Equity Research

Private and Confidential
Equity Research
Equity Research
CRISIL Analyst Certification Program
Dheeraj Vaidya
March 2008
dheerajvaidya@corporatebridge.net
www.corporatebridge.net
1
Private and Confidential – Not for Circulation
Table of Contents
 Equity Research Overview

 What is Equity Research?
 Equity Research Methodology
 Key Valuation tools
 Valuation: Subjective or objective
Equity Research
 Valuation Tools
 Discounted Cash Flow
 Relative Valuation
 Others
• Asset Based Valuation
• Replacement Cost Method
• M&A comparables
• Sum of Parts
 Report Writing
Private and Confidential – Not for Circulation 2

Equity Research
Equity Research Overview
3
Equity Research Overview
 Role of Equity Research

 Lack of information creates inefficiencies that result in stocks being
misrepresented (over or under valued)
 Research is valuable because it fills information gaps so that each individual
investor does not need to analyze every stock
Equity Research
 Analysts use their expertise and spend a lot of time analyzing a stock, its
industry and peer group to provide earnings and valuation estimates
 Division of labor makes the market more efficient
 Types of Equity Research Brokerage firms

 Major brokerage firms
 Independent research firms and small boutique brokerage firms
 Who pays for the research?

 Major brokerage firms: Fee income earned by brokerage trades (Soft
Dollars)
 Independent brokerage firms: Fees charged on per report basis

Equity Research Methodology
 Top to Bottom Approach

 EIC (Economy Industry Company) Framework
 M2M (Macro to Micro) Method
Prospective Analysis
 Forward Looking
Equity Research
 Forecasting Financials
 Valuations - DCF
Company Analysis
 Company Financials
 Ratio/Margin Analysis
 Comparable Analysis
Strategic Analysis
 Industry Analysis
 SWOT Analysis
 Porter’s five forces
Macro Analysis
We will focus our overview discussion
 Fiscal Policy
on Prospective Analysis
 Monetary Policy

Equity Research: Valuation
CEO/CFO/Operating Mgr
Insiders Decision Making
Identifying Opportunities
Equity Research
FIIs / MFs / Insurance Comp
Investors Pension/Hedge Funds
Retail Investors
Investment Bankers
Consultants Sell side / Buy Side Analyst
Credit Analyst

Equity Research: Importance of Valuation
Standalone Valuations
 Mergers and Acquisition
 Company Sales / Subsidiary Sales
 Start-ups / Joint Ventures
 De-listing/ Share Option Program
Equity Research
 Defense Analysis – Hostile Takeover?
Public Equity Offerings Financing

 Initial Public Offerings  Re-capitalization
 Subsidiary IPOs  Leveraged Buyout (LBOs)
 Follow-on IPOs  Share repurchase programs
How much is your valuation?

Equity Research: Key Valuation tools
 Present value of projected unlevered free cash flow

Discounted Cash Flow
 Captures the “intrinsic value” of the business
Equity Research
 Based on market trading multiples of comparable comp

Relative Valuation
 Usually focuses on forward looking Profit / EBITDA / Cash Flow
 Based on multiple paid for comparable comp. assets in sale transaction

M&A Comparables
 Focus mainly on multiples of Historical Profit / EBITDA / Cash Flow
 Based on fair value of individual assets

Asset Valuation
 Book Value may not be equal to fair value
 Divides the business into separate sub-entities (parts)

Sum of Parts
 Add the value of each part to find the total value

Valuation Summary Table
 Company valuation is a function of more than one valuation tool

 Different weights can be applied to each individual valuation approach
as per analyst’s judgment
$60
Equity Research
XYZ C orp. Share Price ($)
$50
$40
$30
$20
$10
$0
DC F Public Asset Repl M&A Repl C ost Sum of 12-mnt
C omp C omp Parts High Low
Which approach is the most reliable?

