Reading...
Play button
Play button
Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
87 Cards in this Set
- Front
- Back
|
leverage
|
-refers to the effect of fixed elements in cost structure
-two types, business risk, and financial risk |
|
|
business risk
|
-Variability in EBIT
-Affected by operating leverage |
|
|
financial risk
|
Variability of EPS from fixed interest costs of debt financing
|
|
|
Degree of Operating Leverage (DOL)
|
Definition/Interpretation %change in EBIT/% change in sales
calculation: sales-TVC/ sales-Tvc- fixed -When fixed costs are zero, DOL = 1, there is no operating leverage: %∆ EBIT = %∆ sales |
|
|
3 characteristics of leverage
|
High fixed costs = high operating leverage
High debt ratio = high financial leverage High fixed costs + high debt ratio = high total leverage |
|
|
break even quantity of sales
|
total fixed cost/price-variable cost per unit
|
|
|
net income
|
q(p-v)-fixed cost-interest
|
|
|
cash dividends
|
payments made to shareholders in cash
|
|
|
three types of dividends
|
regular dividends, special dividends, liquidating dividends
|
|
|
stock dividend
|
payment to shareholders in shares of stock(eg. 10% of existing shares)
|
|
|
stock split
|
proportionate increases in shares outstanding(2 for 1)
|
|
|
reverse stock split
|
proportionate decrease in shares outstanding (1 for 5)
stock spits stock dividends do no change value of stock outstanding |
|
|
effects on financial ratios
|
-cash dividend: decrease in asset, and decrease in equity
-liquiditiy ratios decrease due to decreases in cash (current assets) -leverage ratios increase due to decreases in assets, equity stock dividends, stock splits, do no affect liquidity ratios or leverage ratios |
|
|
open market repurchases
|
-buy at market price in the open market
-flexibility in timing Tender offer -buy fixed number of shares at fixed price -typically at a premium to market -direct negotiation -typically at a premium to market |
|
|
share repurchases
|
-rationales for share repurchase instead of cash dividend
-1. tax advantage to shareholders if tax rate on capital gains<tax rate on dividends 2. signal to shareholders that management believes shares are undervalued |
|
|
equity securities
|
-higher risk and return compared to government bills and bonds
-real return, world equities =5% -real return, world bills and bonds =1% -worst world equity declines=-50% |
|
|
equity market capitalization can be compared to GDP
|
-us is approximately 20% of world GDP and 43% of world equity
-emerging markets are approximately 44% of world GDP and 11% of world equity -2008 world equity value 100% of world GDP but historically approximately 50% |
|
|
equity security characteristics
|
-dividends are variable, no obligation to pay dividends
-common shareholders have a residual claim to firm assets -common shareholders vote for board members -different classes of common shares can have different voting rights |
|
|
cumulative voting
|
-allows minority shareholder greater representation
-example- 3 board positions are up for vote, shareholders owns 100 shares: statutory (non cumulative) voting- shareholder can give maximum of 100 votes to each of 3 candidates -cumulative voting- shareholder can give maximum of 300 votes to one candidate |
|
|
preferred stock (preference shares)
|
-similarities to common stock include
-dividends not an obligation -no maturity date -similarities to debt include -fixed payment (scheduled dividends) -usually no voting rights -does not participate when firm does well |
|
|
types of preferred stock
cumulative preferred |
must receive any unpaid dividends before common shares may be paid dividends- less risk than non-cumulative preferred shares
|
|
|
participating preferred
|
receives extra payment if firm does well, claim can exceed par value if firm is liquidated
|
|
|
convertible preferred stock
|
-preferred shares can be converted to common shares at a conversation ratio
-advantages : -preferred dividend> common dividend -shareholders can benefit from firm growth by converting to common -less risky than common stock |
|
|
callable and putable shares
|
-both common and preferred equity can have a call feature or put feature
-callable shares: give the from the right to repurchase the shares at the call price--more risk than regular shares putable shares- give shareholders the right to sell the shares back to the firm at the put price--less risk than regular shares |
|
|
private equity
|
-advantages compared to public equity:
-reporting requirements less -more able to focus on long term -potentially greater return for investors once firm goes public disadvantages: -less liquid -less ability to raise capital -less disclosure, may weaken governance |
|
|
private equity investments
|
-venture capital: provides financing for early stages of firm development
