• 26/06/2015

Business Valuation

1L- v_a_Iu_e_"_" "_"_W_h_a_t_i_s _it_?_? _

{(Price" is what you pay"

{(Value" is what you get""
Warren Buffett
(4'" Richest Person In the world)

Humans buy only when they GET more than they PAY!!

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Value Investing?

• involves buying securities that appear

underpriced by some form of fundamental
analysis •
• Introduced by Benjamin Graham and David
Dodd in their book "Security Analysis" in
1934.

What is Valuation?

• Valuation is the process of determining the

value of an asset.
• Steps in Equity Valuation Process
1. Understand the business
2. Forecast the company performance
3. Select a suitable valuation model
4. Convert the forecast into a valuation

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Intrinsic Value

• It refers to the value of an asset estimated by

someone who has complete understanding of
the characteristics of the asset/issuing firm

• Market price does NOT always reflect the Value

(Byestimating value. the analyst is assuming that the market price
is not necessarily the best estimate of intrinsic value)

Estimated Value and Market Price

• Compare: P"l-I••.••.I'J
'.i'<>h'''tl< ve.\.v.

Vs.
(Intrinsic Value ~Present Value of Future cash flows of the security)

• Can arrive at three conclusions:

10
10
10

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Estimated Value and Market Price

• An analyst using a number of models and a range of inputs,

estimates a security's value to be $250. The security is
trading at $260. The security appears to be:
@ Overvalued
B. Undervalued
C. Fairly valued

Valuation Models

• Two major categories of Equity Valuation models:

1. Absolute Valuation Models
2. Relative Valuation Models

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Absolute Valuation Models

• Estimating intrinsic value using the asset's own

investment characteristics
Intrinsic Value = Present Value of Future cash flows of
the security
• Can be divided into two:
• Discounted cash flow models
Example: Dividend discount model
• Asset based models

Relative Valuation Models

• Estimating intrinsic value of the asset in relation to

the value of other comparable assets
Intrinsic Value = Value of a similar asset

• Example:
• Multiplier models (PIE Ratio, P/B Ratio)
;f
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no.!'O
//
(!lilt- pr I<M ~ •.• St-.....
E.ur~"'")5 p..,. ~\-<.- (£pj
l'\.lf.

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Discounted Cash flow Models

Based on the logic:

• Individuals make an investment because they expect a rate
of return over the investment period
• So, value of the investment today should be equal to the
present value of, the expected future benefits
• , What is the expected future benefit of buying and holding a
common share?

Dividend Discount Model (DDM)

• Expected Benefits = Dividends

Assuming business will continue for a indefinite future

Present Value of Future

Intrinsic
= Dividends expected to
Value receive from the security

00
D t = Period
Value Lt~ I (1 + r) t
0t = Dividend
r = Required
in period t
rate of return

Original ODM Formula, "The Theory of Investment Value",

John Burr Wllliamsl1938l

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One Period Dividend Discount Model

• If an investor buys and holds a share for one year:

Intrinsic Present Value of two cash flows:

Value = Expected Dividend + Expected
Selling prince in one year

Value -
D] + P j
-
(1 + r)
OJ "Dividend in period 1
r '" Required rate of return
p1 = Market price in period 1

One Period Dividend Discount Model

• Apple shares are expected to pay a dividend at the end of the year of $S.
The analyst estimates the required return to be 10% and the expected
price at the end of the year to be $450. The current price is $400.00.
• Calculate the value of the shares today, and determine whether Apple is
overvalued, undervalued, or properly valued.

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One Period Dividend Discount Model

YO YI
Required return := 10010

I I
$450+ $5

Intrinsic value $413.64

(450+5)
I
Market price $400.00 (1+0.1)

. Undervalued

Two Period Dividend Discount Model

• If an investor buys and holds a share for two year:

present value of the dividends in
Intrinsic
Value
= years 1 and 2, plus the present value
of the expected price in Year 2

D1 D +P2
Value = + 2
(l +rY (l +r)2
01 and 01 "Dividend in period 1 and 2
, =
Required rate of return
P1 and Pj = Market price in period 1 and 2

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Two Period Dividend Discount Model

• Apple shares are expected to pay a dividend at the end of the year 1 and
year 2 as $5 and $10. The analyst estimates the required return to be 10%
and the expected price at the end of the year 1 and year 2 to be $415 and
$425. The current price is $400.00.
• Calculate the value of the shares today, and determine whether Apple is
overvalued, undervalued, or properly valued.

