Equity Analysis &

Valuation
Ashutosh Jaiswal
MoF, RBSC

Equity
Represents a claim of
companys net assets.

ownership

on

Net assets are excess of companys assets

over liabilities.

Global equity Mkt Cap Share- Top 20 countries ( as on

2012)

Spain; 2%

Russia; 2%

Netherlands; 1% South Africa; 1% Sweden; 1% Mexico; 1%

Italy; 1%

Switzerland; 2%
Hong Kong, China; 2%
South Korea; 3%
Brazil; 3%
United States; 41%

India; 3%
Australia; 3%
Germany; 3%
France; 4%
Canada; 4%
United Kingdom; 6%
Japan; 8%

China; 8%

Source- World
Bank

Global GDP Share- Top 20 countries ( as on

2013)

Indonesia 1%
Mexico 2%

Turkey 1%

Netherlands 1%

United States 28%

Korea, Rep. 2%
India 3% Spain 2%
Australia 3%
Italy 3%
Russian Federation
4%
Canada 3%
Brazil 4%
United Kingdom 4%
France 5%
Germany 6%

Saudi Arabia 1% Switzerland 1%

China 16%
Japan 8%

Real Returns on Global Equity Securities, Bonds, and Bills

during
1900-2008

Source: E. Dimson, P. Marsh, and M. Staunton (2009)

 Voting rights on major corporate

decisions.
Claim on assets after all
liabilities have been paid.
Share in the operating
performance of the company.

Governance
participants
Residual
claimants
Ownership
interests

Common Shareholders

Voting Rights
Statutory
voting

Vote by
proxy

Voting
rights

Share
classes

Cumulative
voting

Embedded Options

Callable
common
shares

Putable common
shares

Preference Shares (Preferred

Stock)
Rank above common stock for dividend
payments and liquidation claims
Shareholders do not share in the firms
operating performance
Generally do not have voting rights
Dividends are fixed and typically higher
than common dividends

Dividends on Preference Shares

Cumulative

Noncumulative

Participating

Nonparticipatin
g

Possible Advantages of
Convertible Preference Shares
Earn a higher dividend
Opportunity to share in profits
Benefit from a rise in the price of the
common shares
Price is less volatile than the common
share price

Private Equity Securities

Venture capital

Private

Leveraged
buyouts

Public

Private
investment in
public equity

Equity securities

Investing in Nondomestic Equity

Securities

Direct
investment
Depository
receipts
(DR)

Buy and sell shares directly in foreign

markets.

Global depository receipts (GDR)

American depository receipts (ADR)
Global registered share (GRS)
Basket of listed depository receipts (BLDR)

Return Characteristics of Equity

Securities
Dividend
income
Price change
(capital gain)
Foreign
exchange gains
or losses
Reinvested
dividends

Impact of Reinvested Dividends on Cumulative Real Returns

in the U.S. Equity Market: 19002008

Source: Dimson, Marsh, and Staunton (2009).

Methods for Estimating Risk

and Return
Historical data
Average rate of return
Standard deviation

Probability distribution of possible returns

Expected return
Standard deviation

Preference Shares Are Less

Risky than Common Shares
Priority
claim on
income

Fixed
dividend

Known
liquidatio
n value

Less risk

Embedded Options and

Risk
Higher risk:
Callable
Nonputable
Noncumulativ
e
Lower risk:
Noncallable
Putable
Cumulative

Why Issue Equity?

Raise capital

Increase
liquidity

Finance revenuegenerating activities

Mergers and
acquisitions

Ensure going concern

status

Stock-based
compensation

Goals for Managing Equity

Increase
book value

Maximize
market
value

Increase net
income
Retain more
earnings
Issue shares
Manage investors
expectations

Accounting Return on Equity (ROE)

Financial Year Ending
31 Dec 2008
31 Dec 2007
31 Dec 2006
Pfizer
Net income
Total stockholders equity

$8,104,000
$57,556,000

$8,144,000
$65,010,000

$19,337,000
$71,358,000

NIt
ROE t
BVEt BVE t 1 / 2
$8,144,000
11.9%
($65,010,000 $71,358,000) / 2
$8,104,000

