How Financial Statements are used in Valuation

1. How Financial Statements are used in Valuation

2. Preface • Valuation models: • Multiple Analysis (The method of Comparables & Screening) • Asset-Based Valuation • Fundamental Analysis • The Architecture of Fundamental Analysis

3. Multiple Analysis • Methods of Comparables • Screening on Multiples • Technical Screens • Fundamental Screen

4. Price-To-Book Ratio - P/B Ratio A ratio used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. Also known as the "price-equity ratio". P/B = Stock Price (Total assets – Intangible Assets and Liabilities)/ No. of Shares outstanding

5. Price-to-Book Ratio • Perhaps the least valuable ratio is the Price-to-Book Ratio. Conceived in a time when world was made up mainly of industrial companies that had actual hard assets like factories to back up their stock, its utility has diminished in the past few decades as more and more companies that are not very capital intensive have grown and become commercial giants. The fact that Microsoft doesn't have very much in the way of book value doesn't mean the company is overvalued -- it just means that the company does not need a lot of land and factories to make a very high-margin product.

6. Price-to-Book Ratio • Traditional book value is simply the shareholders' equity divided by the number of shares of stock outstanding. In order to look at the company as a whole, you can use the aggregate market capitalization of the company divided by the current shareholders' equity.

7. Price-Earnings Ratio - P/E Ratio A valuation ratio of a company's current share price compared to its per-share earnings.P/E = Market Value per Share Earnings per Share (EPS) For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95). EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variationuses the sum of the last two actual quarters and the estimates of the next two quarters.Also sometimes known as "price multiple" or "earnings multiple".

8. Explanation of P/E Ratio Price –earning ratio compares current price with earning. P/E = Future Earnings Current Earnings Price the numerator is the market anticipated price is the market anticipation of value to be added from sales in future, that is the future earnings. The denominator is current earning , value added from current sales. So P/E ratio compares forecasted future earnings to current earning. If one considered more future earnings than current earnings, the P/E ratio should be high and vice versa. To be more concise P/E ratio reflects anticipated earning growth.

9. Forward Price To Earnings - Forward P/E A measure of the price-to-earnings ratio (P/E) using forecasted earnings for the P/E calculation. While the earnings used are just an estimate and are not as reliable as current earnings data, there is still benefit in estimated P/E analysis. The forecasted earnings used in the formula can either be for the next 12 months or for the next full-year fiscal period. Forward P/E = Market Value per Share Expected Earnings per Share (EPS)

10. Price-To-Sales Ratio - Price/Sales A ratio for valuing a stock relative to its own past performance, other companies or the market itself. Price to sales is calculated by dividing a stock's current price by its revenue per share for the trailing 12 months: PSR = Share Price Revenue Per Share The ratio can also be referred to as a stock's "PSR". The price-to-sales ratio can vary substantially across industries; therefore, it's useful mainly when comparing similar companies. Because it doesn't take any expenses or debt into account, the ratio is somewhat limited in the story it tells.

11. Price-To-Cash-Flow from operations Ratio A measure of the market's expectations of a firm's future financial health. Because this measure deals with cash flow from operations, the effects of depreciation and other non-cash factors are removed. Similar to the price-earnings ratio, this measures provides an indication of relative value. P/CFO = Share Price Cash Flow from Operations per share Because accounting laws on depreciation vary across jurisdictions, the price-to-cash-flow ratio can allow investors to assess foreign companies from the same industry (ex. mining industry) with a bit more ease.

12. Relative/Comparable Valuation

14. Enterprise Value • The enterprise value (EV) to shareholders' equity (SE) • EV/SE = (Shares Outstanding x Price) + Debt-Cash) Shareholders' equity • This number will get you a simple multiple, much like the price/earnings ratio or the price/sales ratio. If it is below 1, then it means that the company is selling below book value and theoretically below its liquidation value. Some value investors will avoid any companies that trade above 2 times book value or more

15. Enterprise Value • Enterprise Value, which is market capitalization minus cash and equivalents plus debt. The reason you subtract cash and equivalents from market capitalization is because if someone were to actually buy the company, they would get all the cash the company currently has, meaning it would effectively be deducted from the cost after the transaction was closed.

16. Advantages of Relative/Comparable Valuation • Relative valuation is much more likely to reflect market perceptions. This can be an advantage when it is important that the price reflect these perceptions as is the case when the objective is to sell a security at that price today (as in the case of an IPO). • Relative valuation generally requires less information than discounted cash flow valuation. • Easy to measure but chances of fallacy is relatively high. • Relative Valuation / Comparables Methods are used where similar companies are available in the business. (An initial public offering (IPO), referred to simply as an "offering" or "flotation", is when a company (called the issuer) issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately owned companies looking to become publicly traded.)

