Aestimatio Aequitatis: Introductio

• Equity Valuation

Defining Valuation

• Helps determine the economic value of an asset or company.
• Crucial for investment decisions like buying, selling, or holding stocks.
• Involves analyzing financial data, market conditions, and future potential.
• A precise estimate of intrinsic value to inform investment decisions.
• Determines if an asset is overvalued, undervalued or fairly valued.

Common Valuation Methods

• Discounted Cash Flow (DCF): Projects future cash flows and discounts them back to present value.
• Relative Valuation: Compares a company's valuation metrics to those of its peers.
• Asset-Based Valuation: Focuses on the net asset value of a company.

Discounted Cash Flow (DCF)

• Intrinsic valuation method that determines value based on future cash flows.
• Projects future free cash flows (FCF) and discounts them using the Weighted Average Cost of Capital (WACC).
• Terminal Value estimates value beyond the explicit forecast period.
• The present value of these cash flows is the estimated value of the company.
• Can be highly sensitive & reliant on assumptions.

Relative Valuation

• Determines a company’s value by comparing it to similar companies or industry benchmarks.
• Uses multiples like Price-to-Earnings (P/E), Price-to-Sales (P/S), and Enterprise Value-to-EBITDA (EV/EBITDA).
• Benchmarking against peers helps determine if a company is over or undervalued.
• Simpler and more straightforward, but relies on the assumption that comparable companies are properly valued.
• Affected by market sentiment and comparable set.

Asset-Based Valuation

• Calculates a company's net asset value (NAV) by subtracting total liabilities from total assets.
• Suitable for companies with substantial tangible assets.
• May not accurately reflect the value of intangible assets or future earning potential.
• Useful for valuing companies going through liquidation.
• Ignores future earnings potential.

Key Financial Ratios

• Price-to-Earnings (P/E): Share price divided by earnings per share; indicates how much investors are willing to pay per dollar of earnings.
• Price-to-Sales (P/S): Share price divided by sales per share; useful for valuing companies with negative earnings.
• Enterprise Value-to-EBITDA (EV/EBITDA): Enterprise value divided by earnings before interest, taxes, depreciation, and amortization; assesses total company value relative to its operating cash flow.
• Debt-to-Equity Ratio: Total debt divided by total equity; measures a company's financial leverage.
• Return on Equity (ROE): Net income divided by shareholders' equity; indicates how efficiently a company is generating profits from shareholders' investments.

P/E Ratio

• Calculated as Market Value per Share divided by Earnings per Share (EPS).
• Indicates how much investors are willing to pay for each dollar of a company's earnings.
• High P/E may suggest overvaluation or high growth expectations.
• Low P/E may suggest undervaluation or lower growth expectations.

P/S Ratio

• Calculated as Market Capitalization divided by Total Sales or Share Price divided by Sales per Share.
• Useful for valuing companies with negative earnings.
• Lower P/S ratio may indicate undervaluation.
• Higher P/S ratio may indicate overvaluation or high growth expectations.

EV/EBITDA Ratio

• Calculated as Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).
• EBITDA represents a company's operating cash flow.
• Provides a more comprehensive valuation measure than P/E ratio.
• Lower ratio may indicate undervaluation.
• Higher ratio may indicate overvaluation or high growth expectations.

Debt-to-Equity Ratio

• Calculated as Total Debt divided by Total Equity.
• Measures the proportion of debt and equity a company uses to finance its assets.
• Higher ratio indicates higher financial leverage, which can increase risk.
• Lower ratio indicates lower financial leverage, which can provide more financial flexibility.

Return on Equity (ROE)

• Calculated as Net Income divided by Shareholders' Equity.
• Measures how efficiently a company generates profits from shareholders' investments.
• Higher ROE indicates better profitability.
• Used to compare a company's profitability to that of its competitors.

Factors Affecting Valuation

• Micro Factors: industry trends, competitive landscape, company-specific factors (e.g., management, business model).
• Macro Factors: economic growth, interest rates, inflation.

Industry & Competitive Landscape

• Understanding the industry helps assess growth opportunities and challenges.
• Analyzing the competitive landscape helps evaluate a company's market position and competitive advantages.
• Porter’s Five Forces framework can be used to assess industry attractiveness.

Company-Specific Factors

• Management quality, business model, financial health, and competitive advantages (e.g., brand, patents).
• Strong management and a sustainable business model can positively impact valuation.
• Unique competitive advantages can justify a premium valuation.

Economic Growth

• Higher economic growth typically leads to increased consumer spending and business investment.
• Positively impacts company revenues and earnings, leading to higher valuations.
• Slower economic growth or recession can negatively impact company performance and valuations.

Interest Rates

• Higher interest rates increase the cost of borrowing, which can reduce corporate investments and consumer spending.
• Impacts present value calculations in DCF valuation.
• Lower interest rates can stimulate economic activity and increase valuations.

Inflation

• High inflation can erode purchasing power, increase operating costs, and reduce corporate profitability.
• Central banks may raise interest rates to combat inflation, which can negatively impact valuations.
• Moderate inflation may have a neutral or slightly positive impact if companies can pass on costs to consumers.

Practical Steps in Valuation

• Preliminary Analysis: Understand the company's business model, industry, and competitive position.
• Financial Statement Analysis: Review the income statement, balance sheet, and cash flow statement.
• Method Selection: Choose appropriate valuation methods based on the company's characteristics.
• Sensitivity Analysis: Assess how changes in key assumptions impact the valuation.

Preliminary Analysis

• Understand the company's business, industry, and competitive landscape.
• Review annual reports, investor presentations, and news articles.
• Identify key value drivers and potential risks.

Financial Statement Analysis

• Review the income statement, balance sheet, and cash flow statement.
• Calculate key financial ratios to assess profitability, liquidity, and solvency.
• Identify trends and anomalies that may impact valuation.

Method Selection

• Choose appropriate valuation methods based on company characteristics.
• DCF is suitable for companies with predictable cash flows.
• Relative valuation is useful for comparing companies to their peers.
• Asset-based valuation is appropriate for companies with substantial tangible assets.

Sensitivity Analysis

• Assess how changes in key assumptions impact the valuation.
• Vary assumptions such as growth rates, discount rates, and terminal value.
• Understand the range of potential values and the key drivers of valuation.