Ratio Analysis and Valuation.ppt

Ratio Analysis and Valuation Valuation theory Discounted free cash flows Residual income ROE disaggregation into RNOA and financial returns ROE - Identifying and Computing Operating Working Capital and Operating Assets exercise ROE Disaggregation (PG) exercise Pfizer (PFE) valuation exercise Margin and Turnover EVA FCF and RI models The FCF and RI models are theoretically equivalent since both are derived from the dividend discount model. They will, therefore, yield the same valuation in a steady state (constant RNOA) FCF defines value in terms of cash flows. RI defines value in terms of accrual accounting (earnings and book values) Lower terminal value for ROPI version of RI model vs. DCF Spreads v. Market-to-Book For Dow Jones Industrials ROE Disaggregtion – PG Profitability Ratios ROE Disaggregtion – PG Turnover Ratios ROE Disaggregtion – PG ROE Components ROE Disaggregtion – PG ROE Components ROE Disaggregtion – PG Liquidity and Solvency ROE Disaggregtion – PG Altman Z-Score PG 5-Year Stock Price Trend ROE DisaggregationEmpirical Findings Definition:ROE = RNOA + LEV × Spread Median 12.2% ≈ 10.3% + 0.40 × 3.3% Companies are, on average, conservatively financed (LEV1.0). They earn, on average, a positive spread on borrowed monies. RNOA is, on average, approximately 84% of reported ROE. All industries that survive must earn a combination of operating and financial returns that meet shareholder expectations. Behavior Over Time(Nissim and Penman 2001) ROCE v. Ke (Nissim and Penman 2001) Margin and Turnover Exercise Compare RI with Economic Value Added TM (“EVA”) Under EVA, MV = capital + PV of future EVA, where EVA1 = NOPAT1 - kwacc*capital0 EVA Exercise EVA Exercise – Areas for Improvement * ? 2005 by Robert F. Halsey, all rights reserved * * ? 2005 by Robert F. Halsey, all rights reserved * * ? 2005 by Robert F. Halsey, all rights reserved * Approaches to valuation Dividend discount model: From the statement of cash flows, d =