Equity Research: Subjectivity / Objectivity
Equity Research
Equity Research
Subjective Objectivity
 Judgment & interpretation of data  Reasonable analytical justification

 Making assumptions  Macro to Micro Approach
 Selling the story / crafting the deal  Ratio Analysis
 Information available may be limited  Valuation tools – DCF,
 Time constraints Relative Valuation, Sum of Parts
 Do all analyst have the same rating?

 Is valuation all about Gut feeling?

Equity Research
Discounted Cash Flow
11
Overview of Discounted Cash Flow
Enterprise Value is sum of
 Present value of all its expected cash flows for a period (year 2008 till 2016)
 Present value of terminal value calculated for future point in time (year 2016)
Equity Research
500
425
Cash Flows (Rs mn)
400
300
Terminal Value
200
102 110
89
100 53
24 24 31
17
0
2008 2009 2010 2011 2012 2013 2014 2015 2016
Annual cashflow Terminal Value
DCF is a rigorous method (compared to Relative Valuations)

Steps in a Discounted Cash Flow (DCF)
 Project free cash flows over the forecast period (5-10 years)
Projections
 Project enough years to provide for achieving a normalized cash flows
 Trading multiples of terminal year Net Profit, EBITDA, EBIT

Terminal Value  Trading multiples of (terminal year + 1) Net Profit, EBITDA, EBIT
Equity Research
 “Perpetuity value” of cash flows after terminal year
WACC of companies in similar businesses to reflect the relative risk

Discount Rate
 Cost of Equity using CAPM Model
 Determine a range of values for the enterprise by discounting the projected

Present Value
free cash flows and terminal values to the present
 Adjust valuations for all assets & liabilities not accounted for in projections
Adjustments
 Incremental shares are calculated using treasury stock method
 DCF is sensitive to changes in growth rate & margin assumptions

Sensitivity Analysis
 Sensitivity with respect to terminal value and discount rate

Equity Research
DCF – Projections
14
DCF - Projections
 Company should reach steady state by the end of forecast period

 Analyst typically forecast for 5-10 years
 Should consider only recurring items before financial leverage,

extraordinary items, discontinued operations
Equity Research
 Projections should be based on

 Historical Performance
 Management Projections
 Consensus Estimates
 Business Cycle
 Industry Data
 Analyze the numbers

 Are the numbers are clean? How relevant are historical figures?
 Major changes in business or industry
 Run sensitivity Analysis on key value drivers

Free cash flow to firm (FCFF)
 FCFF is a pre-debt cash flow
 Used to find Enterprise Value of the company

Equity Research
 A simplified DCF can be created which projects only the below items
 A more rigorous approach pulls such results from a fully integrated

three-statement model
Computation Comments
Flow to total capital

EBIT * (1-t)
Removes capitalization effects on earnings
Add: Depreciation,Depletion & Amortization Add back all non-cash charges to earnings
Less: Changes in Working Capital Watch for large swings year-to-year in forecasted working capital
Less: Capital Expenditure Critical to determine CapEx levels required to support sales and margins in forecast
Add: Changes in Other Assets/Liabilities Must take into account investments in other assets that are a regular part of running a business
= Free Cash Flow to Firm (FCFF)

Free cash flow to equity (FCFE)
 FCFE is a post-debt cash flow
 Used to find Equity Value of the company

Equity Research
 FCFE measures how much cash a firm can afford to pay out (e.g..
dividends) to its stockholders
Computation Comments
Net Income Shareholders have claim over its net income
Add: Depreciation,Depletion & Amortization Add back all non-cash charges to earnings
Add: New debt issues New borrowings are cash coming into the firm
Less: Capital Expenditure Critical to determine CapEx levels required to support sales and margins in forecast
Less: Increase in working capital Watch for large swings year-to-year in forecasted working capital
Less: debt repaid Cash going out from the firm to repay debt reduces the amount that can be paid to shareholders
= Free cash flow to equity (FCFE)

