L8_Valuing_the_Company

L8_Valuing_the_Company - Valuing the Company and its Shares...

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Valuing the Company and its Shares
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2 Relative Valuation Adjustments May need to adjust : the multiple (P/E, P/NAV, P/CF etc.), and / or the base quantity (earnings, NAV, CF etc.) to best reflect characteristics of firm being valued These adjustments are based on: Financial Valuation Metrics Non-Financial Valuation Metrics Sensitivity and Risk Metrics
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3 Financial Valuation Metrics Earnings Earnings Quality Normal Earnings Dividends ROE Cash Flow
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4 Earnings Quality Higher when: accounting earnings are accurate reflect ion of economic reality and is trustworthy the company's earnings are stable / predictable over time and not highly volatile Reduces the risk to the investor the earnings are less uncertain e.g ., there is a high degree of annuity / regular / guaranteed income Higher quality of earnings = lower risk = better business = higher value = higher justified share price
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5 The Concept of “Normal Earnings” Determine earnings power of company, which affects its value in the longer term Eliminate “financial” noise Look at the long-term picture Focus on sustainability of earnings generated by operations Look through the cycle
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6 Cyclical Earnings Many industries are cyclical to some extent: Commodity cycle ( e.g., Sappi, Anglo) Insurance underwriting cycle (e.g . Santam) IT cycle (e.g ., Didata) Banking cycle (e.g , FNB, Standard etc.)
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7 Cyclical Earnings Analyst needs to “ look through ” the cycle Determine normal level of earnings (average earnings through the cycle) for use in a relative P/E valuation This will be subjective to some extent Exclude non-recurring gains and losses
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8 Nonrecurring Items Discontinued operations Capital gains and losses Once-off disasters Insurance settlements Regulatory changes Changes in accounting methods Etc.
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9 Cyclical Example: Sappi Earnings
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10 Example: Hansen Electrical Value one share of Hansen Electrical using a P/E methodology and normal earnings , using the information in the tables on the next slide. Assume the following: 55,000 shares in issue. An average tax rate of 30% Similar companies to Hansen are Taiwoo and EGP Electronics
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11 Hansen Electrical: Data Information from Income Statements
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12 Calculating Normal Earnings Calculate relevant averages Reverse non-normal expenses and incomes Apply tax to “normal” EBIT Divide by # shares to get “normal” EPS
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13 Determining the P/E to use Ice Telecoms irrelevant: not similar to Hansen. Average of other 3 (last 4 years): 7.4 Average for Hansen: 7.8 Conservatively, it looks reasonable to use 7.5 But this is not a fixed answer – reasonableness and motivation is the test!
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14 Bringing it together: earnings normal x P/E share of Value cps 2723 cps 363 x 7.5 Depending on assumptions and P/E chosen,
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This note was uploaded on 06/01/2011 for the course FIN 3026W taught by Professor Drtoerien during the Summer '09 term at University of Cape Town.

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L8_Valuing_the_Company - Valuing the Company and its Shares...

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