17. Disadvantages of Relative/Comparable Valuation Relative valuation may require less information in the way in which most analysts and portfolio managers use it. However, this is because implicit assumptions are made about other variables (that would have been required in a discounted cash flow valuation). To the extent that these implicit assumptions are wrong the relative valuation will also be wrong. (

18. Unlevered (or Enterprise) Multiples • Leverage involves borrowing. A given set of assets can be financed by equity or by debt (borrowing). Hence, the balance sheet equation, Assets = Liabilities (Debt) + Shareholders’ Equity. Some items in the financial statements have nothing to do with the amount of debt relative to equity (the amount of leverage). So the price multiple for this item should not reflect the leverage. What is the price that is not affected by leverage (the unlevered price)?   • Value of the Firm = Value of Debt + Value of Equity  • The unlevered value is the value of the firm – or the value of the enterprise – that is, the value that is independent of the amount of debt relative to equity.

19. Unlevered (or Enterprise) Multiples • Below are some unlevered multiples. The multiple of sales, for example, must be an unlevered multiple. Sometime people calculate the P/S ratio as the price of the equity/sales. But sales are generated by the assets of the enterprise, not by the amount of equity. Sales are not affected by the degree to which the assets are financed by borrowing. So the appropriate price in the numerator is the price of the enterprise, that is, the price of the equity plus the price of the debt.

20. Unlevered Price to Sales, ebit & ebitda • Unlevered P/S Market Value of Equity + Debt sales • Unlevered P/ebit Market Value of Equity + Debt ebit • Unlevered P/ebitda Market Value of Equity + Debt ebitda

21. Price-to-ebitda Ratios • Some analysts use the ratio, price/ebitda, to value shares. Ebitda is earnings before interest, taxes, depreciation and amortization. The use of this multiple can lead to errors. • Taxes have to be paid (but excluded in ebitda), so you should pay less for a firm that has higher taxes. So taxes must be taken into account in the earnings you are buying. We all wish that we could ignore taxes, but we can’t unfortunately. And depreciation is a real cost, just like wages expense: plants rust and becomes obsolescent and have to be replaced. Amortization expense can be a real cost also: patents expire and goodwill can decline in value.

22. P/E Ratios and Dividends • P/E Ratios and Dividends   Trailing P/E ratios from rolling P/E and leading (or forward) P/E ratios. It also indicates that, in calculating standard and rolling P/E ratios, price in the numerator should be adjusted for dividends that have been paid.

24. Technical Analysis • Two major types of analysis for predicting the performance of a company’s stock • Technical Analysis / Technical screening • Fundamental Analysis / Fundamental Screening Technical Analysis • looks for peaks, bottoms, trends, patterns, and other factors affecting a stock’s price movement • makes a buy/sell decision based on those factors • The world of technical analysis is huge • Hundreds of different patterns and indicators investors claim to be successful

25. What is Technical Analysis? • Method of evaluating securities by analyzing statistics generated by • Market activity • Past Prices • Volume • It does not attempt to measure intrinsic value • Instead look for patterns and indicators on charts to determine future performance

26. What is Technical Analysis • Technicians believe that securities move in very predictable trends and patterns • Trends continue until something happens to change the trend • Until that change takes place, price levels are predictable • Most agree that technical analysis is much more effective when combined with fundamental analysis

27. The Bar Chart

28. The Bar Chart • Some of the most popular type of charts are bar charts • Advantage is that it show the high, low, open and close for each day

29. Technical Analysis / Technical Screening • Price Screening Buy stock whose price drop a lot, sell whose price have increase a lot • Small Stock Screening Buy stock with low market value and sell stock with high market value • Neglect Stock Screening Buy stock not followed by many analysis • Seasonal Screening Buy stock that are certain time of the year • Momentum Screening Buy stock that have had increase in stock price • Insider Trader Screening Get real data from SECP about the firm and then decided where to invest

30. Fundamental Analysis / Fundamental Screening • Price to Earning (P/E)Screening Buy firm with low P/E ratio and sell firm with high P/E ratio • Price to Book Value (P/B) Screening Buy firm with low P/B ratio and sell firm with high P/B ratio • Price to Cash Flow (P/CFO) Screening Buy low price relative to cash from operations, sell high P/CFO • Price to dividend (P/D)Screening Buy low p/d & sell high p/d

31. The Bar Chart

33. http://screen.yahoo.com/stocks.html Some engines rank firms on particular price ratios. For example, http://screen.morningstar.com/stocksearch/stockrank.html http://www.globalfindata.com