UNIT 3 :

EQUITY VALUATION
INTRODUCTION

INSTRUCTOR NAME- NEHARIKA SOBTI

For : MBA FINANCE (PART 1)

DEPARTMENT OF FINANCIAL STUDIES (DFS)
UNIVERSITY OF DELHI
21ST JANUARY 2020
 SYLLABUS
 Unit III: Equity types and features; Fundamental analysis, overview of
economic-industry-company (E-I-C) analysis framework, dividend capitalization
models, price multiple approach; classical and modern technical analysis – price
and volume based indicators.

READING MATERIALS
 Core Reading Texts
 Bodie Z., Kane A., Marcus A., Investments, Latest Edition.
 Damadaran, A., Investment Valuation, John Wiley & Sons, Latest Edition.
 Other References
 Damodaran, A. Dark Side of Valuation, Prentice Hall, Latest Edition
 Fuller R., and Farreel J.L., Modern Investments and Security Analysis, Latest edition.
 Charles P. Jones, Investment Analysis and Management, John Wiley & Sons, Latest
Edition.
 Fabozzi and Markowitz, The Theory and Practice of Investment Management, John
Wiley & Sons Inc., Latest Edition.

Course : Investment Analysis DFS(DU)-MBA (Finance) 2020

 WHAT DO YOU WANT TO BE ?
Investment Banker
Sell Side - Underwrite new debt and
equity securities for all types
of corporations; aid in the sale
of securities; and help to
facilitate mergers and
acquisitions, reorganizations, and
broker trades for both institutions and
private investors.
Course : Investment Analysis
Equity Research
Analyst
Buy Side-Conduct thorough analysis and
research of companies and their share price
to issue investment recommendations.
Financial Modelling - help portfolio
managers make better-informed
investment decisions by identifying
profitable stock investment opportunities.
DFS(DU)-MBA (Finance) 2020
Source – Investment Philosophies, Aswath Damodaran 2014
 ROLE OF EQUITY ANALYST

 Extensively analyses investment characterisation of an asset

 Recommend buy/sell of a stock/industry/country exposure

 Stock Selection - Identify undervalued and overvalued stocks

 Generate Alpha – Positive risk adjusted return

 Assess the impact corporate events – mergers, acquisition, spinoffs,

divestiture
 Valuing private business ; IPO

 Share based compensation - ESOP

Identify Mispricing by estimating

intrinsic value to get positive alpha.

Course : Investment Analysis DFS(DU)-MBA (Finance) 2020

 WHAT IS THE VALUE OF AN ASSET?
 ASSET -An asset is a resource with economic value that an individual,
corporation, or country owns or controls with the expectation that it will
provide a future benefit.

Financial Assets Real Assets

• A financial asset is a liquid asset that gets
its value from a contractual right or
ownership claim.
• Claims on real assets
• Cash, stocks, bonds, mutual funds, and
bank deposits are all are examples of
financial assets.
• Real assets are physical assets that have
an intrinsic worth due to their substance
and properties.
• Real assets include precious metals,
commodities, real estate, land, equipment,
and natural resources.
• low correlation with financial assets, such
as stocks and bonds.
• Less liquid

Course : Investment Analysis DFS(DU)-MBA (Finance) 2020

 WHAT IS EQUITY?
 Definition
 ‘Ownership in a firm’ – A stock is a ‘claim to funds after all debts have
been paid’

 Types of Equity
 Common Stock -Residual Claim on firms assets if firm is liquidated &
voting rights
 Preferred Stocks – fixed periodic dividends, no voting right, preferential
claim on assets during liquidation

 Book Value vs. Market Value

 Cash flows in Equity

Course : Investment Analysis DFS(DU)-MBA (Finance) 2020

 WHAT IS VALUATION?
 Definitions :
 “An analytical process of determining the current (or projected)
worth of an asset or a company.”
– Investopedia

 A process of determining the present value of a company or an asset.

 “It is the estimation of an asset’s value based on variables perceived

to be related to future investment returns, on comparison with
similar assets, or, when relevant, on estimates of immediate
liquidation in investing.”
-CFA Institute
Course : Investment Analysis DFS(DU)-MBA (Finance) 2020
WHAT IS VALUE ?
 Value is contextual – depends upon objective.

• “Value of an asset with hypothetically complete

understanding of its investment characteristics.”
1. Intrinsic
Value • Accuracy of forecast with appropriate valuation models.
• Quality of forecast - Expectational inputs of analyst.

 Essentials –
 Capacity to generate positive cash flows over some period over its life
 Uncertainty about receiving those Cashflows

 Mispricing – undervalued vs. overvalued stocks

 Ve – P = (V - P) + (Ve – V)

 Does Gold have an intrinsic value ? Picasso ? Commercial Real Estate?

 WHAT IS VALUE ?:
PRICE VS. VALUE
 Is market price of an asset is also its intrinsic value?

 Traditional Efficient Market Hypothesis : “An asset’s market price is

the best available estimate of its intrinsic value.”
 Fama (1970): Three levels of Market Efficiency ?

vs.
 Rational Efficient Market Formulation (Grossman and Stiglitz, 1980):
Investors will not rationally incur the expense of gathering information
unless they expect to be rewarded by higher gross returns compared with
the free alternative of accepting the market price.”
 Identify Mispricing by estimating intrinsic value to get positive
alpha.

Course : Investment Analysis DFS(DU)-MBA (Finance) 2020

 WHAT IS VALUE ?

2. Going • Value under going concern assumption- company will continue

Concern vs. its business activities for a foreseeable future- Reliance ?
Liquidation • Liquidation Value – distressed firms- value if it is dissolved
Value or assets sold individually- Air India?

• Privately traded Firms , partnerships , LLP

3. Fair • FMV – price at which assets(or liabilities) will change hands
between knowledgeable & willing buyer and sellers in an arm’s
Market vs. length transaction.
Investment • Investment Value: value of an asset to a specific buyer taking
Value into account potential synergies and based on investor’s
requirements and expectations. E.g. Vodafone-Idea merger
APPROACHES TO VALUATION
• Absolute valuation approach
• You value an asset based upon its fundamentals (or intrinsic characteristics).
Intrinsic • Discounted Cash Flow Models(DCF)
Valuation • Expected Cash Flows & Risk adjustment on ???
• Value of an asset is present value of expected future cash flows.

• Pricing
• How much to pay for an asset by looking at what others are paying for
Relative “comparable assets” , scaled to a common metric that all share (earnings,
Valuation revenues, subscriber)
• Currencies & Collectibles

Contingent • Augments the value of an asset whose cash flows are contingent on an event
happening.
Claim (Real • Options – derives value from underlying and has right not obligation
Option) • Call option is exercised when value of underlying asset > strike price