Suitability of FCFF and FCFE
Cash flows relating to debt do not have to be

considered
Best suited when leverage is expected to change

significantly over time
FCFF
Equity Research
Requires debt ratio and interest rates for

estimating WACC
Suited for firms that have negative FCFE but have

positive FCFF
Capital expenditure is not significantly greater

than depreciation
Beta of stock is close to one or below one
FCFE
FCFE is significantly different from dividends or
dividends are not relevant
Should be used when Leverage is stable

Equity Research
DCF – Terminal Value
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DCF – Terminal Value: Overview
 Analyst typically do not forecast free cash flow for more than 10 years
 However, on a “going concern basis” the company still has value after
the forecast period known as Terminal Value
Equity Research
 Terminal value of a manufacturing equipment at the end of the useful

life is its salvage value, typically less than 10% of the present value
 In contrast, terminal value of a business is 50-70% of the Total

Enterprise Value
 For this reason, terminal value calculation is critical in performing

valuations
 Two Methods primarily used for calculation

 Exit Multiple
 Perpetuity Growth

DCF – Terminal Value: Exit Multiple Calculation
 Terminal value is estimated to be a multiple of an operating statistics

(EBITDA / EBIT)
 Multiple should reflect the ongoing growth potential of the business

Equity Research
 It should be based on the appropriate multiple used in that particular

industry (EBITDA / EBIT / EBITDAR)
 Multiple is derived from valuation of comparables companies
 Normalized multiples should be used

 Multiple should reflect the long term market valuation of the company
rather than a current multiple that may be distorted by industry or
economic cycle
 Sensitivity analysis should be done on the multiples

DCF – Terminal Value: Perpetuity growth method
 Assumes that the business grows at a constant rate in perpetuity
 Gordon Growth formula for calculation of Terminal value

Unlevered FCFn +1
Terminal Valuen =
(r - g )
Equity Research
Unlevered FCFn+1:Unlevered free cash flow in first year after the forecast period
r: WACC
g: Perpetuity growth rate
 Use Normalized cash flow in final year where

 Depreciation is approx equal to CapEx
 Steady working capital needs
 No deferred taxes
 The perpetuity growth rate used must be realistic

 Can be safely assumed to be equal to nominal GDP growth
 Expected long-term growth rate of the industry (e.g., IT Industry versus Oil
& Gas companies growth rate)
 Sensitivity analysis should be done on perpetuity growth rates

DCF – Terminal Value: Example
FY07E FY08E FY09E FY10E FY11E
Net Revenues 18,087 21,587 25,999 31,451 38,101
Ebitda 3,834 4,576 5,512 6,668 8,077

Less Dep & amort (1,389) (1,465) (1,541) (1,545) (1,550)
EBIT 2,446 3,112 3,971 5,122 6,527
Less tax@33% (807) (1,027) (1,310) (1,690) (2,154)
EBIT * (1-tax) 1,639 2,085 2,661 3,432 4,373
Equity Research
Plus: D&A 1,389 1,465 1,541 1,545 1,550

Less Capex (12,650) (1,400) (1,400) - -
Less changes in WC 1,472 1,194 1,420 1,349 1,231
Free Cash Flow (8,151) 3,343 4,222 6,326 7,154
Sugar Comparable Sheet

EV/Ebitda EPS P/E
M Cap EV
Name Price 08E 07E 08E 09E 07E 08E 09E
(US$m) (US$m)
Bajaj Hindusthan 234 841 1,121 13.7 (8.0) 2.9 23.8 NA 79.8 9.9
Balrampur Chini 93 584 614 11.4 (0.1) 3.6 11.6 NA 25.8 8.0
EID Parry 183 413 343 10.0 9.4 11.0 19.0 19.4 16.7 9.6
Triveni 115 749 895 11.1 5.7 6.6 8.7 20.0 17.5 13.2
Average 743 11.6 19.7 34.9 10.2
 Exit Multiple: What is the present value of terminal value assuming a discount rate of 10%?
 Perpetuity Growth Method: What is the present value of terminal value with 3.0% perpetuity
growth rate assuming a discount rate of 10%?

