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PE to earnings growth ratioDoes not factor in risk
Identical assets should have identical price, market is efficent
allows analysts to say asset is over, under, or at fair value relative
to benchmark. Assumes the benchmark ratio or value is correctly valued
by the market (efficiently priced)
SP500 EPS / 10 Year Yield
operating earnings - capex
P = EPS1 / ( k - g ) EPS1 is next year's EPS
P/E = 1/ (Corp Bond Yield - .10 X g)
Only shows relationship w/in sample period, may not hold out of
sampleRelationships are time varyingMulticollinearity makes individual
coefficients difficult to interpret
Book value doesn't consider value of human capital.Book value hard to
use if companies deploy assets differently (hard to use outside
industry).Expensing and charge-offs can render book value
meaningless.Book value a historical cost measure that doesn't capture
inflation and technology.
Analysts like P/S ratios becauseSales are harder to misstate or
misrepresentSales are positive so ratio easy to use.Sales are less
volatile than earnings.P/S valid expecially for mature, cyclicals such
as steel stocks. P/S ratios are found to be related to some long run
returns in studies.Drawbacks to P/S ratiosP/S may rank an unprofitable
company favorably.P/S doesn't consider cost structures.Can be distorted
some by revenue recognition differences between firms.Sales = Total
Sales less discounts and retur
long term growth, calculated as:g=NETINC/SALES^2/ASSETS^2/EQUITYg=retention * ROE
weighted average of individual security ERs
Stability (low volatility means lower downside)Low risk of defaultRisk
in business ops relative to industryStrong position relative to
industry competitorsGood position vs suppliers & resourcesregulatory
environment
first attempt to quantify and organize valuation knowledge and
conceptsSecurity Analysis was their first book and was a serious look at
linking returns to stock characteristics
Profitability1. NETINC / ASSETS > 0 this year (1 point)2. CFOPER
> 0 this year (1 point)3. NETINC / ASSETS > 0 (ROA) in this year
compared to the previous year (1 point)4. CFOPER > NETINC this year
(1 point)Leverage, Liquidity and Source of Funds5. LTD / ASSETS < LTD
/ ASSETS this year compared to previous year (1 point)6. CA / CL >
CA / CL this year compared to previous year (1 point)7. OUTSHRS this
year = OUTSHRS previous year (1 point)Operating Efficiency8. CGS / SALES
this year < CG
Tangible Value:Book value of equity - goodwill
...
CFO (operations)FCFE (free cash flow to equity)EBITDA (pre-interest,
pre-tax operating cash flow)CF = NETINC + DEPRC + AMORT (no working
capital adjustment)
Risk vs return, risk appetite
Calculated By:5 year average of EPS5 year average of ROE * Book Value per ShareChoose lower to be more conservative
Current P / qualitative prediction (4X current Q)
investors expect return probabilities over a periodinvestors maximize
return over one period with diminishing marginal utilityrisk is the
variability of portfolio returnsinvestors seek higher return while
minimizing riskinvestors only consider risk and return in decisions
(utility curve has 2 factors)
Nonperforming Loans + Delinquent Over 90 DaysDivided ByTangible Equity Capital + Loan Loss Reserve
Stock Price/EPS OR Market Value of Firm/Net Earnings of FirmInvestors
use commonly use P/E because earnings drive value and is an important
metric to forecast differences in future returnsOften not useful for
growing/volatile companies because P/E can be negative or vary greatly
from quarter to quarter
E(r) = Rf + ( Rm - Rf) X Beta
Security selection - for inclusion in a portfolioInferring market
expectations -- to determine Fundamental Value differs from market price
and To determine value as a Benchmark for company comparisonEvaluating
Corporate Events -- ie value of merger or spin-offFairness Opinion -
evaluation of offers for firm stock or assetsEvaluating Business
Strategies -- to see if SHAREHOLDER VALUE IS MAXIMIZEDCommunicate w.
Business Analysts and Shareholders -- value used to convey reason for an
actionEvaluate Private Bus
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