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Unformatted text preview: FINC 202 2009 Lecture 13: Ratio Analysis + Towards Free Cash Flows 1 Market value ratios P/E Ratio Price/Cashflow per Share Ratio Market to Book Ratio P P ratio = E EPS 2 Calculate the P/E ratio.
P0 = $12.17 NPAT EPS = = N P P0 = = E EPS .
3 Price/Cashflow Ratio Share Price P/CF = NPAT + Dep n Shares Outstanding P = n NPAT + Dep N 4 NPAT + Depreciation Cash Flow per share = N = =
Pr ice P0 Ratio = Cash Flow Cash Flow per share = = 5 Market to Book (M/B) Ratio Market to Book (M/B) Ratio P M /B= BV ps P = Shareholders ' Equity N 6 The higher the value of M/B, the greater the esteem investors have of the firm Book Value per Share = = = Common Equity E = N N Market Price per share Market − to − Book Ratio = Book Value per Share P0 = MV PBV = = 7 Book-to-Market Ratio This ratio is the inverse of the Marketto book ratio
• The M/B ratio tends to be favoured by ____________________________. • The lower the value of the B/M ratio, the more value investors put on the firm: M should ideally be much larger than B • Think back to finance’s “Objective Function” 8 Book-to-Market Ratio
Book Value per Share Market − to − Book Ratio = Market Price per share = = ≈ 9 2009 P/E P/CF M/B 2008 -0.4x -0.6x 1.7x 2007 9.7x 8.0x 1.3x Ind. 14.2x 11.0x 2.4x • • • • P/E: How much investors will pay for $1 of earnings. High is good. P/CF: How much investors will pay for $1 of cash flow. High is good. M/B: How much paid for $1 of BV. Higher is better. P/E and M/B ____________________________________________.
10 Typical industry average P/E ratios C2000 or 2001
Industry P/E ratio Banking 17.15 Computer Software Services 33.01 Drug 41.81 Electric Utilities (Eastern U.S.) 19.40 Internet Services* 290.35 Semiconductors 78.41 Steel 12.71 Tobacco 11.59 Water Utilities 21.84 * Because many internet companies have negative earnings and no P/E, there was only a small sample of internet companies. 11 What are some potential problems and What limitations of financial ratio analysis? limitations Comparison with industry averages is difficult if the firm operates many different divisions.
• Often difficult to identify industry category • The whole industry might be sick “Industry Average” performance not necessarily good. Seasonal factors can distort ratios. Different operating and accounting practices distort comparisons. Sometimes hard to tell ____________________________ Difficult to tell whether company is, on balance, in strong or weak position. 12 • “Window dressing” techniques can make statements and ratios look better. What are some qualitative factors analysts should What consider when evaluating a company’s likely future financial performance? future Are the company’s revenues tied to 1 key customer? To what extent are the company’s revenues tied to 1 key product? To what extent does the company rely on a single supplier? What percentage of the company’s business is generated overseas? How much ____________________________________ What are the industry’s future prospects? Are there changing issues concerning the Legal and regulatory environment?
13 Final Comments on Ratio Analysis Ratio analysis useful when comparisons made • over time (trend analysis) • against targets • _____________________________ …But the issues outlined in the previous two slides have to be taken into account 14 Valuing the firm with WACC You have already met the twopart Discounted Dividend Model. DT +1 D1 D2 DT 1 P0 = + + ... + + 2 T 1 + rS ( 1 + rS ) ( rS − g 2 ) ( 1 + rS ) T ( 1 + rS ) We can adapt it to value the firm: FCFT +1 FCF1 FCF2 FCFT 1 = + + ... + + 2 T 1 + wacc ( 1 + wacc ) ( wacc − g 2 ) ( 1 + wacc ) T 1 + wacc ) ( 15 VFIRM FCF Method Similar to the dividend growth model, • assumes that at some point in time, the growth rate in free cash flow will become constant. • Terminal value represents the value of the firm at the point at which ___________________________________ • Instead of dividend per share (D1 etc or DPS) we use: FCF which is the entire free cash flow to the firm for the period
• Thus Not on a per share basis.
16 FCF Method: VFIRM = VDEBT + VEQUITY The model provides a fair value estimate of:
• Market value of both debt + equity
Example: VFIRM = $110m VDEBT = $50m N = 40m shares ⇒ VEQUITY = 110m − 50m = $60m $60m P0 = = $2.50 40m
17 To find estimate of P0:
• Subtract the VDEBT and divide by N Problem 4 The present value of the free cash flows of Cheetah Ltd is $700m. The market value of Cheetah’s debt is 200m There are 100m shares outstanding. Given this information, what is our best estimate of P0? 18 Solution 4
VFIRM = VEQUITY + VDEBT $700m P0 = = = VEQUITY + $200m (estimated market valuations ) 19 Data for Managerial Decisions Some terms defined: Net Cash flows (NCF …or ATCF) Operating Assets Nonoperating Assets Operating Working Capital Net Operating Working Capital (NOWC) Total Operating Capital (TOC) Net Operating Profit After Tax (NOPAT) Operating Cash Flows (OCF) Free Cash Flow (FCF) 20 Defining NET CASH FLOWS (NCF) Also often called “After Tax Cash Flow” (ATCF) Cash flow data more important than NPAT
• But we do not use Cash Flow Statement! Net Cash Flow formula:
NCF = NPAT – Non Cash Revenue + Non Cash Expenses Assume that:
• • • Depreciation & amortization are the major Non Cash Expenses Assume that other items net out to zero Therefore Modified formula for NCF : NCF = NPAT + Depn + Amortization 21 OPERATING ASSETS OPERATING (Background first! …Then Definition) …Then
Comparing firms by traditional accounting measures such as ROE becomes nonsense with differences in: Capital structure
Debt:Equity mix Tax regimes ____________________________________________ Presence of Nonoperating assets
Marketable securities So…
22 Managers should be judged by: Managers should be judged by: Operating Income they produce from Operating Assets they control. Operating Income = EBIT Total Assets are (at the level necessary to operate the business) :
• • • • • Cash Marketable Securities (where needed) Accounts Receivable Inventories Fixed Assets TA TA = CA + FA – Accumulated Depreciation 23 Defining Non-operating Assets Cash above level required for normal operations Marketable Securities above level required for normal operations Investments in subsidiaries ____________________________ Other nonessential assets • (the Lear Jet etc)
But these are counted in Total Assets !
24 Operating Assets are (at the level necessary to Operating Assets operate the business) :
• Cash • Marketable Securities (where needed) • Accounts Receivable • __________________________ 25 Defining Net Working Capital (NWC) and and Net Operating Working Capital (NOWC) Net Working Capital (WC) = __________________ Operating Working Capital (OWC) = CA • to the extent that CA are needed to support operations
Assume that all CA are needed Net Working Capital (NWC) = ______________ Net Operating Working Capital (NOWC) = CAL*
• L* = Current Liabilities that are spontaneous:
• Accounts Payable • Accrued Wages & Tax • L* = CL – Notes Payable 26 Operating Working Capital • Subtract Accounts Payable and Accrued Wages and Taxes (L*) 27 • • • • Cash Marketable Securities (where needed) Accounts Receivable Inventories
Operating Working Capital • Subtract L* Net Operating Working Capital • Add ______________________ 28 Problem 5 For D’Leon in 2009: a) Calculate ATCF (net cash flow)
b) Calculate the value of L* Calculate Net Operating Working Capital Calculate Total Operating Capital
29 c) d) Solution 5 30 31 ...
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- Spring '09