-leveraged buyout(LBO) : uses debt to buy all outstanding stock -Management buyout(MBO) : management-led LBO -private investment in public entity(PIPE) : public firm raises equity capital in private placement |
|
|
Investing in foreign equities
|
-disadvantages of direct investing on a foreign exchange:
-investment and return may be denominated in foreign currency -often less liquid -often less transparency - exchange regulations and procedures may be quite different |
|
|
depository receipts
|
-shares are deposited in a bank
-claims to deposited shares(receipts) trade like a local stock in local currency -accounting standards and market procedures are those of the local market |
|
|
sponsored depository receipts
|
-firm is involved with issue
-investor has same voting and dividend rights as foreign shareholders -greater grim reporting requirements(must be registered with SEC in USA) unsponsored depository receipts : -depository buys shares in foreign market -bank retains voting rights |
|
|
investing in foreign securities
global depository receptis |
-issued outside U.S and outside firms home country, most denominated in USD, some in pounds and euros
|
|
|
American depository receipts
|
denominated in USD and traded on US exchanges, oldest and most common type
|
|
|
Global registered shares
|
identical common shares that trade in local currencies on stock exchanges worldwide (1998)
|
|
|
baskets of listed depository receipts
|
ETF's, portfolio of depository receipts
|
|
|
return characteristics of equity
|
-components of equity return:
-dividends -capital gain or loss -share repurchases -possible foreign exchange gain or loss compounding of reinvested dividends: -has historically been an important part(2/3+) of investors compound returns on equity securities |
|
|
Risk characteristics of equity
|
-preferred stock is less risky than common stock
-fixed dividend -receives distributions before common stock -claim to par value fig rim is liquidated; after claims of debt holders but before claims of common stockholders |
|
|
equity insurance
|
-provides funds to buy productive assets to increase shareholder wealth
-can be used to buy other companies or for employee incentive compensation -decreases firms reliance on debt financing |
|
|
book and market value of equity
|
book value of equity- value of the firms balance sheet assists minus liabilities
market value of equity- reflects investor expectations regarding firm risk, amount and timing of future cash flows |
|
|
ROE and cost of equity
|
-ROE- (net income/average equity) measures the return management is generating on equity capital
-cost of equity-is investors minimum required rate of return on the from equity securities--difficult to estimate compared to required return of debt |
|
|
use of industry analysis
|
-understanding a firms business environment--growth, competition, risks
-active management--industry analysis can be used to weight a portfolio and rotate among industries -performance attributes--industry selection as a source of portfolio return |
|
|
approaches to industry groupings
products and services |
group by sector or primary business activity
|
|
|
business cycle sensitivity
|
-cyclical or non cyclical
-high sensitivity- consumer discretionary, energy, financials, industrials, technology, materials low sensitivity- consumer staples, health care, telecommunication, utilities |
|
|
business cycle sensitivity
|
cyclical: earnings highly dependent on the business cycle
non-cyclical: earnings largely independent of the business cycle -defensive: basic goods and services with relatively stable demand -growth- demand is so strong the firm is largely unaffected by business cycle |
|
|
peer groups
|
-start with narrowest commercial classification
-find specific competitors--annual report -find comparable companies- industry reports, management comments -determine similar business model/activity -peer group companies should have similar business activities, demand of drivers, cost structure drivers, availability of capital |
|
|
cyclical
|
-earnings highly dependent on the business cycle
|
|
|
non-cyclical
|
-earnings largely independent of the business cycle
-defensive- basic goods and services with relatively stable demand -growth-demand is so strong the firm is largely unaffected by business cycle |
|
|
elements of industry analysis
|
-evaluate relationships between macroeconomic variables and industry
-estimate industry projections using different approaches and scenarios -cross-check analysis against that from other analysts -compare industry valuations across time to determine risk and rotation strategies -analyze industry prospects using strategic groups(similar business or product delivery) |
|
|
elements of industry analysis
|
-classify industries within life-cycle stage(embryonic, growth, shakeout, mature, or declining)