Equity Research
DCF – Discount Rate
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DCF - Discount Rate Overview
 Discount rate is a function

 Risk inherent in any business and industry
 Degree of uncertainty regarding the projected cash flows
 Capital structure
Equity Research
 For low risk industries like utilities, discount rate is lower. However,
for high risk sectors like real estate, the discount rate use is higher
 Discount rate is called Weighted Average Cost of Capital (WACC)
 WACC analysis assumes that capital markets (both debt and equity)
in any given industry require returns commensurate with perceived
riskiness of their investments
 Debt provides tax benefit as interest is a deductible expense
After-tax Proportion of Debt Cost of Proportion of Equity

WACC = X + X
Cost of Debt in Capital Structure Equity in Capital Structure

DCF – Discount Rate: Cost of Debt
 Yield to Maturity Method (Only for Public Debt)

 Weighted average of current yields to maturity or yields to worst on all
issues in the target capital structure
 The yield to maturity incorporates the market’s expectations of future
returns on debt and should be used instead of the coupon rate
Equity Research
 Average cost of debt (not marginal) may be more appropriate when the
entire enterprise is being valued
 Include short-term and medium-term debt (along with long-term debt) if it
is expected to be part of the permanent capital structure going forward
 Credit Rating Method

 Bond rating given to the company by Standard & Poors / Moody’s
 Use the spread associated with the bond rating
 Cost of Debt = Risk Free Rate + Default Spread
 Note: The difference between company’s cost of debt and the

benchmark rate (LIBOR/Government Bond) is called a Spread

DCF – Discount Rate: Cost of Debt
 Synthetic Rating Method

 Calculate the interest coverage ratio = EBIT / Interest Expense
 Derive the synthetic default spread for the coverage ratio
 Cost of Debt = Risk Free Rate + Synthetic Default Spread
Equity Research
 Company Report Method (Spot Check!)

 From the Annual report / quarterly report find interest rate applicable on
each debt
 The cost of debt may be historical but it may provide a good double check
Interest Expense
Cost of Debt =
Average Debt

DCF – Discount Rate: Cost of Equity CAPM Model
 Most common method of determining cost of equity is using the

Capital Asset Pricing Model (CAPM)
 CAPM quantifies the relationship between risk and required return in a
well functioning market
Equity Research
Cost of Equity
Risk Free Rate + Beta X Risk Premium
 The return investor expects from  The degree to which a company’s  Investing in stock market is riskier
a completely risk free investment equity returns vary with the return of than investing in government bond
the overall market
 Should be in the currency cash  Investors expect a higher return
flow  Beta is a function of both the to induce them to take the higher
business risk as well as the financial risk of investing in equities
risk
 Beta is a measure of systematic

risk

DCF – CAPM Model: Risk Free Rate
 Risk free security has no default risk, no volatility and beta of zero
 Practically such a security does not exist and hence, we use securities
issued by political and stable government
 Selecting the bond depends on the forecast horizon – short term or
long term?
Equity Research
 Ten year government bond is typically taken as risk-free rate
Short Term Treasury Bill Long Term Government Bond
 Changes significantly over time  Consistent with DCF forecasting period of

 Long term average would better five to ten years
approximate the real risk-free rate  Long term forecast of Inflation
For economically and politically unstable country, add the country risk premium

