Chapter 14 Investment Analysis andPortfolio Management

1、Investment Analysis and Portfolio Management by Frank K. Reilly & Keith C. BrownCompany Analysis & Stock Valuation Company Analysis versus Stock Valuation Economic, Industry, and Structural Links to Company Analysis Company Analysis Estimating Intrinsic Value Analysis of Growth Companies Mea

2、sures of Value Added14-2Company Analysis and Stock Valuation After analyzing the economy and stock markets for several countries, you have decided to invest some portion of your portfolio in common stocks After analyzing various industries, you have identified those industries that appear to offer a

3、bove-average risk-adjusted performance over your investment horizon Which are the best companies? Are they overpriced?14-3Company Analysis and Stock Valuation Good companies are not necessarily good investments Compare the intrinsic value of a stock to its market value Stock of a great company may b

4、e overpriced Stock of a growth company may not be growth stock14-4 Growth companies have historically been defined as companies that consistently experience above-average increases in sales and earnings Financial theorists define a growth company as one with management and opportunities that yield r

5、ates of return greater than the firms required rate of returnGrowth Companies 14-5Growth Stocks Growth stocks are not necessarily shares in growth companies A growth stock has a higher rate of return than other stocks with similar risk Superior risk-adjusted rate of return occurs because of market u

6、ndervaluation compared to other stocks14-6Defensive Companies and Stocks Defensive Companies The firms whose future earnings are more likely to withstand an economic downturn Low business risk No excessive financial risk Typical examples are public utilities or grocery chainsfirms that supply basic

7、consumer necessities Defense Stocks The rate of return is not expected to decline or decline less than the overall market decline Stocks with low or negative systematic risk14-7Cyclical Companies and Stocks Cyclical Companies They are the companies whose sales and earnings will be heavily influenced

8、 by aggregate business activity Examples would be firms in the steel, auto, or heavy machinery industries. Cyclical Stocks They will have greater changes in rates of return than the overall market rates of return They would be stocks that have high betas.14-8Speculative Companies and Stocks Speculat

9、ive Companies They are the firms whose assets involve great risk but those that also have a possibility of great gain A good example of a speculative firm is one involved in oil exploration Speculative Stocks Stocks possess a high probability of low or negative rates of return and a low probability

10、of normal or high rates of return For example, an excellent growth company whose stock is selling at an extremely high P/E ratio14-9Value versus Growth Investing Growth stocks will have positive earnings surprises and above-average risk adjusted rates of return because the stocks are undervalued Val

11、ue stocks appear to be undervalued for reasons besides earnings growth potential Value stocks usually have low P/E ratio or low ratios of price to book value14-10Economic, Industry, and Structural Links to Company Analysis Company analysis is the final step in the top-down approach to investing Macr

12、oeconomic analysis identifies industries expected to offer attractive returns in the expected future environment Analysis of firms in selected industries concentrates on a stocks intrinsic value based on growth and risk14-11Economic and Industry Influences If trends are favorable for an industry, th

13、e company analysis should focus on firms in that industry that are positioned to benefit from the economic trends Firms with sales or earnings particularly sensitive to macroeconomic variables should also be considered Research analysts need to be familiar with the cash flow and risk of the firms14-

14、12Structural Influences Social trends, technology, political, and regulatory influences can have significant influence on firms Firms can grow and succeed despite unfavorable industry or economic conditions due to demographic changes or shifts in consumer tastes and lifestyles Early stages in an ind

15、ustrys life cycle see changes in technology which followers may imitate and benefit from Politics and regulatory events can create opportunities even when economic influences are weak14-13Company Analysis Firms Overall Strategic Approach Industry competitive environment SWOT analysis Strengths Weakn

16、esses Opportunities Threats Firms Valuation Approaches Present value of cash flows Relative valuation ratio techniques14-14Firm Competitive Strategies Defensive strategy involves positioning firm so that it its capabilities provide the best means to deflect the effect of competitive forces in the in

17、dustry Offensive strategy involves using the companys strength to affect the competitive industry forces, thus improving the firms relative industry position 14-15Firm Competitive Strategies Porter suggests two major strategies: Low-Cost Strategy The firm seeks to be the low-cost producer, and hence

18、 the cost leader in its industry Cost advantages vary by industry and might include economies of scale, proprietary technology, or preferential access to raw materials Differentiation Strategy Firm positions itself as unique in the industry in an area that is important to buyers A company can attemp

19、t to differentiate itself based on its distribution system or some unique marketing approach14-16Focusing a Strategy Select segments in the industry Tailor strategy to serve those specific groups Determine which strategy a firm is pursuing and its success Evaluate the firms competitive strategy over

20、 time See Exhibit 14.114-17Exhibit 14.114-18SWOT Analysis Internal Analysis Strengths Give the firm a comparative advantage in the marketplace Perceived strengths can include good customer service, high-quality products, strong brand image, customer loyalty, innovative R&D, market leadership, or