-position industry on experience curve(cost per unit relative to output) -consider demographic, macroeconomic, governmental, social, and technological influences -examine forces that determine industry competition |
|
|
external industry influences on growth, profitability, and risk
macroeconomic factors |
-economics output, interest rates, credit availability, inflation
|
|
|
technology factors
|
new or improved products
- |
|
|
demographics factors
|
age distribution, population
|
|
|
social influences factors
|
how people conduct their lives and chose to spend their incomes
|
|
|
government factors
|
tax rates, business regulations, purchases
|
|
|
industry life cycle
embryonic stage |
slow growth, high prices, large investment required, high risk of failure
|
|
|
growth stage
|
rapid demand growth, low competition, falling prices, increasing profitability
|
|
|
shakeout stage
|
slower growth, intense competition, increasing overcapacity, declining profitability, cost cutting, increased failures
|
|
|
mature stage
|
-slow growth, industry consolidation, high barriers to entry including brand loyalty and efficient cost structure
- superior products lead to market share increases -with stable demand, firms avoid price competition -during economic downturns, overcapacity can lead to intense price competition |
|
|
decline stage
|
-negative growth, excess capacity leads to price competition, higher production costs as demand falls, weak companies merge or exit
-reasons for decline -technology: decline of newspapers -global competition: decline of us textile industry -social change and changing tastes: declining beer sales per capita in Germany |
|
|
limitations of life-cycle analysis
|
-most useful during stable periods
-stages may not be as long as anticipated or might be skipped altogether -some firms will experience dissimilar growth and profits due to competitive position |
|
|
barriers to entry
|
-high barriers to entry limit new competitors
-to determine east of entry, examine industry composition over time( if same frisk over time, entry is difficult) -barriers to entry may not imply pricing power if competition among existing firms is strong ---undifferentiated products ---high barriers to exit(--> overcapacity) -barriers to entry and competitive environment may change over time |
|
|
industry conditions
|
-hight industry concentration does not necessarily imply pricing power
-absolute market share may not matter as much as relative market share(having larger share than next-largest competitor) -low industry concentration (market fragmentation) usually results in strong competition, little pricing power |
|
|
industry capacity
|
-under-capacity( demand exceeds supply) often implies pricing power
-overcapacity can lead to strong price competition, especially when carriers to exit are high -capacity is fixed in the short run and variable in the long run -producers may overshoot future required capacity, especially in cyclical markets -non-physical capacity(capital, skills) can be reallocated more quickly to new industries than physical capacity -physical capacity comes into production more slowly than non-physical capacity -if capacity is physical and specialized, there may be overcapacity if producers overshoot |
|
|
porters five forces
|
intensity of industry competition depends on:
-rivalry among existing competitors -threat of new entrants -thereat of substitute products -bargaining power of buyers -bargaining power of suppliers |
|
|
elements of strategic industry analysis
|
-major firms
-barriers to entry/success -industry concentration -influence of industry capacity on pricing -industry stability -life cycle -competition -demographic influences -governmental influences -social influences -technological influences -wether the industry is growth, defensive, or cyclical |
|
|
elements of company analysis
|
-firm overview
-industry characteristics -product demand -product costs -pricing environment -financial ratios -projected financial statements and firm valuation |
|
|
company analysis should examine the firms competitive strategy
|
cost leadership(low cost)- lowest costs of production, lowest prices, sell enough volume to earn superior return
-product or service differentiation- distinctive in terms of type, features, quality, or delivery, achieve price premium |
|
|
security valuation
|
-market price < estimated value: asset is undervalued
-market price> estimer value: asset is overvalued -for security valuation to be profitable, the security must be misvalued now and must converge towards intrinsic value in the future -market price is more likely to be correct when a security is followed by many analysts |
|
|
types of equity valuation models
discounted cash flows models |
-discounted cash flow models
--estimated value is the PV of: -future cash distributed to shareholders (dividend discount models) or -future cash available to shareholders(free cash flow to equity models) |
