ex. IF Rent: 2million, and required return is 25%, then 2 million / .25 = …………
If required return is 0.15: 2 / 0.15 = …..
If required return is 0.08: 2 / 0.15 = …..
ex. Rent of 1 bn, required 12%, value of the building is: ……………………
Value of a business
Stable business, generates P20m a year
Earnings / “r” = Value. PER
20 / .15 = 133m 1/.15 = 6.6x
20 / .20 = 100m 1/.20 = 5.0x
20 / .30 = 66m 1/.30 = 3.3x
PER multiple = 1/ required return
Value of 133/earnings of 20 = 6.6x
Earnings of 20/Value of 133 = 15%
Value of a business
Stock PeR multiple= Price / Earnings
Earnings x multiple = value.
Net income x multiple = value
Sales x multiple = value
Cash flow x multiple = value
This business earns 30,000 a year. Other businesses of this same type are valued at a multiple of 15x. This business must be worth P…………
This business earns 4 million a year. Other businesses of this same type are valued at a multiple of 12x. This business must be worth P…………
Value of a business
300,000 a year Take the same earnings of 300,000
at 15x = 4.5m discounted using 0.066667 =…….
at 12x = 3.6m discounted using 0.08333 =…….
at 8x = 2.4m discounted using 0.125 =…….
Part 2 Company analysis
Understanding a Company
How elastic is the demand for the company’s products/services?
Is the demand seasonal?
What is the raw material situation?
What are the key products for the company and what is their contribution?
How is the company competitively placed in that product segment?
Which geographies are key revenue contributors to the company revenues?
How competitively poised is the company in that geography?
How risk free is the geography?
Which product contributes maximum to the company’s profits
Which geographies contribute the maximum to the company’s profits
Does the company have a unique selling proposition (USP)?
How strong/sustainable is the company’s USP?
Does the company enjoy an important position in the market (like largest player etc)?
Business Product Segments Geographic Segment Key Profit Contributors USP
Raw Material 1 Raw Material 2 Raw Material 3 Manufacturer (Production Processes) Distributor/Wholesaler Retailer Allied Components Allied Services like Transportation; security etc Exclusive Showrooms Intermediaries in Raw Material Procurement Value Chain Analysis
Quality of Components
Cost of components
Speed of Delivery
Time for scaling up
Factory location (near RM or customer)
Ability to scale up
Efficiency of routing and scheduling
Cost-Benefit of having exclusive show rooms
Benefit of additional visibility through showrooms
Margins/incentives to dealers
Timely distribution (wh salers)
Competition from local products
Retail level promotions
Cost of Raw Mat
Adequacy of supply
Long term supply contracts
Cost of Transport
Value chain’s impact Cost of Raw materials Warehousing Trucking Cost of Goods Sales Other income Workers salaries Selling Gen Admin expenses Tax savings Lower Interest expenses Making money or saving money, from manufacturing process or from any other process. Value
Interpreting News Items/Developments
What will be the impact of the news/development on the company’s business?
Is the news/development a positive or a negative aspect about the company?
Why will a particular development/news affect the business of the company?
In case of a threat, can the company escape it?
How profound will be the impact of a news/development on the company’s business
What? Why? How Much?
Part 3 Financial statement analysis
Growth in Prices Growth in Volumes REVENUE GROWTH
Volume Growth Because of:
Better marketing/brand promotion by the company
Improved/enhanced distribution by the co.
Expansion into new region/product/variant
Take over of a competitor
Industry wide demand increase
One time increase because of a special order
Is the Price Growth Sustainable
Price increase is industry wide/individual initiative?
How elastic is the demand for the product?
What is the competition scenario (fragmented?)
Does the industry operate on a premium concept?
Is there scope for another price increase?