DCF – CAPM Model: Beta
 Beta measures the volatility of a stock compared to the volatility of

the overall market.
 Beta = 1.0; every 1.0% return on market, stock will return 1.0%
 Beta = 0.5; every 1.0% return on market, the stock will return 0.5%
 Beta = 2.0; every 1.0% return on the market, stock will return 2.0%
Equity Research
Beta: 2.0
Return on stock
Beta: 1.0
over the risk free
return
Beta: 0.5
Return of market over risk-free rate
 Negative Beta?
 Calculation of Beta
 Regression Beta Methodology
 Bottom-up Beta Methodology
DCF – CAPM Model: Calculation of Bottom-up Beta
Bottom-up Beta
Equity Research
Nature of Business Operating Leverage Financial Leverage
 Type of business – Cyclical  It is the measure of the  Financial leverage refers to

firms are expected to have proportion of fixed cost to the debt taken on by the firm
higher beta than non-cyclical the overall cost
firms  A company with high
 If the fixed cost component borrowing tends to have a
 Company’s products are is higher, the stock will tend higher beta
discretionary – Beta will be to have a higher beta
usually high  By taking on debt, even a
 The airline industry where relatively safe business can
 Business of providing basic a large proportion of their end up having a high beta.
necessity such as food and costs are fixed in nature e.g.,
clothing – Low Beta air craft leasing, the beta will
be higher
 Information Technology,
which require lower sunk
costs, would in general have
relatively lower beta

DCF – CAPM Model: Calculation of Bottom-up Beta
 Step 1: Calculate the Unlevered Industry Beta

 Unlevered Beta of Industry = 1.15/(1+(1-0.1137)*1.76) = 0.45
 Business Beta of Industry = 0.45/(1+0.14) = 0.40
Regression Effective Fixed/var
Company D/E Ratio
Beta tax rate % cost
Financial Leverage Adjustment
Equity Research
Tata Steel 1.14 0.40 30.66 0.32

Tulsyan 0.98 3.46 9.15 0.05 Un-leveraged beta = Regression beta/ {1+ (1-tax-rate) *
Uttam Galva 1.18 1.87 8.98 0.05 debt-equity ratio}
Tayo 0.85 0.99 22.74 0.30
Operating Adjustment
Sunflag Iron & Steel 1.31 0.67 10.31 0.14
Shree Precoated Steel 1.25 2.11 9.58 0.07 Business beta = Unlevered beta/ {1+ (fixed to var ratio)}
Shivalik Bimetals 0.78 1.03 10.77 0.16
National Steel 1.09 0.97 5.56 0.03
Mukand Ltd 1.51 4.08 9.80 0.19
Monnet Ispat 1.28 1.60 7.83 0.18 Standard error reduces
Mahindera Ugine Steel 1.31 0.71 7.85 0.13
Kalyani Steel 1.14 0.57 9.39 0.06
Individual Error / Square root of number of sample
J S W Steel 1.16 1.30 6.08 0.20 SAIL: 0.50/Sqrt(14) = 0.13
Hisar Metal 1.16 4.90 10.50 0.03
Average (Simple) 1.15 1.76 11.37 0.14
SAIL 1.28 0.50 7.95 0.28
 Step 2: Calculate the Unlevered Beta for SAIL (adjust for operating leverage)
 Unlevered beta of SAIL: 0.4*(1+0.28) = 0.51
 Step 3: Calculate the Levered Beta (adjust for financial leverage)

 Levered Beta of SAIL: 0.51*(1.0 +0.50*(1.0 - 0.0795)) = 0.75
Equity Research
DCF – Present Value
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DCF – Present Value
 Time Value of Money

 A Rupee today is worth more than a Rupee tomorrow
 Discounting
 Discounting is the process of finding the present value of a future sum
Equity Research
PV of PV of Non
Shareholder = forecast + Terminal + Operating - Net Debt
Value FCFF Value Assets
Example
2007 2008 2009 2010 2011
Free Cash Flow 5 10 18 21 70
Period 1 2 3 4 5
Discount Factor @10% 1/(1.10)^1 1/(1.10)^2 1/(1.10)^3 1/(1.10)^4 1/(1.10)^5
Discount Factor @10% 0.909 0.826 0.751 0.683 0.621

Present Value 4.5 8.3 13.5 14.3 43.5
 Mid Year Discounting?

