1、Chapter 1,Introduction To Investing and Valuation,The Aim of the Course,To develop and apply technologies for valuing firms and for planning to generate value within the firm Features of the approach: A disciplined approach to valuation: minimizes ad hockery Builds from first principles Marries fund

2、amental analysis and financial statement analysis Stresses the development of technologies that can be used in practice: how can the analyst gain an edge? Compares different technologies on a cost/benefit criterion Adopts activist point of view to investing: the market may be inefficient Integrates

3、financial statement analysis with corporate finance Exploits accounting as a system for measuring value added Discovers good (and bad) accounting from a valuation perspective,What Will You Learn from the Course,How intrinsic values are calculated What determines a firms value How financial analysis

4、is developed for strategy and planning The role of financial statements in determining firms values How to pull apart the financial statements to get at the relevant information How ratio analysis aids in valuation How growth is analyzed and valued The relevance of cash flow and accrual accounting i

5、nformation How to calculate what the P/E ratio should be How to calculate what the price-to-book ratio should be How to do business forecasting,Links,Users of Firms Financial Information (Demand Side),Equity Investors Investment analysis Management performance evaluation Debt Investors Probability o

6、f default Determination of lending rates Covenant violations Management Strategic planning Investment in operations Evaluation of subordinates Employees Security and remuneration Litigants Disputes over value in the firm Customers Security of supply Governments Policy making Regulation Taxation Gove

7、rnment contracting Competitors Investors and management are the primary users of financial statements,The Source of Financial Information (Supply Side),Public information Mandated information Interim and annual financial reports governed by GAAP SEC filings (10K, 10Q, 8K) Voluntary disclosure by fir

8、ms Forecasts, expenditures, plans Other sources Industry data, economy wide data, popular demand, supply conditions, etc Private information Firms internal information See Web Page,Investment Styles,Intuitive investing Rely on intuition and hunches: no analysis Passive investing Accept market price

9、as value: no analysis Screening Use a few pieces of information and no forecasting: minimal analysis Fundamental investing Discover the value in an investment through anticipations of payoffs 1.- Analyze information 2.- Forecast payoffs from information,Costs of Each Approach,Danger in intuitive app

10、roach: Self deception; ignores ability to check intuition Danger in passive approach: Price is what you pay, value is what you get Danger in screening Ignores information about the future Fundamental analysis Requires work ! Prudence requires analysis: a defense against paying the wrong price (or se

11、lling at the wrong price) The Defensive Investor Activism requires analysis: an opportunity to find mispriced investments The Enterprising Investor,Questions that Fundamental Investors Ask,Dell Computer trades at 76 times earnings (in 1998). Historically, P/E ratios have averaged about 14. Is Dells

12、P/E ratio too high? What growth in earnings is required to justify a P/E of 76? Yahoo! Has a market capitalization of $92 billion (in 1999). What future sales and profits does this imply? Coca-Cola has a price-to-book ratio of 17 (in 1999). Why is its market value so much more than its book value? H

13、ow are business plans and strategies translated into a valuation?,Analyst Perspectives,The outside analyst looking into the firm to understand the firms value Equity analyst Credit analyst The inside analyst planning within the firm to generate value The accountant “running the numbers” to indicate

14、the value generation in a firm,Investing in a Business:Outside Investors,Business investment and the firm: value is surrendered by investors to the firm, the firm adds or losses value, and value is returned to investors. Financial statements inform about the investments. Investors trade in capital m

15、arkets on the basis of information on financial statements,The Firm and Investor Wealth,Value of the firm = Value of Assets = Value of Debt +Value of Equity Typically valuation of debt is a relatively easy task,Investing Within a Business:Inside Investors,Business Ideas (Strategy) Investment Funds:

16、Value In Apply Ideas with Funds Value Generated: Value Out,Value - Based Management,Test strategic ideas to see if they generate value 1. Develop strategic ideas and plans 2. Forecast payoffs: pro forma analysis 3. Use pro forma analysis to discover value creation Applications: Corporate strategy Me

17、rgers firms that are not traded,Typical Values for Common Multiples,Unlevered Multiples (that are Unaffected by the Financing of Operations),Variations of the P/E Ratio,Dividend-Adjusted P/E,Asset Base Valuation,Values the firms assets and then subtracts the value of debt: The balance sheet does thi

18、s calculation, but imperfectly: Shareholders Equity = Total Assets -Total Liabilities Problems with this approach: Getting the value of operating assets when there is not a market for them Identifying value in use for a particular firm Getting the value of intangible assets (brand names, R&D) Gettin

19、g the value of “synergies” of assets being used together Applications: “Asset-base” firms such as oil and gas and mineral products,The Analysts Checklist,Investment Returns, Equity Value, and Financial Statements,PART I,Gaining the Understanding to do Fundamental Analysis,Chapter 3,Investment Return

20、s,Investment Returns,What you will learn in this chapter,How investment returns are calculated The difference between normal and abnormal returns What an efficient market price means What an arbitrage opportunity is The difference between active and passive investment The difference between an alpha

21、 and a beta How asset pricing models work (in outline) How screening strategies work (and dont work) What a contrarian strategy is How fundamental analysis differs from screening and contrarian analysis How various stock selection strategies have worked in the past,For a terminal investment: For an

22、investment in equity: For a one-year equity investment Payoff: Return: Rate-of-Return: Expected Return: Expected Rate-of-Return: Required Payoff per dollar: Required Rate-of-Return: The required return is also called the normal return or the cost of capital,The Structure of Investment Returns,Hewlet