Decline in Prices Decline in Volumes REVENUE DECLINE
Volume Decline Because of:
Better brand promotion by competitors
Obsolete/outdated technology; quality issues
Problems in supply chain management
Failing relationships with workers/distributors
Reasons for Price Decline:
Competition induced price decline. not always sustainable)
Product un-sellable (forced to reduce price)
Regulatory price fixing (my force out small players)
More efficient production (should reflect positively in volumes)
Favorable tax policy (should reflect positively in volumes)
Analysing Revenue Changes: Growth/Decline in Revenues
Cost of Goods Sold (COGS) Selling, General & Admin Expenses (Includes Marketing Expenses) Salaries & Wages Interest Income/Expenses
COGS Increase :
Increase in RM prices (is this rise more than revenue increase?)
Increase in production/take over of new company (should reflect positively in revenues)
COGS decline – More efficient raw material procurement/ use of alternative RM
COGS decline – More cost efficient production process
Intensive Marketing and Promotion Campaign (should reflect in revenues)
Acquisition/expansion activity going on (check whether earlier acquisitions were compatible)
Company caught in litigations/legal activity (this cost is also categorized as Professional Exp)
Increase in Salaries and Wages:
Increase in average wage rate (check whether this is a because company is doing good?)
Additional hiring in marketing/production/legal departments (does it reflect in co performance)
Payment of performance oriented bonus/ bonus for employee retention (is labor mkt stressed)
Interest Expense Increase:
Additional debt taken by the company (check how company expects to use this debt)
Earlier default by company, new interest is penal interest
New liabilities taken over due to new acquisitions (check whether acquisition was profitable, i.e assets greater than liabilities)
If new acquisition not profitable, did company get a government aid for acquisition
Analysing Cost Changes Note: Also check reasons for increase in depreciation & amortisation; unusual expenses and use of deferred tax asset/liability
Understanding the Balance Sheet
A balance sheet indicates all sources of funds for a company and where it applies those funds
Liabilities reflect the various ways in which a company has raised short term and long term funds
Assets are where such funds are utilised
All sources of funds come at a cost.
All application of funds should come at a profit
A balance sheet analysis involves analysing efficiency of use of funds, measuring solvency (asset-liability matching) and operational efficiency
Analysing a Balance Sheet
Analysis of solvency of the company
Gearing Ratio (Long term Liabilities/Net Worth)
Working Capital should be positive (current assets - current liabilities)
Long term assets should be backed by long term liabilities only
Analysis of Operational Efficiency
Inventory Days of Handling
A/c Receivables Days of Handling
A/c Payables Days of Handling
Working Capital Turnover (Sales/Working capital *100)
Analysis of Efficiency in use of capital/assets
Return on Equity
Return on Capital Employed
Return on Assets
Compare Ratios with Peers to get Industry view
Ratios: what they mean for business Solvency Ratios Ratio for measuring operational efficiency Ratio’s for measuring efficient use of capital/assets
An adverse short term solvency ratio (current ratio/quick ratio) indicates a short term liquidity crunch
A high gearing ratio means that much more interest expenses
A high gearing ratio may also make it difficult for the company to raise new debt
Long term assets backed by short term liabilities (current liabilities) is a potential liquidity problem
High inventory days of handling (especially as compared to peers) may indicate problems with inventory management.
This ratio say that either demand is low for products or company is producing more than needed. Both will affect profits
High A/c receivables days of handling means receivables are not quickly converted to cash. Hence operating cash flow will not grow in sync with profits
Low a/c payable days of handling means credit period from suppliers is very low. This will reflect into greater requirement of working capital, hence more short term loans
Adverse ratio (in comparison to competitors) means company is not utilizing its capital/assets as well as its competitors
Adverse ratio could reflect problems with low revenues or high costs. High costs may also reflect in to problems with pricing of products
Maintenance CAPEX: Is maintenance CAPEX as a percentage of revenues going up. Check why and is that rational
Expansion CAPEX: Expansion capex drains out cash reserves. Check whether expenditure will help company
Additional Debt: Additional Debt means more interest costs. Check how company expects to use new debt.
Debt substitution: debt substitution means taking low cost debt to pay off high cost debt. This is a positive sign