|
|
multiplier models
|
-price multiplier: ratio of stock price to earnings, sales, book value, or cash flow
-enterprise value multiplier: ratio of enterprise value to sales or EBITDA |
|
|
asset based
|
-equity value= total asset value minus liabilities and preferred stock values
|
|
|
dividend discount model
|
-corporation has an indefinite life
-investor must receive future cash dividends to be willing to invest today |
|
|
free cash flow to equity model
|
FCFE: cash available after a firm meets its debt obligations and necessary capital expenditures
-FCFE=CFO-FCInv+net borrowing |
|
|
FCFE model rationale
|
-FCFE reflects the firms capacity to pay dividends
-useful for firms that currently do not pay a dividend -analyst does not have to project the amount and timing of future dividend payments |
|
|
preferred stock valuation
|
-usually pays a fixed dividend and has no maturity date
|
|
|
Gordon (constant) growth model
|
assumptions:
-dividends grow at a constant rate forever -ke must be greater than gc |
|
|
estimating the value of g
|
-g represents the earnings and dividend growth rate in the constant growth model
-g=(RR)(ROE) -where RR= earnings retention rate ROE= return on equity RR=(1-dividend payout ratio) |
|
|
multistage DDM
|
-for companies experiencing temporary rapid growth
-assumes that dividend growth will be constant at some future date -estimate dividends during the rapid growth period -uses Gordon growth model to find the terminal value of the firm when growth is constant |
|
|
dividend discount model use
|
-Gordon growth model is most appropriate for firms that pay a dividend that will grow at a constant rate, such as:
--stable and mature firms -noncyclical firms |
|
|
dividend discount model use
DDM stage 2 and 3 |
-2-stage DDM appropriate forL
-firms with high current growth that will fall to a stable rate in the future -older firms that were in the constant growth phase, but are not in a high growth phase or are losing market share 3-stage DDM appropriate for: -young firms still in the high growth phase |
|
|
P/E based on fundamentals
|
-the primary determinants of a P/E ratio are the required rate of return(k) and the growth rate(g)
-the same factors that affect a stocks price affect the stocks P/E ratio - other things equal, fundamental P/E ratio (price) is higher if the firm has: -higher growth rate -lower required returns - note that increasing the payout ratio will decrease the growth rate:g=ROE * (1-payout ratio) while higher dividends will increase firm value, a lower growth rate will decrease firm value. This relationship is referred to as the dividend displacement of earnings |
|
|
price multiples
|
-P/E= stock price / earnings per share
-P/S=stock price/ sales per share -P/B=stock price/ book value per share -P/CF= stock price/ cash flow per share, where cash flow=operating cash flow or free cash flow |
|
|
using price multiple com parables
|
-based on the law of one price: two comparable assets should sell for the same multiple
-P/E,P/S, P/B, or P/CF ratio lower than industry average or comparable stock suggests stock is undervalued |
|
|
Enterprise value multiples
|
-EV represents total market value of firm
-EBITDA represents total earnings to both debt and equity investors -EV/EBITDA ratios are useful when: -firms have different capital structures -earnings are negative and P/E ratio cannot be used |
|
|
asset based models
|
-equity equals market or fair value of assets minus liabilities
-analysts usually adjust asset book values to market values -asset-based valuation models provide a floor value |
|
|
present value models
|
advantages:
-theoretically sound -widely accepted disadvantages: -inputs must be estimated -valuation can be very sensitive to input values |
|
|
multipler models
|
advantages:
-widely used, associated with stock returns -easily calculated and readily available -good for identifying attractive companies in an industry -useful for time-series or cross0sectional analysis disadvantages: -differences in accounting methods reduct comparability -multiples for cyclical companies highly variable |
|
|
asset based models
|
advantages:
-can provide floor values -useful for firm with mostly tangible short-term assets or if firm is to be liquidated disadvantages: -ongoing firm value may be greater than asset value, does not reflect future cash flows -fair values of assets can be difficult to estimate; especially with primarily intangible assets, high inflation environment |
|
|
choice of valuation model
|
-model should be chosen based on available inputs
-model should be chased based on the intended use of the valuation -more complexity in not necessarily better -consider values using more than one method -consider uncertainty about input values -consider uncertainty about the appropriateness of the model |
