Equity Valuation

Equity Valuation (1)

Applications and Processes

Considerations in Using Accounting Information

Important: Table of Quality of Earnings Indicators

Communicating Valuation Results

Default report template:

  • Table of Contents
  • Summary and Investment Conclusion
  • Business Summary
  • Risks
  • Valuation
  • Historical and Pro Forma Tables

Return Concepts

Equity Risk Premium

The equity risk premium is the amount over the risk free rate that is required by an investor. Sometimes in backward looking calculations ERP is the realized excess return of equities over the risk free rate.

CAPM

CAPM = RF + beta(ERP) where RF is a long government bond yield

Blume Beta adjustment = (2/3)(unadjusted beta) + (1/3)(1.0)

Summary

Discount rates must be on a nominal (real) basis if cash flows are on a nominal (real) basis.

Equity Valuation (2)

Industry and Company Analysis

Porters Five Forces: threat of substitute products, intensity of rivalry among incumbent companies, bargaining power of suppliers, bargaining power of customers, and threat of new entrants.

Equity Valuation (3)

Market Based Valuation

Justified P/E 
p/e = (1-b)*(1+g) / (r-g)
Justified P/B 
p/b = (ROE*(1+g)) / (r-g)
Justified P/S 
p/s = (E0 / S0)*(1-b)*(1+g) / (r-g)
Normalized EPS 
Normalized EPS = arithmetic average EPS or,
Normalized EPS = ROE * Present BV/Share

\[ BV/Share = Shareholder's equity - preferred equity .\]

\[ FCFE = FCFF - Int(1-t) + Net Borrowing .\]

\[ Blume's adjusted beta = (2/3) * beta + (1/3) * 1 .\]

\[ GGM ERP = Div/P + g - long term rfr + adjustments .\]

\[ Macro ERP = (1+Einfl)*(1_+ Eg_real_eps)*(1 + Eg_p/e) - 1 + Einc -Erfr .\]