13.2%
($57,556,000 $65,010,000) / 2

ROE 2007
ROE 2008

Market Value, Book Value, and

Price-to-Book Ratio

Market value of equity = Market price per share Shares

outstanding
Market value of equity = US$16.97 6,750,000 = US$114,547,500
Book value of equity per share = Total shareholders equity/Shares
outstanding
Book value of equity per share = US$57,556,000/6,750,000 =
US$8.53
Price-to-book ratio = Market price per share/Book value of equity per
share

The Cost of Equity

Company
wants to
raise equity
capital

Company not
contractually
obligated to
shareholders

What is
the cost
of
equity?

Investors Required Rate of Return

Investors minimum required rate of

return

Estimate with pricing models:

dividend discount model (DDM),
capital asset pricing model (CAPM),
etc.

Cost of
equity

Equity Valuation Models

Multiplier
Models/Method of
Comparables

Present Value Models

Dividend discount
model
FCFE model
Gordon Growth
Model

P/E ratio
P/B ratio
P/S ratio
P/CF ratio
EV/EBITDA

Asset Based Valuation

Dividend Discount Model

Intrinsic
value of equity is PV of future
dividends
Suitable for firms with history of dividend
payments and going concern

Dividend Discount ModelGordon Growth

Exercise 1

Price of a perpetual preferred stock paying

5.50% annual dividend?

= 5.50/rate of return
= 5.50/.08
= 68.75
Heard of this type of product in
Insurance ?

Exercise 2
Annual dividend= 5 per share
Exp div growth rate = 4%
Required rate of return = 8%
Equity value=

Variations of DDM

Multi Stage Dividend growth

Free Cash Flow to Equity Model

FCFE= CFO-FCInv+ Net borrowings

FCFE = cash flow available for equity

holders
CFO= cash flow from operations
FCInv= Fixed capital Investment

A thought on the discount

rate
1.

2.

CAPM:
Other approaches include adding
corporate bond risk premium to risk free
rate

Multiplier Models
Price calculation based on some multiple of
measures such as EPS, book value, cash
flow, sales etc that are associated with the
performance of the company
Industry or sector specific ratios are also
used such as oil reserves for oil company,
ARPU for mobile companies, land bank for
real estate companies..

Method of Comparables
Law of one price
Identical assets should sell for the same
price
Compares price multiples between the
company & the benchmark to measure
value
e.g. Company
P/S

GM
.01
FORD
.14
DAIMLER
.27
NISSAN
.32
HONDA
.49
TOYOTA
.66
Which is most lucrative equity investment opportunity ?

Enterprise Value (EV)

EV can be seen as cost of take over
= mkt value of equity, debt & preference
shares cash balances
Value of equity is indirectly calculated
EV/EBITDA multiple can be used even when
EPS is negative and no dividends are being
paid

Asset Based Valuation

Uses mkt value or fair value estimate of net
assets of the company
Good for companies with minimal intngible
assets
Provides a good baseline for the valuation
Other methods should be used to
supplement this model

Exercise 3
Company DPS, EPS, Share Price. And P/E Data

Balance Sheet at end of Year 5

Yea DPS EP
r
S

Share
Price

TTM
P/E

10

3.10E

5.20E

2.91E

4.85E

2.79E

4.65E

2.65E

4.37E

2.55E

4.30E

2.43

4.00

50.80

12.7

2.32

3.90

51.48

13.2

2.19

3.65

59.86

16.4

2.14

3.60

54.72

15.2

Assets

Liability

Cash- 5,000

Accounts Payable3,000

Inventories- 30,00

Notes payable17,000

Accounts receivables- Term loans- 25,000

15,000
Fixed Assets- 50,000

Common equity55,000

Total Assets- 100,000

Total Liability100,000

The valuation date is at end of year 5. The

company has 1000 shares outstanding
1.

2.

3.

Using Gordon growth model, estimate

intrinsic equity value. Assume disc rate of
10%.
Estimate intrinsic value using multiplier
approach (TTM P/E based)
Estimate intrinsic value using asset based
approach. Assume market value of assets
are 110% of BV of assets

Thanks
Questions ?