Fin 42018001

1
Fin 4201/8001

• Topic 4a Valuing Companies
• The adventure continues.

2
The Project

• Next few classes, little reading time to get
  organized
• Sources usual suspects
• Analyze with tenets, spread sheet w/ forecasts,
  ratios.
• Play from your strengths

3
Another look

• Abstract
• Introduce firm and environment
• Operations
• Industry

4
Another look

• Ratio analysis
• Buffetts tenets
• Equity Valuation
• Recommendation
• References, Tables, Charts,

5
Valuation

• Objective Investment decision
• Price
• Three step approach (Top-down)
• Analysis of economies and markets
• Analysis of Industry
• Analysis of individual firm

6
Valuation (The softer side)

• Most of the 12 tenets
• Macro economic implications
• Corporate governance and the market for corporate
  control
• Buffett cost
• How do you know? Valuation
• Our focus ROIC, NOPLAT, and DCF

7
Return On Invested Capital Profit/capital

• ROIC is after tax profit divided by (working
  capital PPE)
• Scorecard vs. some benchmark
• Goal ? maximize
• But cant just look at either Capital costs
  money (growth for growths sake)
• ROIC Opportunity cost of capital
• Ultimate stock performance or value creation

8
NOPLAT Net Operating Profit Less Adjusted Taxes

• Owner earnings
• Look at example in a couple of slides

9
DCF Discounted Cash Flow

• Returns depend on market expectations
• The great equalizer
• Goal Maximize PV of cash or economic profit
• Ultimate measure is stock performance
• Problems
• Predict future (Buffett KISS and stable)
• Earnings can be manipulated

10
Historical Analysis

• Need to understand past to be able to predict the
  future
• Reorganize statements to reflect economic vs.
  accounting performance
• Measure and analyze ROIC ability to create
  value
• Assess financial health and capital structure for
  short and long term

11
Historical Analysis

• ROIC NOPLAT / Invested capital
• Reorg Balance Sheet to create invested capital
• Reorg Income statement to get NOPLAT
• How much cash can be taken out?
• FCF NOPLAT noncash Op exp invested capital

12
ROIC NOPLAT / Invested Capital

• Invested capital Balance sheet Debt Equity?
• Debt equivalents unfunded retirement
  liabilities, restructuring reserves,
• Equity equivalents deferred taxes

13
Non op assets not included in capital
Operating liabilities netted against operating
assets
14
ROIC NOPLAT / Invested Capital

• Now to Income statement NOPLAT
• Interest expense not subtracted
• Exclude non operating income
• Adjust taxes to reflect exclusions
• What you have is basically an all equity,
  operations only firm

15
Interest payout to investor, not expense
If not in capital not in NOPLAT
Taxes calcd on operating profits
16
ROIC NOPLAT / Invested Capital

• Now what about Free Cash Flow?
• Basically the same as tenet 8 in Topic 3 FCF
  NOPLAT Non cash opexpense investment in
  capital
• Intangibles and goodwill usually exclude
• Other Long Term assets
• Hidden Assets leases, RD
• Cash if large ? operating

17
Interest payout to investor, not expense
CF from non-op treated separate
Taxes calcd on operating profits
18
Forecasting

• Models try to reduce to simple numbers
• Make realistic assumptions on sales and costs
• Look for the drivers
• Two-stage growth model

19
The Forecast

• Analyze historicals
• Aggregate items or add more lines
• CNBC, Yahoo, Edgar, Compustat (WRDS),
• Start with IS
• Revenue forecast consistent with historical and
  economy-wide growth

20
The Forecast

• Forecast rest of income statement consistent with
  drivers
• COGS function of sales adjusted for competition
  and/or productivity
• Depreciation of revenue or of PPE or
  historical equipment purchase
• Interest exp or income tied to asset or liability
  that generates it
• Taxes look to historical or just plug 39
• Forecast Balance sheet, invested capital, and
  non-op assets
• E.g. working capital tied to COGS or PPE tied to
  revenue or depreciation

21
The Forecast

• Forecast investor funds
• Retained earnings old RE NI - dividends
• Other equity accounts
• Calculate ROIC and FCF to generate value
• Can use WACC or do like Buffett (long treasury
  rate)
• Other issues