Chapter_06 - Chapter 6 Accrual Accounting and Valuation...

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Accrual Accounting and Accrual Accounting and Valuation: Pricing Earnings Valuation: Pricing Earnings Chapter 6 Chapter 6
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Accrual Accounting at Valuation: Accrual Accounting at Valuation: Pricing Earnings Pricing Earnings Chapter 5 showed how to price book values in the balance sheet and calculate intrinsic price-to-book ratios. Chapter 7 begins the financial statement analysis that is necessary to carry out the price-to-book and price- earnings valuations discussed in Chapters 5 and 6 This chapter shows how to price earnings in the income statement and calculate intrinsic price-earnings ratio The web page has more applications of the techniques in this chapter Link to previous chapter This Chapter Link to next chapter Link to web page How are price-earnings ratios determined? How does the analyst infer the market’s forecast of earnings growth? How do valuation methods protect the investor from paying too much for earnings growth? How is the firm valued from forecasts of earnings growth? When should an investor not pay for growth?
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What You Will Learn From This What You Will Learn From This Chapter Chapter 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. The advantages and disadvantages of using an abnormal earnings growth valuation and how the valuation compares with residual earnings valuation. How dividends, share issues, and share repurchases affect abnormal earnings growth. That abnormal earnings growth is equal to the change in residual earnings How abnormal earnings growth valuation protects the investor from paying too much for earnings growth. How abnormal earnings growth valuation protects the investor from paying for earnings that are created by accounting methods. How to use the abnormal earnings growth model in reverse engineering. What a PEG ratio is.
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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 Compare with price-to-book: P/B is based on expected earnings relative to current book value (ROCE) ROCE is growth in book value P/B is based on expected growth in book value
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Beware of Paying Too Much for Beware of Paying Too Much for Earnings Growth 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
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Reminder: Residual Earnings Valuation Reminder: Residual Earnings Valuation
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