Valuations
A=E+L
Coupon rate
Rate at which interest is paid / dividends are earned.
Face value
Value at which a debenture is registered.
Dividend cover of 2
Dividend is equal to half of the profit.
[Net profit after tax / Dividends = 2]
Dividend yield
Dividend based on the market value.
=Dividend per share / Market price per share.
Value of asset
PV of future cash flows, discounted at an appropriate discount rate. (also influenced by
the ratio of risk and return -> Higher risk = Higher return)
Price-earnings ratio
= Share price /Earnings per share
1
Valuation of debentures and bonds [long term loans]
When calculating the value of debt, always use PRE-TAX rates
Redeemable
Non-Redeemable
Cash flows consist of:
−
−
The periodic interest payments
Interest payments never stop
PV 0 = pmt 1/i
Repayment of capital at the date of redemption
Value of bond
Normal TVM calculation:
Value of bond (In perpetuity)
= Instalment /
Required rate of return
N= Number of payments
I/Y=Required rate of return
PMT= Interest per period
FV= Face value of debenture
COMP PV= Value of bond
● Accept first instalment will be paid at the end of
the first period.
● Required rate of return: Market rate for similar
bonds.
● Instalment = interest pmt (coupon rate)
Total value = Value of bond + Value of perpetuity
Valuation of preference shares
When no preference share dividends are declared, no ordinary dividends can be
declared
Redeemable
[Ordinary TVM calculation]
Non-redeemable
PV = current value of dividend received in perpetuity.
PV = Face value
FV = Redeeming payment at the end of the period
PMT = Dividend payments
I/Y = Coupon rate
N = amount of periods
Value = Preference dividend / Market related rate on
similar preference shares
Cumulative
Non-cumulative
1.
2.
3.
4.
Value of perpetuity [Dividend / Market rate]
Sum of overdue dividends
Cash flow table / TVM
Comp NPV / Comp PV
Calculate the dividends for each year separately
Only the value of FUTURE dividends
[Only need to consider whether dividends will be paid
in the future or not]
Value = PV of dividend received in perpetuity.
2
Valuation of equity
Market capitalisation = Amount of shares x Market value per share
The valuation of Equity is more complicated than with bond or preference share because:
−
−
−
Future cash flows are uncertain as earnings and dividends are dependent on a
number of factors.
Ordinary shares have no maturity [redemption date] and companies are assumed to
have an indefinite life.
The cost of
subject to
Dividend Growth
Model
𝐷
1
𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 (𝑉0 ) = 𝐾 −𝑔
𝑒
equity and – capital is
greater uncertainty.
OR
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 (𝑜𝑟 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛)−𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒
Valuing shares with a non-constant growth rate:
Use two-stage valuation: [Do calculation for ONE share]
1) Value the high growth period. [Calculate PV of dividend until the growth rate changes]
2) Value the constant growth in dividends thereafter. [Value growth @date growth rate
changes]
How Ke is adjusted
Ke of similar listed company
12%
Growth: Co grows at 10% and industry only grows at 5%
Size of Co: Private co smaller than listed Co.
Marketability: Limited tradability because shares are
not quoted.
Family business: Specialist management lost.
Gearing lower than industry: Lower risk.
Prospects for the industry
Proportion of shares
Size of holding to be valued
Limits on negotiability of shares
Special skills
Estimated Ke
10% - 15%
Adjustments for Ke is in the opposite direction as the earnings multiple adjustments
3
Net Asset
value
EQUITY = ASSETS - LIABILITIES
When this method is used:
•
•
•
Value of business primarily represented by MV of its assets
Business does not generate sufficient ROA, higher value can be obtained by.
liquidation
Reasonability test.
Value of other valuation methods should be > value with Net Asset Value method
A liquidated company no longer has future cash flows to
offer investors. The only thing left to do with such business is
to sell all assets (@MV) and pay off all liabilities (@MV). The
remaining value = NET ASSET VALUE
Earnings Valuation
Method
General notes:
● Used to determine whether shares are over/under-valued.
