VALUATION OF SHARES AND OTHER EQUITY IN
THE FINANCIAL ACCOUNTS OF THE SPANISH
ECONOMY (FASE).
The discounted value of future profits
Begoña Gutiérrez del Olmo Moreda
Central Balance Sheet Data Office Specialist
WORKING PARTY OF FINANCIAL STATISTICS-OCDE
Paris, 3 November 2009
STATISTICS DEPARTMENT
VALUATION OF UNQUOTED SHARES AND OTHER EQUITY
IN THE FASE. The discounted value of future profits
Contents
1.
Introduction to the Spanish valuation methods: Description and
aggregates
1. Issues of resident units
2. Issues of non-resident units held by residents
2.
Discounted value of future profits (method D): Conceptual framework

References to the method in the reviewed SNA

Reasons for applying method D as an alternative to method C

Requirements for applying method D
3.
Description of method D

Components of the discount factor (dq)

Process of grossing up
Statistics Department
2
INTRODUCTION TO SPANISH VALUATION
METHODS: DESCRIPTION AND AGGREGATES
General criteria
Market valuation in strict
sense
Approximations to market
valuation
Book value
Statistics Department
Specific criteria
(method)
Issues of residents
Aggregates
Market capitalisation (A)
Quoted public limited companies
(Non-financial and banks)
Net asset value (B)
Mutual Funds
Capitalisation / Own
funds ratio (C)
Unquoted banks
Discounted value of
future profits (D)
Unquoted non-financial public
limited companies
Own funds (E)
Unquoted public limited
companies (Financial except
banks)
Other legal forms (Other equity)
3
INTRODUCTION TO SPANISH VALUATION
METHODS: DESCRIPTION AND AGGREGATES
Issues of non-residents held
by residents (F)
Valuation methods based on:
– Market value: In case of quoted shares
– International Investment Position Statistics: In other cases
Statistics Department
4
VALUATION OF UNQUOTED SHARES AND OTHER EQUITY
IN THE FASE. The discounted value of future profits
Contents
1.
Introduction to Spanish valuation methods: Description and aggregates
1. Issues of resident units
2. Issues of non-resident units held by residents
2.
Discounted value of future profits (method D): Conceptual framework

References to the method in the Reviewed SNA

Reasons for applying method D as an alternative to method C

Requirements for applying method D
3.
Description of method D

Components of the discount factor (dq)

Process of grossing up
Statistics Department
5
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK

References to the method in
the reviewed SNA
Reviewed SNA:
–
Statistics Department
13.70 When actual market values are not available, an estimate is required.
Alternative methods of approximating market value of shareholders’ equity in a
direct investment enterprise follow. These are not ranked according to
preference, and each would need to be assessed according to the
circumstances and the plausibility of results:
…
c. Present value/price to earnings ratios. The present value of unlisted
equity can be estimated by discounting the forecast future profits. At its
simplest, this method can be approximated by applying a market or industry
price-to-earnings ratio to the (smoothed) recent past earnings of the
unlisted enterprise to calculate a price. This method is most appropriate
where there is a paucity of balance sheet information but earnings data are
more readily available
6
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
Reasons for applying method
D (as an alternative to method C)
Why does Spain use an alternative method?

Only in case of banks are unquoted companies well represented by
quoted ones

Unquoted non-financial public limited companies are not well
represented by quoted ones because quoted public limited
companies,
–are much more larger than unquoted ones
–usually have a different financial structure from unquoted companies
–are concentrated among particular economic activities which usually demand a larger
volume of funds
–The number of quoted public limited companies is very small relative to the total
Statistics Department
7
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
Reasons for applying method
D (as an alternative to method C)
Method D is the most commonly used by financial analysts
Method D is well considered by Accounting standard setters: IASB. Draft
about Fair Value Measurement and Valuation techniques:
Paragraph 38 b): “The income approach uses valuation techniques to
convert futures amounts to a single present (discounted) amount.
The fair value measurement is determined on the basis of the value
indicated by current market expectations about those future amounts”
Paragraph 44: “… A fair value measurement developed using a present
value technique might be categorised within Level 2 or Level 3,
depending on the inputs that are significant to the entire measurement and
the level in the fair value hierarchy within which those inputs are
categorised”.
Where Level 2 o 3 could mean inactive markets.
Financial crisis reducing so much liquidity as to have listed but iliquidity
corporations could be an example of this situation.
Statistics Department
8
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
Reasons for applying method
D (as an alternative to method C)
Some figures to measure the problem
NON-FINANCIAL FIRMS IN SPAIN. 2005
Number (1)
Abs. Number
%
TOTAL NON-FINANCIAL FIRMS (excluding sole partnerships)
1.- Public limited companies
1. Quoted
1. Continuous market
Of which, IBEX-35
2. Floor trading
2. Unquoted
2.- Privated limited companies
3.- Other corporate status
Employees (2)
%
GVA (2)
%
1,122,271
100.00
100.00
100.00
114,722
10.22
41.89
54.96
140
0.01
2.85
9.90
101
28
39
0.01
0.00
0.00
2.80
2.05
0.05
9.68
8.05
0.22
114,582 10.21
39.04
45.06
978,299
87.17
54.52
41.52
29,250
2.61
3.59
3.52
(1) Source : Central Directory of Firms (DIRCE) of the National Institute of Statistics (INE) and author' s calculations based
on CNMV data
(2) Source: INE and data estimated by the Banco de España Central Balance Sheet Data Office
Statistics Department
9
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
Reasons for applying method
D (as an alternative to method C)
The problems of using multi-country ratios
Additional limitations arise when trying to use multi-country ratio data
because of the differences between countries’ financial structures1.
Some of these differences are:
1.
2.
3.
4.
5.
6.
7.
8.
The amount and the structure of assets
Revaluation criteria
Financing practice in each country
Relationships between firms and banks
Tax systems
Guarantees offered to lenders
Pensions
Bankruptcy law insolvency rules
(1) According to the conclusions of the Own funds Working Group of the European Committee of
Central Balance Sheet Data Offices set out in one of its studies: “Corporate Finance in Europe
from 1986 to 1996
Statistics Department
10
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK

Requirements of the method
The application of this method requires:
1. A quality data source for non-financial companies’ profit and loss accounts to
estimate future profits to be discounted
2. A market reference to estimate the discounting rate
3. Demographic statistics for non-financial companies

In Spain the information comes from:


Central Balance Sheet Data Office Database: Accounting information and
a conversion table to go from business accounting to National accounts
National demographic statistics for corporations: DIRCE from National
Institute of Statistics
Statistics Department
11
VALUATION OF UNQUOTED SHARES AND OTHER EQUITY
IN THE FASE. The discounted value of future profits
Contents
1.
Introduction to Spanish valuation methods: Description and aggregates
1. Issues of resident units
2. Issues of non-resident units held by residents
2.
Discounted value of future profits (Method D): Conceptual framework

References to the method in the reviewed SNA

Reasons for applying method D as an alternative to method C

Requirements for applying method D
3.
Description of method D

Components of the discount factor (dq)

Process of grossing up
Statistics Department
12
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
Components of the discount
factor (dq)

This method estimates the market value of shares issued by unquoted
firms by calculating the present value of the future profits generated by
such firms

The method is based on the fact that the market value of quoted firms
can be obtained by dividing their expected profits by a discount factor
ONPq
Risk-free interest rate
dq
Risk premium
Capitalisation = MVq =
Expected growth rate
of profits

Underlying this method is the hypothesis that the profits generated by
such firms are considered to be perpetual.
Statistics Department
13
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
Components of the discount
factor (dq)
About ONPq (Ordinary Net Profit):
It’s to be the expected profit for the following year. Failing that, it is used
the average of last five years
Calculated as Gross Value Added at factor cost minus personnel costs, net
financial charges and operating depreciation and provisions
About dq:
It’s to be the implicit discount factor or Internal Rate of Return of quoted
companies: Capitalization/ONPq
Three components of dq:
Risk free interest rate
Risk premium
Expected growth rate of profits
Statistics Department
14
COMPARED EVOLUTION OF THE COMPONENTS OF dq :
Risk-free interest rate, risk premium, expected growth rate
of profits and discounted rate
Discount factor
Risk-free interest rate
Components of the discount
factor (dq)
Expected growth rate of profits
Risk Premium
12
9
6
3
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Statistics Department
15
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
Components of the discount
factor (dq)
Likewise, the following expression can be deduced for unquoted
shares:
ONPnq
MVnq=
ONPnq
=
dnq
dq + 0,03
Where 0,03 is the illiquidity premium:
This premium should consider not only the illiquidity but, also, the
possibility that unquoted public limited companies’ profits are not as
perpetual as those of quoted ones. Therefore, an increase in the
discount rate, because of the different time horizons, must be
considered
The level of this premium has been quantified according to theoretical
analysis of the gap between perpetual income and temporary
income
Statistics Department
16
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
Components of the discount
factor (dq)

dq is calculated as the median of the discount rates of all the quoted nonfinancial corporations traded on the continuous market, which means
excluding floor-traded companies

Extremely volatile corporations are stripped out of the aggregate by
means of the trust interval, which is defined as the average plus/minus twice
the standard deviation.

Sector differentiation is only applied in the case of the electricity sector
because of its specific features
Statistics Department
17
DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
Process of grossing up

The Central Balance Sheet Data Office Database provides information on
approximately 30,000 unquoted public limited companies

Using the conversion table which allows one to go from business accounting to
National Accounts, a full chart of accounts, including those relating to other
changes in volume and revaluation, is prepared.

There must be a process of grossing up, from the original aggregate to the
whole unquoted non-financial public limited corporations aggregate.

Finally, whole unquoted non-financial public limited corporations’ estimated
values by this way is used, with several adjustments coming from other
Institutional Sectors, for preparing Financial Accounts of the Spanish
Economy.
Statistics Department
18
COMPARED EVOLUTION OF REVALUATION RATES:
Quoted and unquoted shares
Quoted FASE
Unquoted MENF
Process of grossing up
Unquoted FASE
40%
30%
20%
10%
0%
-10%
-20%
-30%
2001
Statistics Department
2002
2003
2004
2005
2006
2007
19
COMPARED EVOLUTION OF UNQUOTED SHARES
REVALUATION RATES COMPONENTS:
ONPnq and discount factor
Ordinary Net Profit (nq)
Definitions
Discount factor
40
30
20
10
0
-10
-20
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Statistics Department
20
BEGOÑA GUTIÉRREZ DEL OLMO
THANK YOU FOR
LISTENING
Statistics Department
21