Equity Research
DCF – Adjustments
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DCF – Adjustments
 DCF analysis calculates the Enterprise Value (also sometimes known

as Adjusted Market Value) of a company
 The Equity Value of a company is equal to its Enterprise Value less

Corporate Adjustments
Equity Research
 Corporate Adjustments include the company’s net debt plus other

obligations, less other assets not included in the DCF analysis or
financial forecasts
 Long term debt (including current portion)
 Short term debt
 Minority interest
 Capitalized leases
 Incremental common-equivalent shares are calculated using the

treasury stock method

Equity Research
37
 Allows to run different scenarios with different variables
 Better view of valuation in the best case and worst case scenario
Equity Research
 Cases of sensitivity analysis

 NPV of FCF and terminal value using growth rate and WACC as inputs
 Enterprise Value using growth rate and WACC as inputs
 Price/share using growth and WACC as inputs
 Effect on EPS by changing the value drivers
 Sensitivity Analysis Example: NPV of FCF using growth rate and WACC
WACC
### 8% 9% 10% 11% 12%
Terminal Growth Rate
2% $591 $484 $403 $340 $289
3% $709 $567 $464 $386 $325

4% $881 $680 $543 $444 $369
5% $1,156 $846 $653 $521 $425
6% $1,665 $1,111 $812 $626 $499

Equity Research
Relative Valuation
39
Relative Valuation: Valuation Multiple
 What is a Multiple?
 An expression of market value relative to a key statistic that is assumed to
relate to that value
 To be useful statistic – earnings, cash flow or some other measure must
bear a logical relationship to the market value observed
Equity Research
 Why Multiples Vary?

 Difference in quality of the business / value drivers
 Accounting differences
 Fluctuations in cash flow or profits
 Mispricing
Advantages of Multiples Disadvantages of Multiples
 Usefulness  Simplistic?
 Simplicity  Static
 Relevance  Difficult to compare

Relative Valuation: Identifying Comparable
 Useful Sources to check for comparables

 Bloomberg = Company Ticker RV
 SIC code searches
 Prospectuses
 Company Documents – Competitors Section (10K, 10Q and Annual Reports)
Equity Research
 Other Research Reports?
Operational Financial
 Industry  Size
 Products  Leverage
 Distribution Channels  Growth
 Markets  Margin
 Consumers  Shareholder Base
 Seasonality
 Cyclicality

Equity Value versus Enterprise Value
 Enterprise Value = Market value of operating assets

 Equity Value = Market value of shareholders’ equity
 Equity Value = Enterprise Value – Net Debt
Equity Research
Liabilities and
Total Assets Shareholders’ Equity
Net Debt
Enterprise
Enterprise Value Value
Equity Value

Equity Value versus Enterprise Value
 Equity Value  Enterprise Value (EV)

 Express the value of  Cost of buying the right to the
shareholders’ claims on the whole of an enterprise’s core
assets and cash flows of the cash flow
business  Includes all forms of capital –
Equity Research
 Reflects residual earnings after equity, debt, preferred stock,

the payment to creditors, minority interest
minority shareholders & other
non-equity claimants
 Advantages of Equity Value  Advantages of Enterprise Value

 More relevant to equity  Accounting policy differences
valuations can be minimized
 More reliable?  Avoid influence of capital
 More familiar to investors structure
 Comprehensive
 Enables to exclude non-core
assets
 Easier to apply to cash flow

Relative Valuation: Enterprise Value Multiples
Enterprise Value Multiple

Equity Research
EV/Sales EV/EBITDA EV/EBIT EV/FCF EV/Capacity
Equity Value Multiple
P/E P/CF P/BV PEG Div Yield