● Used when FCF method not applicable/not enough information to use FCF method.
● Minority/majority shareholding
● Companies with a high growth rate usually also has a high PE ratio -> could indicate
that shares are overvalued, BUT can also mean that the company has very low
earnings for the year.
● ONLY LISTED COMPANIES has a PE ratio -> If unlisted adjust earnings multiple of
similar companies.
Choice of similar company
Requirements
Similar risks
Going concern
Similar growth in earnings
Established business
Similar yield on investment
Earnings history
Similar business activities
Expect sustainable earnings
Driven in the same market
Similar listed company
4
Same size
Non-current assets valued separately
Step 1: Adjust maintainable earnings: must be market related amounts
use historical figures but if Earnings is 0: use forecasted info (2017 no profit, 2018 forecast
and you are in the beginning of 2018 -> use 2018); usually if business is changing/expanding
● Change in activity; (no longer manufacturing 2 products remove all costs of 1
product)
● Expenses not within normal limits; (pay directors more than normal/not market
related)
● Change in accounting policy;
● Non-business transactions; (penalty/once off transactions)
● Unusual income and expenses;
● Interest/income -> investments valued separately (pref div)
Deduct interest on LOANS; NOT interest on bank overdrafts; if cash is part of normal
operations include interest in earnings
If no trend:
● WA: most recent years = more weight -> [(2018*1)+ (2019*2) + (2020*3)]/6
● If only ½ years given only use current year -> can’t have trent if <3y info available
Step 2: Adjust earnings multiple: yield (%) is opposite: higher -> less
EV (enterprise value)= Equity + Debt
● PE multiple = Share price / EPS -> PE multiple * earnings
● EBIT multiple = EV/ EBIT -> EBIT multiple * EBIT
● EBITDA multiple = EV/EBITDA -> EBITDA multiple * EBITDA
Earnings = Profit after tax
Market price = PE ratio * earnings
[earnings before interest, tax, depreciation & amortization]
EBIT & EBITDA = before interest -> still deduct value of debt
● Not a listed company
● Private company: Shares are not marketable.
● Smaller sized firm in a comparison to other firms in the industry.
● Reliance on key management and staff.
● Something that differentiates them positively from other
companies in the industry.
5
● Local company compared to international company: Bigger market.
● Not in the industry for a long time compared to other companies in
the industry.
● Highly geared. [Higher debt/equity ratio than other in the industry].
● Smaller growth rate than other companies in the industry.
● Family business: Specialist management.
● Diverse product ranges / quality
● Competition
Step 3: Value
Maintainable earnings for one period * adjusted earnings multiple.
+ Investments IF not investment co otherwise it is part of normal operations (valued
separately -> cash/pref shares/buildings ect)
+ Premium of majority interest
- Discount for minority interest
● No terminal value to adjust for growth as it is already adjusted for in PE ratio
● No debt reduction since finance costs are included in earnings
Disadvantages of the Price-earnings ratio [ALSO THE DISADVANTAGES OF EARNINGS MULTIPLES]
Uses historical information to determine the Earnings per share (and thus the EPS ratio). Not considering the
future
Considers earnings rather than cash flows. (non-cash items such as dep influences valuation
If business makes a loss, the answer is negative. [It is impossible to have a business with a negative value].
Does not measure growth objectively
Based on EPS which is subject to shortcomings and manipulation
Absurd answers can result. A company with poor earnings will show a high multiple since the price of shares
are unlikely to fall below liquidation value
Business risk to be considered by a company before doing valuation
Business risk: risk that relates to the daily running of the operating activities of a company.
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State of the assets of company (assets used for production)
Nature of business activities in relation to local, global markets and competitors
Operating leverage capital vs labour intensity
future prospects of products, industry
Political considerations
Quality of management
6
Free Cash Flow Valuation
Method
−
−
Free Cash Flow = Estimated future after-tax operating cash flows that a firm can generate
and ordinary shareholders are entitled to.
