statements • Know how, human capital, specific assets, growth opportunities • On the other side: • dissimuated liabilities

  15. 2.1. Book value approach • Listed companies: IFRS • Assets and liabilities are valuated at their « fair value »  A2 approach • Only some untangible assets are valuated at the fair value: acquired brands and licences, financial investments, etc. • Goodwills are controversy • IFRS are sometimes contrevorsy, but the induced valuations are closer to market valuations • Nevertheless, the difference between market and book values are large

  16. 2. Book value approach • A3: the goodwills: Idea: valuate assets that accounting systems are not able to do, but generate profits. Untangible assets, know how, human ressources,… These additionnal value = Goodwill. But methodologies suggest hazardous formulas: No cash, no discount, no risk and no expectations! The Goodwill valuation approach has no backgroud But Goodwill exists : ex post, GW = Price of a firm – Book Value…

  17. Example: Hermes

  18. Example: Renault

  19. 3. the « multiples » • Underlying idea: markets evaluate identical firms at the same price. • Consider the PER: Market price /net income • Price Earning Ratio indicates how many times of annual profit you pay a company • PER Air liquide = 18  the price of the share = 18 times its annual net profit • The current net profit is commonly seen as the main reference to measure the profitability of a company. • the PER shows the expected growth of the profits • PER 6-8 = low growth • PER 10 = maturity • PER > 20 = growing company

  20. The multiples • Consider now the links between economic variables of the firm: income, sales, net assets, book value • Net profit = Sales x net margin in% • Sales = invested assets x turn over speed • Links between 1 economic variable and the market price are established • A « multiple » = market price / economic variable • there are links between market valuation and most economic variables. • Multiples are very closed among an industry, because companies run the same business model

  21. multiples • But the debt will infer. Thus separate these indicators • Market cap / net income, variables related to equities, • Enteprise value / variable limited to economic variables • Where Enteprise value = market cap + debt

  22. multiples Ev commonly means market value of assets = market cap + debt P:S, P:EBIT are often computed on market cap and not Ev . Please pay out

  23. examples

  24. The multiples • The use of the multiples if non listed company • Look for listed similar companies on a market • Compute main multiples • Duplicate the multiple to unlisted companies, or analyse the place of a company among its competors • Advantages • simple, easy • Cons • Difficult to build samples of similar companies • What else if no earnings… • What else if the maket price is very volatile • Book datas are delayed in regards to market datas

  25. Example 2006 • Strong differences even in the same industry!

  26. Value of equities = value of assets – value of debt. Assets = sum of investment projects Assets value = present value of future economic cash flows, discounted @ the cost of capital.  Infer equities Value of equities = present value of the future cash flows to shareholders  equities value = (economic cash flow – cash flow to bondholders) discounted @ the cost of equities 4. Discountedapproaches

  27. 4. Discountedapproach • Exemple: a company produces cheese and generate a stable and infinite EBITDA = 20 M. The balance sheet shows 50 M debt at 6% interest. Income tax = 30%, and shareholders require a 9% return. • 1. Estimate the value of its equities, • 2. Estimate the WACC and the value of its assets

  28. 4.1. The DCF method • DCF = Discounted Cash Flows. • Translate strategy into a stream of future economic cash flows. • Discount @ wacc • DCF gives the value of assets

  29. 4.1.DCF • « free cash flow » table • Economic cash flow including • operating flows after tax (NOPAT + depréciations) • + Delta Net Working Capital • - investment required to maintain operations possible • No interest or debt flows (except if you compute cash flow to shareholder) • Techniques • Assume depreciations = investment (roll over) • Cash flow every year as long as the visibility is correct • Troncate the subsequent flows at the end: « terminal price » • Assume a multiple • Or assume a long term growth rate • Discount the free cash flows  value of assets

  30. 4.1. DCF • Advantages • Translate a strategy into datas • Specific DCF if diversified company. Then consolidate. ( SOTP = sum of the part) • Cons • Few visibility over long period • DCF is very sensitive to the « terminal price » • Requires to know the WACC

  31. Example: Memscap • Memscap: high tech company at Grenoble. • IPO: january 2001  valuated by Société Générale Owen • Subsequent DCF are published:

  32. 4.2.Discountedapproaches:dividends or fundamentalapproach • Price of a stock = present value of the cash flows to shareholders • Dividends and capital gains: D1 and (P1-P0) if cash flo to shareholders are restricted to dividends • If D1 and P1 are estimated, the required return to shareholders wellknown,

  33. 4.2. dividends • = present value of inifinite dividend stream • If you introduce a long term growth rate: Gordon-Shapiro model. • Dividend and growth rate are not independant • Growth rate has to be < return rate • Reverse the model and get • Required return = dividend yield + growth rate • Fundamental and Gordon Shapiro models have a weak explainatory power: • < 40% in US stocks • 60% in France

  34. 4.2. dividends • Limits of Gordon Shapiro model • Valid with mature companies • Irrelevant with growing companies • Troncate the model into growing period and maturity • ROE often irrelevant (delayed) to estimate g with( way 2) • Irrelevant if the dividend policy is unstable