Sample Upstream Companies Comparable Sheet
P/E EV /Ebitda P/CF
Net
MCap EBITDA
Name Pric e (lc y ) EV ($bn) Inc ome 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E 2009E
($bn) ($bn)
($bn)
Oil Majors
Exxon 89 485 463 59 26 12.9 12.2 11.7 5.8 5.9 5.5 10.1 9.9 10.8
Shell 1,938 253 258 40 15 9.8 10.1 10.3 4.8 4.8 5.0 7.0 7.1 6.8
BP 589 230 248 36 16 11.6 10.0 10.3 5.8 5.3 5.3 7.5 6.8 6.7
Petrobras 74 198 212 9 4 14.8 12.2 11.7 8.2 7.2 6.9 9.9 8.2 7.7
Chevron 88 185 183 34 11 11.0 10.1 10.0 4.5 4.3 4.2 7.8 7.6 7.2
Equity Research
Mean 1,918 2,005 11.0 10.2 10.1 5.1 4.9 4.8 7.3 6.9 6.8
Median 10.4 10.1 10.0 4.8 4.8 5.0 7.2 6.8 6.7
Independents
Occidental 71 58 59 9 5 14.1 11.9 11.3 5.8 5.1 5.0 9.2 7.8 7.3
Encana 65 49 59 6 4 13.0 14.2 14.8 6.3 6.3 5.7 6.2 6.2 6.4
Devon 83 37 43 7 3 14.0 11.3 9.5 6.3 5.3 4.6 6.3 5.8 5.0
Apache 96 32 37 6 2 13.7 10.9 10.0 5.7 5.0 4.3 6.2 5.4 4.8
Mean 362 435 15.9 14.0 13.0 6.6 5.7 5.0 6.8 6.0 5.6
Median 15.1 13.9 13.0 6.3 6.0 5.0 6.3 6.1 5.4
Asia Oil & Gas Companies

Petrochina 14 723 284 36 22 12.3 12.9 6.9 7.2 13.1 12.7
Sinopec 10 247 80 11 5 13.7 10.5 6.6 5.2 7.1 5.5
CNOOC 14 80 66 7 4 13.0 15.0 7.2 7.7 10.0 10.4
Mean 1,065 445 12.7 12.4 10.5 6.4 6.2 4.6 9.5 9.1 7.5
Median 12.6 11.9 10.5 6.7 6.2 4.6 8.8 9.0 7.5
Mean 3,863.1 3,458.0 445.0 199.9 13.4 12.3 11.7 6.3 5.7 5.2 7.4 7.1 6.5
W eighted Mean 12.0 11.3 10.7 5.8 5.5 5.2 8.3 7.9 7.2
Mean ex Asia 2,798.3 3,013.4 13.4 12.3 11.7 6.3 5.7 5.2 7.1 6.8 6.5
Median 13.0 11.9 10.9 6.0 5.6 5.1 7.1 6.8 6.6
Comp A 1,306.9 71 66 6.9 3.9 12.7 12.6 12.9 5.9 5.7 5.5 9.0 8.3 8.3
% to Oil Majors 16 24 27 15 16 15 22 20 21
% to Independents (20) (10) (1) (10) (1) 12 33 39 48
% to Asia 0 2 24 (8) (9) 21 (5) (8) 10
% to Total (5) 3 11 (5) (1) 7 21 18 26
% to Total ex Asia (6) 3 11 (5) (0) 7 26 22 27

Other Valuation Tools
Asset Based
Equity Research
Replacement Cost Valuation Sum of parts
M&A Comparable
Final valuation is obtained by applying suitable weightages to DCF, Relative

valuation, Asset Based, Sum of parts, Replacement Cost, M&A comparables

Lets put it together!
Valuation Method
Industry DCF M&A Comp Asset Repl Sum of Parts Div Yield
Retail
Industrials
Telecom
Equity Research
Banks
Real Estate
Oil and Gas
Sugar
Relative Valuation
Industry EV/Sales EV/EBITDA EV/Capacity P/E P/CF P/BV PEG
Retail
Industrials
Telecom
Banks
Real Estate
Oil and Gas

Sugar

Equity Research
Report Writing
48
Report Writing
 Who reads the equity research reports?