Two Period Dividend Discount Model

.

YO YI Y2
RCQUire1retum 10%
I $S
I
$10~$425

$ 4.55 :
I
$ 359.50 I
Intrinsic value $374.05
Market price $400.00

• Overvalued

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26/06/2015

Gordon constant growth model

• It assumes that the Dividends increase at a constant

rate indefinitely
Intrinsic = present value ofthe increasing
Value dividends

Value = Do(l+g) = D j

(r-g) (r-g)
Do :::Dividend just paid
01 = Dividend receive in year 1
r = Required rate of return
Ii :::Dividend growth rate

Gordon constant growth model

• The Gordon Growth Model suggests that

valuation is a function of:
• Dividend- D
• Growth in dividends- g
• Discount rate- r

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Gordon constant growth model

• Apple recently paid a dividend of $1.80. An analyst has examined the

financial statements and historical dividend policy of Apple and expects
that the firm's dividend rate will grow at a constant rate of 3.5%
indefinitely.
• The analyst also determines that required rate of return on investment is
10%.
• Calculate the current value of Apple share.

Multiplier Models

• Price muftiple:refers to a ratio that compares

the share price with some sort of monetary
value to allow evaluation of the relative
worth of an asset
• values a stock based on the average price
multiple of stock of similar companies.

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PIE Multiple model

• PIE Ratio = Market price per share (£)

Earnings per share (EPS)

MK Technologies shares are selling for $50. They were bought for
$ 40. Earnings for the last 12 months were $2 per share.
Calculate PIE multiple. .

PIE Multiple model

• Trailing PIE = Market price per share

EPSover past 12 months

• Leading PIE = Market price per share

Forecasted EPF for next 12 months

• Byron Investments Inc., reported (32 million in earnings during

fiscal year 2007. An analyst forecasts an EPSover the next 12
months of€1.00. Byron has 40 million shares outstanding at a
market price of€18.00 per share. Calculate Byron's trailing and
leading PIE ratios.

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I PIE Multiple model

I
• Estimating intrinsic value of a share in relation to
comparable PIE ratio
Intrinsic Value = EPSx Comparable PIE

• MK Technologies shares are selling for $50. Earnings for the

last 12 months were $2 per share. The average trailing PIE
ratio for firms in MK's industry is 32 times. Calculate the
intrinsic value of a share. Decide the share is undervalued,
overvalued or fairly valued.

I PIE Multiple model

I
• Consumer Products, Inc. has a trailing PIE of27.52, while the
median peer group pIE is 33.25. Assuming that there are no
differences in the fundamentals among the peer firms and
Consumer Products, the firm is:
A.' correctly valued.
B. overvalued.
C. undervalued.

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Asset based Model

• Use estimates of the market value of assets and

liabilities in arriving at value of a share
• Relevant for companies that do not have a high
proportion of intangible assets

Asset based Model

~!~~~~IP~h~O~",~l~td
I Phone ltd has 1/Oaashares outstanding. Balance Sheet as at 31/12/20012
Market values of inventories and accounts ',m''''-I';£" ' ',,' ,," ,,,,,,"'$ev;~i
receivable as reported. The market value of ash 5,000
!Accountsreceivable 15,000
net fixed assets is 120% of reported book
Inventories 30,000
value. The reported book values of liabilities Net fhcedassets 70,000
reflect their market values. etalassets 120,000
l}l1Ibjltt1~;~-i",~,::-.... 4'*,' ",""":"ift$:;-v;"
!Accounts nmr.!ble 20,000
Using the asset based valuation- erm loans 25,000
approach, estimate value per share from lEnuitv 75,000
adjusted book values. otalliabilfties 120,000

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Equity Valuation

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