WEEK 12 EARNINGS GROWTH ANALYSIS (1).pptx

WEEK 12 EARNINGS GROWTH ANALYSIS (1).pptx - Financial...

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Financial Statement Analysis and Security Valuation Earnings Growth Analysis May 17, 2018
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What You Will Learn From This Chapter What a P/E ratio means What “abnormal earnings growth” is How forecasting abnormal earnings growth yields the intrinsic P/E ratio What is meant by a normal P/E ratio The difference between ex-dividend earnings growth and cum- dividend earnings growth The difference between a Case 1 and Case 2 abnormal earnings growth valuation How abnormal earnings growth valuation protects the investor from paying too much for earnings growth That abnormal earnings growth is equal to the change in residual earnings How abnormal earnings growth valuation protects the investor from paying for growth What a PEG ratio is 6-2
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The Big Picture for this Chapter To price earnings, one thinks of earnings growth: more growth, higher P/E But: Beware of paying for growth Only pay for growth that adds value Growth is risky: Beware of paying for risky growth Abnormal earnings growth is the metric that protects from paying too much for growth 6-3
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The Concept Behind the P/E Ratio Price in numerator of P/E is based on expected future earnings Earnings in denominator is current (or forward) earnings P/E is thus based on expected growth in earnings: for trailing P/E , growth from current earnings onwards for forward P/E , growth from one-year-ahead earnings onwards Trailing P/E = most recent annual earnings per share (EPS) – earnings for the past 12 months Forward P/E = next year’s earnings per share (EPS) – earnings in the next 12 months 6-4
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Beware of Paying Too Much for Earnings Growth Investment creates growth but does not necessarily add value Earnings growth can be created by the accounting We need a valuation method that protects us from paying too much for earnings growth 6-5
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Reminder: Residual Earnings Valuation Protects You From Paying Too Much For Earnings Earnings from new investment is charged with the required return on investment. Original investment is $100. Residual earnings before new investment: 10% hurdle rate RE = $12 – (0.10 x $100) = $2 (ROCE = 12%) Residual earnings after new investment of $20 million earning at 10%. Original investment + new investment = $120 RE = $14 – (0.10 x $120) = $2 No value added from new investment A P/E model must also protect you from paying too much for earnings growth. 6-6
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P/B Valuation for Nike, Inc. (Ch. 5) 6-7
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From P/B Valuation to P/E Valuation The residual earnings pro forma for Nike, Inc: 6-8
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Change in Residual Earnings and Abnormal Earnings Growth Equivalent valuations: V = Book Value + PV of Residual Earnings = Capitalized forward earnings + PV of Changes in Residual Earnings Equivalent measures: Change in Residual Earnings = Abnormal Earnings Growth Abnormal Earnings Growth (AEG) is growth in earnings over the required growth rate AEG is the focus for P/E valuation 6-9
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The Prototype Savings Account (p.181) 20 05 . 0
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