23、t-Packard: Returns for 1991,If the price paid for a stock is (expected payoff discounted at the required payoff per dollar, r), the stock is appropriately priced: the market price is efficient Or, price is efficient if it equals the expected return capitalized at the required rate-of-return: Or, tod

24、ays price (P0) must be such that the required rate-of-return, r-1, will equal the (expected) rate-of-return :,The No Arbitrage Condition (NA),Required Rate-of-Return,Expected Rate-of-Return,Arbitrage Trading Strategies,If NA holds, the market is efficient in that stock: there is no arbitrage opportu

25、nity Any discrepancy between expected and required rate-of-return, is an arbitrage opportunity that, if exploited, will profit the arbitrage trader An arbitrage opportunity arises if If then BUY If SELL The difference is called the expected abnormal return and the rule can be restated as: BUY if the

26、 expected abnormal return is positive, and SELL if negative. If it is zero, do nothing (HOLD),Types of Arbitrage,Risk 1. Pure (Risk-Free) Arbitrage You get something for nothing, for sure 2. Expectational Arbitrage You have a better chance of an abnormal return than not Location of prices 1. Cross-s

27、ectional Arbitrage Different prices for the same commodity at the same point in time 2. Intertemporal Arbitrage Different prices for the same commodity at different points in time,These concepts apply to an investment for more than one period with two modifications: The multiperiod rate-of-return wi

28、ll be the compounded annual rate. For a T-year period and a flat term structure, the required payoff is: For a changing term structure it would be Dividends for the intermediate years can be reinvested at r. The accumulated value at year T of reinvested dividends is called terminal value of dividend

29、s at T Adding the selling price will give the cum dividend payoff or cum-dividend terminal price: And the T-period cum dividend return will be,Multiyear Equity Investments,Hewlett-Packard 1990-95: Payoffs,1994,1995,1993,1992,1991,1990,d4=0.55,P5=84,d3=0.45,d2=0.36,d1=0.24,d5=0.90,P0=13,Terminal Valu

30、e of Dividends,0,1,2,3,4,5,d,1,d,2,d,3,d,4,d,5,d,2,x,r,-2,d,3,x,r,-3,d,4,x,r,-4,d,5,x,r,-5,d,1,r,-1,d,2,r,-2,d,3,r,-3,d,4,r,-4,d,5,r,-5,(Year 0 value),(Year 5 value),1,2,3,4,5,d,1,d,2,d,3,d,4,d,5,(Year 5 value),(Year 0 value),0,( ),r,5,d,t,r,-,t,t,=,1,5,HP 1990-95: Terminal Dividend Payoff,HP 1990-9

31、5: Five-Year Return,Terminal value of dividends in 19952.76 Price payoff in 1995 (PT) 84.00 Total Payoff 86.76 Purchase price in 1990 (P0) 13.00 Five-year return 73.76 Five-year-rate-of-return 567.38% *Normal rate of return (12% p.a.) 76.23% Abnormal rate of return 491.15% * Normal rate of return =

32、(1.125 - 1) = 76.23 %,The NA condition for a multiyear investment is now Or Or,Multiyear Equity Investment: NA,Expected rate-of-return,Required rate-of-return,Dividends and Capital Gains,T-period return components: For one period:,Capital Gain Component,Dividend Component,+,-,1,0,1,d,P,P,Capital Gai

33、n Component,Dividend Component,Intrinsic Values,Intrinsic value is calculated by forecasting payoffs from the information about them and applying the discount rate Two ways to calculate intrinsic values (V0): 1. Present value of the expected payoff V0 = Expected payoff / rT 2. Capitalized expected r

34、eturns V0 = Expected returns / (rT -1) Always two ingredients: Expected payoffs and discount rates Intrinsic values at different points in time always obey the no arbitrage condition (NA): =,Beta technologies: Calculates the normal return Ignores any arbitrage opportunities This is the denominator i

35、ssue in valuation Alpha technologies: Tries to gain abnormal returns by exploiting arbitrage opportunities This involves the numerator issue in valuation Passive investment needs a beta technology (except for index investing) Active investing needs a beta and an alpha technology,Investment Advising:

36、 Alphas and Betas,Beta Technologies:“Asset Pricing Models”,Required return = Risk-free return + Premium for risk Premium for risk = Risk premium on risk factors x sensitivity to risk factors Some technologies: The Capital Asset Pricing Model (CAPM) One single risk factor: Excess market return over R

37、F Only “beta” risk requires a premium. Multifactor pricing models Identify risk factors and sensitivities to them:,(,),i,Factor,Risk,to,y,sensitivit,i,Factor,Risk,to,turn,Re,R,R,R,R,R,R,R,R,return,Normal,i,i,F,k,k,F,2,2,F,1,1,F,=,b,=,-,b,+,+,-,b,+,-,b,+,=,L,K,F,M,F,R,R,R,return =,Normal,-,b,+,Antici

38、pates that a stock may be mispriced Scenario A: Todays price deviates from its intrinsic value , but this will be corrected in the future ( ). Scenario B: Todays price is correct , but in the future it will deviate from its intrinsic value ( ). To discover these opportunities, a technology for calcu

39、lating intrinsic values is needed,Active strategies: Alpha technologies,A Cheap Analysis: Screening,Technical screens: identify positions based on trading indicators. Some of them: Price screens Small stock screens Neglected stocks screens Seasonal screens Momentum screens Insider trading screens Fundamental screens: identify positions based o