  35. 4.2. dividends • 3 ways to estimate the growth rate? • Try to translate the strategy into sustenable long terme growth rate • Link payout ( Dividend / Earnings) = b, and growth • (1-b) * Earnings are retained and invested • Ceteris paribus, • the book equities increase by (1-b)*ROE • Earnings and Dividends increase by (1-b)*ROE • g = (1-b)*ROE • g is the requested growth to get the same ROE • Observe subsequent dividends over time, and run an exponential regression t / t-1

  36. 4.2. dividends • Exercice: look at a listed company • Compute b, ROE, • infer growth rate, • Compute dividend yield • Infer the cost of equities • Download the dividends over the past 10 years • Regress and infer g

  37. 4.3. growth and stock price • Growth of sales and earnings should show a long term link • g = 0: b = 100%, dividends = earnings. P0= earnings / r  PER = 1/r, or r = 1/PER • If g>0: additionnal cash flows and earnings  Price moves up  PER moves up • r = 15% g = 0% b=100%  PER = 6.67 • R = 15% g =10% b=40%  ROE =16.66%  PER = 8 • r = 15% g =10% b=50%  ROE =20%  PER = 10

  38. French market 2006: average PER = 16 (13 in 1993) • PER were historicaly high 1998-2002. Earnings had to grow ! • Dec 2009: <10 • Growing company : PER > 20 - 25

  39. 4.4 Discountedapproach: Bates Model • Mix DCF + PER approaches • Firm is growing at g over n years, and retained earnings (1-b) are constant over time. • PERn reflects moderate growth. • PER0 can be estimated as follows: • Value of equities = PER0 x Net Income0

  40. Bates • Advantages • Valid for growing companies • Simple • Possible to run Bates with a multiple of NOPAT, and gives the value of assets • Limits • Positive Net income is required • Constant % dividend payout ( possible to input b=0%) • Requires to know the cost of equities

  41. Bates: example Google • Google sept 2011 • Cost of equities 10,3% ( beta 1, rf 1,8%, market 8,5%) • Net income 2010/2011 = 9013 M$ • Market cap = 174 000 M$  PER°=19,3 • b = 0 assumed for a long time • Forecasts = PER 2013 = 10,8 •  implicit growth rate = 47% over 2 years.

  42. Conclusion about valuation methods • Patrimonial approaches reflect the past • Correct if real assets • Avoid a priori Goodwills • Financial approaches are founded on expectations. They price growth opportunities. • It ensures volatility when expectations are revised. • Sensitive methods to hypothesis • Strong links with strategy • Financial approaches requires to estimate first the cost of equities, and/or the cost of capital ! • Strong links with capital structure

  43. 5. Discount rate • Discounted methods (part 4) require to know the discount rate • Cost of equities, or • WACC. • Cost of equities and WACC depend on the D/E leverage ratio • D/E ratio includes the market values and not the book values • Risk of « circular » estimation of discount rate

  44. 5.1 Cost of equities and CAPM • Stock return = risk free + risk premium • Stock risk = systematic risk + specific risk • Systematic risk = risk generated by the stock market on our stock • Specific risk = risk that can be eliminated by diversification of the portfolio owned by the shareholder • Only systematic risk is paid to shareholder • This risk = Market risk smoothed or incréased by the sensitivity of the stock in response to the market fluctuation

  45. 5.1 CAPM • Thus we get the derived equation of CAPM approach Where beta = sensitivity of stock / market = cov (stock, market)/market variance

  46. 5.1 CAPM • How to estimate the cost of equities of a listed company ? • Risk free is observable at a given date: T-Bonds à 10 years is the most commonly used proxy • Market risk premium: often published in financial newspapers. • Average of the market premium over time: 3.5% - 4%. • Never use 1/PER of the market • beta is sometimes published in financial newspaper • unsafe

  47. Risk premium over time

  48. 5.1 CAPM • How to estimate the beta of a listed company • Beta = regression coefficient of Ri = a + beta * Rm • Download stock price and stock index, exchange them into returns • Week data over 1 year is preferable • Regress Ri on Rm and get the beta coefficient • Run a Student test to decide if your estimation is acceptable • Sophisticated econometric tests should be conducted, due to non stationnary datas • Beta reflects the risk of a company, and is not stable over time, or after M&A

  49. 5.1 CAPM • How to estimate the beta of a non listed company • Estimate the beta of a listed company • Compute market D/E ratio • Exchange the beta into the economic beta and duplicate it to the non listed company, • Valuate the company under all equity financed hypothesis  value of assets • Adjust with the debt • Some iterations may be required • Avoid to compute the cost of equities and the WACC under book value D/E

  50. 6. Specific cases. 1. techno firms • Growth opportunities • Single cash flow sequence doesn not reflect correctly • Many stages with uncertain cash flow • Many stages where decisions can change a project • Decision trees • Real options

More Related