Corporate valuation

CORPORATE VALUATION

Capitaux proches = equity

Shareholders = actionnaires

Balance sheet = Bilan

Stakeholders = Parti prenant

Corporate valuation = valeure de l’entreprise

Shares = action

Valuation concepts:

• Estimate intrinsic value vs. market price

        Estimated intrinsic value > market price → stock is undervalued

        Estimated intrinsic value < market price → stock is overvalued

        Estimated intrinsic value = market price → stock is fairly valued

• Going concern value vs. liquidation value

The intrinsic value is the value of the asset given a complete understanding of the asset investment characteristic. For any particular investor, an estimate of intrinsic value reflects his or her view of the “true” or “real” value of an asset. The intrinsic value can differ from the price market of the asset.

The company has one value if it’s to be immediately dissolved and another value if it will continue in operation.

In estimating value, a going concern assumption in the assumption that the company will continue tis business activities in the future.

An alternative to a company’s going-concern value is its value if it were dissolved and its assets sold individually, known as its liquidation value.

Some application of equity value:

• Stock selection
• Valuation of private business
• Assessing the impact of corporate events like M and A
• Evaluation the impact of different expansion strategies

Stock selection is the primary use of the tools of the equity value, it can answer the main question: is this security (asset) fairly priced, overpriced, or underpriced relative to its current estimated intrinsic value and relative to the prices on comparable securities.

Industry analysis… An introduction

• Understanding the industry structure and evolution

• Porter’s (2008) 5 Forces

Industry rivalry

Threat of entrance

Threat of substitute products or services

Bargaining power of suppliers

• Identifying the industry life cycle position

• According to Hill and Jones (2008) these are 5 stages

Embryonic: high level of prices, slow growth

Growth: the prices are decreasing, high industry growth, low competition

Shakeout: growth rate slows, demand approach saturation level, intense competition

Mature: market saturated, low or no growth, high barriers to entry

Decline: industry growth become negative, excess capacity

• Identifying the potential impact of external factors on the performance of the industry

Valuation models:

• Discounted cash flows models (DCF)

• Dividend discount model
• Free cash flow to equity (FCFE)
• Free cash flow to firm (FCFF)

• Multiple valuation
• Asset based valuation

Dividend discount model:

• The intrinsic value of the stock (P0) depends on the expected future dividend

P0 = PV (expected future dividends)

P0 = [pic 1]

P0 = estimated price of a share of stock today

Divt = expected dividend / share in period t

R = required rate of return of shareholders

• For 1 year investment horizon

Expected return (r) =  → P0 = [pic 2][pic 3]

But P1 =  → P0 = +[pic 4][pic 5][pic 6]

• For n periods

P0 =  +  + … + [pic 7][pic 8][pic 9]

P0 = [pic 10]

• If n approaches infinity

P0 = [pic 11]

Gordon Growth model:

• Assumption: dividends growth indefinitely at a constant rate (g)

P0 = [pic 12]

P0 – estimated equity value/share

Div1- expected dividend/share for next year

r – required rate of return of shareholders (cost of equity)

g- dividend constant growth rate

• Appropriate for mature dividend-paying companies
• Measuring the cost of equity (r) with CAPM
• CAPM (The Capital Asset Pricing Model)

E(Ri)= Rf + I (E(Rm) - Rf[pic 13]

E(Ri) - Expected return on asset  

Rf - Risk-free rate

E(Rm)- Rf – market risk premium

I – Beta on asset I [pic 14]

• Constant growth rate

• Historical growth rate
• Industry growth rate
• Sustainable growth rate

        Sustainable growth rate = (1- Pay-out ratio) x ROE

                                       = Plowback ratio x ROE

ROE =                               Pay-out ratio =  [pic 15][pic 16]

Two stage dividend discount model:

• For firms experiencing a period of temporarily high growth followed by a period of sustanable growth

P0 = [pic 18][pic 17]

• Where Pn =  represents the stock terminal value [pic 19]

Alternative discounted cash flow models

• Free cash flow models

• Free cash flow models to the firm (FCFF): cash available to suppliers of capital after meeting all operating expenses, taxes and reinvestment needs
• Free cash flow to equity (FCFE): cash available to common shareholders after meeting all operating expenses, taxes, reinvestment needs, interest and principal payments

Steps of FCF valuation

1. Forecast FCF for the high growth period
2. Determine the discount rate
3. Estimate the terminal value
4. Calculate the firm value and the Equity Value based on discounted FCF and discounted TV

Step 1)

Depends on:

        Size of the firm relative to the market

        Existing growth rate and excess returns

        Competitive advantages

FCFF Formula

Sales (Revenues)

- Cost of goods sold (COGS)

- Selling, general administrative expenses (SG&A)

- Other operating expenses                                                                       .

= EBIT (Earning Before Interest and Taxes = Operating incomes)

- Taxes                                                                                                              .