An unattractive industry average player earns a return below cost of capital

An unattractive industry average player earns a

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An unattractive industry: average player earns a return below cost of capital Industry players with a competitive advantage earn higher returns than average industry player You want to participate in an attractive industry possessing a competitive advantage Ten Key Valuation Concepts 16 Fall 2016
KEY VALUATION CONCEPTS CONCEPT 6: THERE ARE TWO STRATEGIC FORCES THAT LARGELY DETERMINE THE UNDERLYING ABILITY OF THE FIRM TO CREATE AN ROIC > WACC: FAVORABLE INDUSTRY ECONOMICS AND A COMPETITIVE ADVANTAGE Ten Key Valuation Concepts 17 Fall 2016 ? Winners Losers ? High High High Low Favorable Industry Economics Competitive Advantage Winners and Losers
CONCEPT 6: THERE ARE TWO STRATEGIC FORCES THAT LARGELY DETERMINE THE UNDERLYING ABILITY OF THE FIRM TO CREATE AN ROIC > WACC: FAVORABLE INDUSTRY ECONOMICS AND A COMPETITIVE ADVANTAGE The “competitive advantage period” is the length of time the firm can earn a positive spread (i.e., ROIC > WACC) Length of competitive advantage period (CAP) is a function of: current ROIC rate of industry change barriers to entry Competitive forces drive returns to cost of capital However, firms with strong brand names may be able to make positive spreads for the indefinite future Ten Key Valuation Concepts 18 Fall 2016
CONCEPT 7: INVESTORS PRICE A COMPANY’S STOCK ON THE BASIS OF THEIR INFORMATION ABOUT ITS PROSPECTS FOR FUTURE CASH FLOWS Accounting earnings per se will not influence stock prices. But accounting earnings provide clues as to what one can expect future cash flow to be Earnings signal future cash flow If reported earnings differs from expected earnings, and reported earnings changes investor’s expectations about future cash flow, stock price will change 19 Fall 2016 Ten Key Valuation Concepts KEY VALUATION CONCEPTS
CONCEPT 8: THE RETURN THAT A COMPANY EARNS ON ITS INVESTMENTS (ROIC) IS NOT THE RETURN ITS SHAREHOLDERS EARN (TOTAL RETURN TO SHAREHOLDERS)Value creation at the company level is measured one way and value creation at the shareholder level is measured another wayA company measures its return on the book value of invested capital (ROIC)The shareholder measures her return on the market value of the stockThe shareholder measures her return by total return to shareholders (dividends plus price appreciation)Price appreciation is a function of the price paid for the sharesA company can earn a better than average ROIC and yet the shareholder can have a poor return – one below her required return – because the shareholder paid too much for the stockAn investor buying into a high return company may find it difficult to create value because the price paid for the stock incorporates the expected performance in the stock priceUnless company makes additional improvements, beyond what is expected, a shareholders’ return above market averages is difficult to attain20 Fall 2016 Ten Key Valuation Concepts

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