21、 strong financial resources Weaknesses Weaknesses result when competitors have potentially exploitable advantages over the firm14-19SWOT Analysis External Analysis Opportunities These are environmental factors that favor the firm They may include a growing market for the firms products (domestic and

22、 international), shrinking competition, favorable exchange rate shifts, or identification of a new market or product segment Threats They are environmental factors that can hinder the firm in achieving its goals Examples would include a slowing domestic economy, additional government regulation, an

23、increase in industry competition, threats of entry, etc14-20Some Lessons from Peter Lynch Favorable Attributes of Firms Firms product should not be faddish Firm should have some long-run comparative advantage over its rivals Firms industry or product has market stability Firm can benefit from cost r

24、eductions Firms that buy back shares show there are putting money into the firm 14-21Tenets of Warren Buffet Business Tenets Is the business simple and understandable? Does the business have a consistent operating history? Does the business have favorable long-term prospects? Management Tenets Is ma

25、nagement rational? Is management candid with its shareholders? Does management resist the institutional imperative?14-22Tenets of Warren Buffet Financial Tenets Focus on return on equity, not earnings per share Calculate “owner earnings” Look for companies with high profit margins For every dollar r

26、etained, make sure the company has created at least one dollar of market value Market Tenets What is the value of the business? Can the business be purchased at a significant discount to its fundamental intrinsic value? 14-23Estimating Intrinsic Value Present value of cash flows (PVCF) Present value

27、 of dividends (DDM) Present value of free cash flow to equity (FCFE) Present value of free cash flow (FCFF) Relative valuation techniques Price earnings ratio (P/E) Price cash flow ratios (P/CF) Price book value ratios (P/BV) Price sales ratio (P/S)14-24Present Value of Dividends Simplifying assumpt

28、ions help in estimating present value of future dividends Constant Growth DDMIntrinsic Value = D1/(k-g) and D1= D0(1+g) Growth Rate Estimates Average Dividend Growth Rate Sustainable Growth Rate g = RR X ROE1nDD0ng14-25Present Value of Dividends Required Rate of Return Estimate Nominal risk-free int

29、erest rate Risk premium Market-based risk estimated from the firms characteristic line using regressionE(RFR)E(RE(RFR)Rmarketstockstock14-26Present Value of Dividends The Present Value of Dividends Model (DDM) Model requires kg With gk, analyst must use multi-stage model The three-stage model exampl

30、e of the DDM approach in the book illustrates how to estimate the stock price experiences (1) high growth at 13% (2) declining growth (3) a constant perpetual growth of 7 percent14-27Present Value of Free Cash Flow to Equity Computing the FCFEFCFE =Net Income + Depreciation Expense - Capital Expendi

31、tures - D in Working Capital - Principal Debt Repayments + New Debt Issues14-28Present Value of Free Cash Flow to Equity The Constant Growth Formulawhere:FCFE = the expected free cash flow in period 1 k = the required rate of return on equity for the firmgFCFE = the expected constant growth rate of

32、free cash flow to equity for the firm A multi-stage model similar to DDM can also be appliedFCFEgkFCFEValue114-29Present Value of Operating Free Cash Flow Discount the firms operating free cash flow to the firm (FCFF) at the firms weighted average cost of capital (WACC) Computing FCFFFCFF =EBIT (1-T

33、ax Rate)+ Depreciation Expense - Capital Spending- D in Working Capital - D in other assets14-30 The Formulawhere: FCFF1 = the free cash flow in period 1OFCF1 = the firms operating free cash flow in period 1WACC = the firms weighted average cost of capitalgFCFF = the constant growth rate of free cas

34、h flowgOFCF = the constant growth rate of operating free cash flowOFCFFCFFgWACCOFCForgWACCFCFFValueFirm11 Present Value of Operating Free Cash Flow14-31 An alternative measure of long-run growthg = (RR)(ROIC)where:RR = the average retention rateROIC = EBIT (1-Tax Rate)/Total Capital Computation of W

35、ACCWACC=WE k + WD i where:WE = the proportion of equity in total capitalk = the after-tax cost of equity (from the SML)WD = the proportion of debt in total capitali = the after-tax cost of debtPresent Value of Operating Free Cash Flow14-32Relative Valuation Ratio Techniques The general relative valu

36、ation ratio techniques have been discussed in the previous chapters Exhibit 14.3 contains the basic data required to compute the relative valuation ratios Exhibit 14.4 contains the four sets of relative valuation ratios for Walgreens, its industry, and the aggregate market Due to the size, these two

37、 exhibits are not shown here14-33Estimating Company Earnings Per Share A Two-Step Process Sales Forecast It includes an analysis of the relationship of company sales to various relevant economic series It also includes a comparison with the industry series Estimated Profit Margin Identification and

38、evaluation of the firms specific competitive strategy The firms internal performance The firms relationship with its industry14-34Walgreens Competitive Strategies The Internal Performance Industry Factors Company Performance Net Profit Margin Estimate Computing Earnings per Share Importance of Quart

