ch13outline - Chapter 13 I. Valuation by Comparables A. The...

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Chapter 13 I. Valuation by Comparables A. The purpose of fundamental analysis is to identify stocks that are mispriced relative to some measure of “true” value that can be derived from observable financial data 1. Of course, true value can only be estimated 2. In practice, stock analysis use models to estimate the fundamental value of a corporation’s stock from observable market data and from the financial statements of the firm and its competitors 3. These valuation models differ in the specific data they use and in the level of their theoretical sophistication 4. Most of them use the notion of valuation by comparables: they look at the relationship between price and various determinants of value for similar firms, and then extrapolate that relationship to the firm in question B. For U.S. companies, the Securities and Exchange Commission provides information available to the public at its EDGAR C. The SEC requires all public companies (except foreign companies and companies with less than $10 million in assets and 500 shareholders) to file registration statements, periodic reports, and other forms electronically through EDGAR D. Comparative valuation ratios are used to assess the valuation of one firm versus others in the same industry E. Its price-to-sales ratio is more useful for firms and industries that are in a start-up phase F. Earnings figures for start-up firms are often negative and not reported, so analysis shift their focus from earnings per share to sales revenue per share G. Book value is the net worth of a company as reported on its balance sheet H. Limitations of Book Value 1. The book value of a firm is the result of applying accounting rules that spread the acquisition cost of assets over a specified number of years, whereas the market prices of a stock takes account of the firm’s value as a going concern 2. In other words, the market price reflects the present value of its expected future cash flows 3. While it is not common, there are always some firms selling at a market price below book value 4. Typically, these are firms in considerable distress 5. A better measure of a floor for the stock price is the firm’s liquidation value per share a. This represents the amount of money that could be realized by breaking up the firm, selling its assets, repaying its debt, and distributing the remainder to the shareholders 6. Another balance sheet concept that is of interest in valuing a firm is the replacement cost of its asset less its liabilities 7. Some analysts believe the market value of the firm cannot get too far above its replacement cost for long because, if it did, competitors would try to replicate the firm 8. The competitive pressure of other similar firms entering the same industry would drive down the market value of all firms until they came into equality with replacement cost 9. The ratio of market price to replacement cost is known as Tobin’s q
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10. In the long run, according to this view, the ratio of market price to replacement cost will tend toward 1, but the
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This note was uploaded on 09/10/2010 for the course FIN 367 taught by Professor Han during the Fall '08 term at University of Texas at Austin.

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ch13outline - Chapter 13 I. Valuation by Comparables A. The...

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