TradeQuestTradeQuestWorkshop BWorkshop B

Valuation, Analysis & ResearchValuation, Analysis & Research

Record-keepingRecord-keeping

Philosophy of ValuationPhilosophy of Valuation

Value of asset is irrelevant so long as Value of asset is irrelevant so long as “bigger fool” is available?“bigger fool” is available?

An investor does not pay more than the An investor does not pay more than the asset is worthasset is worth Painting or sculpture is not same as financial Painting or sculpture is not same as financial

assetasset

Price paid is related to the level and Price paid is related to the level and expected growth in cashflow that the asset expected growth in cashflow that the asset can generatecan generate

Myths of ValuationMyths of Valuation

““Since valuation models are quantitative, Since valuation models are quantitative, valuation is objective”valuation is objective”

““The more quantitative a model, the The more quantitative a model, the better the valuation”better the valuation”

““A good valuation provides a precise A good valuation provides a precise estimate of value”estimate of value”

““The market is generally wrong”The market is generally wrong”

Role of ValuationRole of Valuation

Fundamental analysis – value of firm can Fundamental analysis – value of firm can be determined by financial characteristicsbe determined by financial characteristics

Franchise buyers – look for value in firms Franchise buyers – look for value in firms that are stable and predictablethat are stable and predictable

Chartists – information about trading Chartists – information about trading patterns is as important as financial patterns is as important as financial informationinformation

Information traders – anticipate news and Information traders – anticipate news and market reactionmarket reaction

““Find the Jewel”Find the Jewel”

Financial Statement AnalysisFinancial Statement Analysis

Valuation ToolsValuation Tools

Market DataMarket Data

Financial Statement AnalysisFinancial Statement Analysis

Balance SheetBalance Sheet

EquityEquity

DebtDebt

AssetsAssets

LeverageLeverage

Income StatementIncome Statement

Operating MarginsOperating Margins

Non-Operating Non-Operating ItemsItems

One-Off ItemsOne-Off Items

TrendTrendCashflow StatementCashflow Statement

Indicator of profitability of core businessIndicator of profitability of core business

Balance SheetBalance SheetCompany XX Company YY

Assets:Current 3,754 21,927Other Assets 278 4,897Fixed Assets 1.140 6,471Total 5,172 33,295

Liabilities:Current 1,810 22,537LT Debt 138 3,442Equity 3,224 7,316Total 5,172 33,295

Income StatementIncome StatementCompany XX Company YY

Net Revenue 2,360 10,979Net Expenses 2,027 10,205Operating Income 334 774Other Items (102) (153)

Net Income 232 621

Earnings per share 2.32 3.10Stock Price 43.50

63.75Price/Earnings 18.8 20.6

Cashflow StatementCashflow Statement

Company XX Company YY

From Operations 1,526 4,321

From Investments (1,169) (3,012)

From Financing (195) (1,122)

Net Cashflow 162 187

Ratio AnalysisRatio Analysis

- Gross Margin Net Earnings - Cost of Sales

Net Sales

- Debt/Equity Long Term Debt

Stockholders Equity

- Interest Cover Net Earnings from Operations

Interest Expense

Ratio AnalysisRatio Analysis

Earnings Per ShareEarnings Per Share

Net Earnings

No. of Outstanding Shares

Price EarningsPrice Earnings

Share Price

Earnings Per Share

Valuation ToolsValuation Tools

Financial Statement ratiosFinancial Statement ratios ROE, ROA …ROE, ROA …

CAPM (Capital Asset Pricing Model)CAPM (Capital Asset Pricing Model)

Discounted cashflowsDiscounted cashflows

Dividend modelsDividend models

Comparables to similar firms or to industryComparables to similar firms or to industry

Quantitative or econometric modelsQuantitative or econometric models

Option pricingOption pricing

Market DataMarket Data

SEC FilingsSEC Filings

Analysts RecommendationsAnalysts Recommendations

Company Conference Calls - Earnings Company Conference Calls - Earnings GuidanceGuidance

Quarterly Earnings ReportQuarterly Earnings Report

Economic IndicatorsEconomic Indicators

SummarySummary

Finding undervalued investment is difficultFinding undervalued investment is difficult

Markets behavior is irregular -- not perfectMarkets behavior is irregular -- not perfect Size of firmSize of firm ““January effect”, “weekend effect”, “holiday January effect”, “weekend effect”, “holiday

effect”effect”

Realize that professionals are not Realize that professionals are not consistently high performersconsistently high performers

Net result: big gap between theory and Net result: big gap between theory and practicepractice