39、erly Estimates A way to confirm our annual estimate If the actual quarterly results are a surprise relative to our estimate, we will want to understand the reason for the surprise14-35Estimating Company Earnings Multipliers Macroanalysis of the Earnings Multiplier Microanalysis of the Earnings Multi

40、plier Comparing dividend-payout ratios Estimating the required rate of return Estimating the expected growth rate Computing the earnings multiplier Estimates of intrinsic value for Walgreens14-36Additional Measures of Relative Value Price/Book Value Ratio Book value is a reasonable measure of value

41、for firms that have consistent accounting practice It can been applied to firms with negative earnings or cash flows should not attempt to use this ratio to compare firms with different levels of hard assetsfor example, a heavy industrial firm and a service firm See Walgreens in Exhibits 14.16 &

42、 14.1714-37Exhibit 14.1614-38Exhibit 14.1714-39Additional Measures of Relative Value Price/Cash Flow Ratio The price/cash flow ratio has grown in prominence and use because many observers contend that a firms cash flow is less subject to manipulation See Walgreens in Exhibits 14.18 & 14.19 Price

43、-to-Sales Ratio Sales growth drives the growth of all subsequent earnings and cash flow and sales is one of the purest numbers available See Walgreens in Exhibits 14.20 & 14.2114-40Exhibit 14.1814-41Exhibit 14.1914-42Exhibit 14.2014-43Exhibit 14.2114-44Analysis of Growth Companies Generating rat

44、es of return greater than the firms cost of capital is considered to be temporary Earnings higher the required rate of return are pure profits How long can they earn these excess profits? Is the stock properly valued? Growth companies and the DDM No growth firms Long-run growth models14-45 A No-Grow

45、th Firm E = r x Assets E = r x Assets = Dividends (Firms has retention ratio, b, of 0) Firm Value Required Rate of ReturnNo-Growth Firm()kEbkEV1vEk 14-46Long-Run Growth Models Simple Growth Model It assumes the firm has growth investment opportunities that provide rates of return equal to r, where r

46、 is greater than k r=mk (m is the relative rate of return operator) D=E (1-b) Gross Present Value of Growth Investments Net Present Value of Growth InvestmentskbEmkbEmk2kbEkbEm14-47Long-Run Growth Models Simple Growth Model (continued) Firm Value PV of Constant Dividend + PV of Growth Investment PV

47、of Constant Earnings + PV of Excess Earnings from Growth Investment()kmbEkEV1kbEmkDVkbEkbEmkEV14-48Long-Run Growth Models Expansion Model Firm retains earnings to reinvest, but receives a rate of return on its investment equal to its cost of capital In this case, m = 1 so r = k Firm Value Recall the

48、 simple growth model When m=1k(mbEkEV1)kEV 14-49Long-Run Growth Models Negative Growth Model Firm retains earnings, but reinvestment returns are below the firms cost of capital. That is, r1 Since growth will be positive (r0) but slower than it should be (rk and m1 Firm value for the dynamic growth m

49、odel for an infinite time periodgkDV114-52Measures of Value-Added Economic Value-Added (EVA) It is equal to the net operating profit less adjusted taxes (NOPLAT) minus the firms total cost of capital in dollar terms, including the cost of equity EVA Return on Capital EVA/Capital This ratio can compa

50、re firms of different sizes and determine which firm has the largest economic profit per dollar of capita Alternative Measure of EVA Compare return on capital to cost of capital14-53Measures of Value-Added Market Value-Added (MVA) Measure of external performance How the market has evaluated the firm

51、s performance in terms of market value of debt and market value of equity compared to the capital invested in the firm Relationships between EVA and MVA mixed results14-54Measures of Value-Added The Franchise Factor Breaks P/E into two components P/E based on ongoing business (base P/E) Franchise P/

52、E the market assigns to the expected value of new and profitable business opportunities Franchise P/E = Observed P/E - Base P/E Incremental Franchise P/E = Franchise Factor X Growth Factorwhere R= the expected return on the new opportunities k=the current cost of equity r = the current ROE on invest

53、ment G= the PV of the new growth projects relative to the current value of the firmGrkkR14-55Growth Duration Model The purpose is to evaluate the high P/E ratio for the stock of a growth company by relating its P/E ratio to the firms rate of growth and duration of growth A stocks P/E is function of

54、expected rate of growth of earnings per share stocks required rate of return firms dividend-payout ratio The growth estimate must consider both the rate of growth and how long this growth rate can be sustainedthat is, the duration of the expected growth rate14-56Intra-Industry Analysis Directly comp

55、are two firms in the same industry An alternative use of T to determine a reasonable P/E ratio Factors to consider A major difference in the risk involved Inaccurate growth estimates Stock with a low P/E relative to its growth rate is undervalued Stock with high P/E and a low growth rate is overvalued14-57Site Visits and the Art of the Interview Focus on managements plans, strategies, and concerns Restrictions on nonpublic information “What if” questions can help gauge sensitivity of revenues, costs, and earnings Management may indicate appropriateness