 Investment Professional (MF, Pension Funds, Sales etc)
 Bankers
 Retail Investors
 Investors are looking at ideas for directing their own inquiries

Equity Research
 First thing First!

 Investment professionals receive more than 100 emails a day
 Write the most important idea in the Report Cover
 The reason to read the report

 One paragraph on key investment conclusions
 What investor should do with the stock and why
 Answer the following important questions in the report

 Why are we writing this report? On what basis do we value the stock?
 What are key investment conclusions and why?
 What is new in our analysis and how different it is from consensus?
 What risk would change your view?

Report Writing: Key points
 Report
 Keep the report short (maximum 20 pages)
 Use Headlines and comment flashes
 Make the format and layout as uncluttered as you can
 Style
Equity Research
 Should be jargon free - Avoid clichés e.g. jack of all, lion’s share
 Be precise, clear and concise
 Use short words like ‘buy’ rather than ‘purchase’
 Use of active voice e.g. ‘We forecast..’ is better than ‘it is forecasted to..’
 Convention
 Headings, Abbreviations
 Bullet points, Currencies
 Time, Dates
 Names and Titles, Figures
 Ranking, Upper Case, Lower Case and Title Case
 Charts and Graphs

 Use charts and graphs – an appropriate picture really is worth thousand words
 Put data in a table
 Discuss the risks

Equity Research
Questions?
51

Equity Research

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Private and Confidential

CRISIL Analyst Certification Program

 Equity Research Overview

Private and Confidential – Not for Circulation 2

Equity Research Overview

 Role of Equity Research

 Types of Equity Research Brokerage firms

 Who pays for the research?

Private and Confidential – Not for Circulation 4

 Top to Bottom Approach

Private and Confidential – Not for Circulation 5

Insiders Decision Making

FIIs / MFs / Insurance Comp

Investors Pension/Hedge Funds

Consultants Sell side / Buy Side Analyst

Private and Confidential – Not for Circulation 6

 Defense Analysis – Hostile Takeover?

Public Equity Offerings Financing

How much is your valuation?

Private and Confidential – Not for Circulation 7

 Present value of projected unlevered free cash flow

 Based on market trading multiples of comparable comp

 Based on multiple paid for comparable comp. assets in sale transaction

 Based on fair value of individual assets

 Divides the business into separate sub-entities (parts)

Private and Confidential – Not for Circulation 8

 Company valuation is a function of more than one valuation tool

XYZ C orp. Share Price ($)

Which approach is the most reliable?

Private and Confidential – Not for Circulation 9

 Judgment & interpretation of data  Reasonable analytical justification

 Do all analyst have the same rating?

Private and Confidential – Not for Circulation 10

Discounted Cash Flow

Enterprise Value is sum of

DCF is a rigorous method (compared to Relative Valuations)

Private and Confidential – Not for Circulation 12

 Trading multiples of terminal year Net Profit, EBITDA, EBIT

 “Perpetuity value” of cash flows after terminal year

WACC of companies in similar businesses to reflect the relative risk

 Determine a range of values for the enterprise by discounting the projected

 DCF is sensitive to changes in growth rate & margin assumptions

Private and Confidential – Not for Circulation 13

 Company should reach steady state by the end of forecast period

 Should consider only recurring items before financial leverage,

 Projections should be based on

 Analyze the numbers

 Run sensitivity Analysis on key value drivers

Private and Confidential – Not for Circulation 15

 FCFF is a pre-debt cash flow

 Used to find Enterprise Value of the company

 A more rigorous approach pulls such results from a fully integrated

Flow to total capital

= Free Cash Flow to Firm (FCFF)

Private and Confidential – Not for Circulation 16

 FCFE is a post-debt cash flow

 Used to find Equity Value of the company

Net Income Shareholders have claim over its net income

= Free cash flow to equity (FCFE)

Private and Confidential – Not for Circulation 17

Cash flows relating to debt do not have to be

Best suited when leverage is expected to change

Requires debt ratio and interest rates for