Value either minority/majority interest in companies, also used for private companies
Requirements:
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●
●
●
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Going concern.
Expected FCF of business can be reliably forecast for projection period.
Company maintains a stable capital structure based on target level allowing for use of WACC
as discount rate.
Non-operating assets valued separately.
Controlling interest being acquired
Free cash flow to firm:
All cash, generated from NORMAL OPERATIONS, available to providers of financing [Equity & Debt].
Adjust projected earnings with:
Non-operating cash flows dividends on investments/pref divs -> Investments has
different risk profiles -> valued separately
Non-cash flow items dep/amortisation/provisions (not CF); BUT penalties (actual CF)
Finance related cash flows interest paid/movement in debt balances
Include:
Effects of capital expenditure and working capital
Tax effect of cash flows included
Tax amount: ONLY tax paid (NOT tax expense) ito OPERATING activities:
O/B SARS payable
C/B SARS payable
O/B deferred tax
C/B deferred tax
Tax per P/L
�
Adjust for items valued separately; ie Interest on LT loan or Investments.
�
Do not adjust for tax on depr/ amort that has been adjusted in FCF calc.
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NOTES:
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●
●
●
●
LESS
PLUS
LESS
Pref div -> not included in PBT
Value long term loans seperately- because in calculating terminal value you use wacc in
valuation and not kdebt
value investments separately- because in calculating terminal value you use wacc in
valuation and not kE.
Calculated value is BEFORE paying debts & dividends including interest.
Short term/medium term debt movement is included in CF’s if part of normal operations &
not separately valued; if not part of normal operations valued separately
● include non-recurring items in planning phase IF part of normal operations, BUT EXCLUDE
when determining terminal value
● FCF to firm -> total firm value, FCF to equity includes long term liability, pref shares
movements: interest & dividends & changes in liability -> discount @Ke
Forecasted years…
Profit before tax and interest
Cash tax paid
= Tax payable o/b + Tax for the year – Tax payable c/b + Tax on interest. +/- movement
in DT if not enough information: cash flows*.27 is used
Deferred tax movement: - if increase, + if decrease
*tax saving on w&t is a CF, and depr is not a CF
Non-cash flow expenditures
Non-cash flow income
Examples:
PLUS
LESS
♦
Movement in provisions
♦
Depreciations
♦
Allowance for credit losses
♦
Fair value adjustments
♦
Profit/loss on sale of fixed assets -> include actual CF received @sale
Long-term interest, dividends paid [Separately valued]
Income from long-term investments [Separately valued]
♦ Dividend income
♦ Interest received
PLUS / LESS
♦ Rent received
Movement in working capital:
♦ (Increase)/Decrease in Inventory
♦ (Increase)/Decrease in accounts receivable
LESS
♦ Increase/(Decrease) in accounts payable
BANK:
Surplus cash [Separately valued]
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PLUS
LESS / PLUS
LESS
PLUS
LESS
Overdraft [If it does not relate to normal operations].
Movement in fixed assets
o/b
(depreciation)
(Book value of assets sold)
(c/b)
Investment in assets
Investments in S/A/JV/Joint operations. [Separately valued]
Free cash flows Discounted @WACC if company uses debt & equity or @Ke if company
only uses equity to finance; if private company -> adjust similar Co’s WACC/Ke
xxx
Terminal value using last forecasted years CF -> perpetuity value -> @ WACC/Ke
Used to calculate FCF for base period [Represents years not included in planning
period] @year that growth stabilizes, EXCLUDING non-recurring items in planning
phase part of normal operations
Long-term debt & Bank overdraft if not part of working capital @MV
Shareholders loans
xxx
PLUS
Long-term investments/non core assets/pref shares @MV
Excess cash
Premium for majority interest OR LESS Discount for minority interest.
=
MARKET VALUE OF EQUITY (ORDINARY SHARES) -> if negative limit to 0
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