Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Lecture Presentation Software to accompany

945 views

Published on

  • Be the first to comment

  • Be the first to like this

Lecture Presentation Software to accompany

  1. 1. Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Seventh Edition by Frank K. Reilly & Keith C. Brown Chapter 13
  2. 2. Applying the DDM Valuation Model to the Market <ul><li>The stream of expected returns </li></ul><ul><li>The time pattern of expected returns </li></ul><ul><li>The required rate of return on the investment </li></ul>
  3. 3. Applying the DDM Valuation Model to the Market <ul><li>Determinants of the Earnings Multiplier: </li></ul><ul><li>1. The expected dividend payout ratio </li></ul><ul><li>2. The required rate of return on the stock </li></ul><ul><li>3. The expected growth rate of dividends for the stock </li></ul>
  4. 4. Market Valuation Using the Reduced Form DDM <ul><li>Estimating k and g for the U.S. equity market </li></ul><ul><li>The nominal risk-free rate </li></ul><ul><li>The equity risk premium </li></ul><ul><li>The current estimate of Risk Premium and k </li></ul><ul><li>Estimating the growth rate of dividends (g) </li></ul><ul><ul><li>g = f(b,ROE) </li></ul></ul><ul><li>ROE = Net Income / Equity </li></ul>
  5. 5. Estimating Growth Rate <ul><li>Growth rate of dividends is equal to </li></ul><ul><ul><li>Retention rate - the proportion of earnings retained and reinvested </li></ul></ul><ul><ul><li>Return on equity (ROE) – rate of return earned on investment </li></ul></ul><ul><ul><li>An increase in either or both of these variables causes an increase in the expected growth rate (g) and an increase in the earnings multiplier </li></ul></ul>
  6. 6. Return on Equity (ROE) Profit Total Asset Financial Margin Turnover Leverage = x x
  7. 7. Market Valuation Using the Free Cash Flow to Equity (FCFE) Model <ul><li>FCFE is: </li></ul><ul><li>+ Net Income </li></ul><ul><li>+ Depreciation Expense </li></ul><ul><li>- Capital Expenditures </li></ul><ul><li>-  in Working Capital </li></ul><ul><li>- Principal Debt Repayments </li></ul><ul><li>+ New Debt issues </li></ul>
  8. 8. Market Valuation Using the Free Cash Flow to Equity (FCFE) Model <ul><li>The Constant Growth FCFE Model </li></ul><ul><li>The Two Stage Growth FCFE Model </li></ul>
  9. 9. Market Valuation Using Relative Valuation Approach <ul><li>The price-earnings ratio (P/E) </li></ul><ul><li>The price-book value ratio (P/BV) </li></ul><ul><li>The price-cash flow ratio (P/CF) </li></ul><ul><li>The price-sales ratio (P/S) </li></ul>
  10. 10. Market Valuation Using Relative Valuation Approach <ul><li>Two-part valuation procedure </li></ul>
  11. 11. Market Valuation Using Relative Valuation Approach <ul><li>Importance of both components of value </li></ul><ul><ul><li>1. Estimating the future earnings per share for the stock-market series </li></ul></ul><ul><ul><li>2. Estimating a future earnings multiplier for the stock-market series </li></ul></ul>
  12. 12. Estimating Expected Earnings Per Share <ul><li>Estimating expected earnings per share </li></ul><ul><ul><li>Estimate sales per share for a stock-market series </li></ul></ul><ul><ul><li>Estimate the operating profit margin for the series </li></ul></ul><ul><ul><li>Estimate depreciation per share for the next year </li></ul></ul><ul><ul><li>Estimate interest expense per share for the next year </li></ul></ul><ul><ul><li>Estimate the corporate tax rate for the next year </li></ul></ul><ul><li>Estimating Gross Domestic Product </li></ul><ul><li>Estimating sales per share for a market series </li></ul>
  13. 13. Estimating Expected Earnings Per Share <ul><li>Alternative estimates of corporate net profits </li></ul><ul><ul><li>Direct estimate of the net profit margin based on recent trends </li></ul></ul><ul><ul><li>Estimate the net before tax (NBT) profit margin </li></ul></ul><ul><ul><li>Estimate an operating profit margin to obtain EBITDA; estimate depreciation and interest to arrive at EBT; estimate the tax rate (T) and multiply by (1-T) to estimate net income </li></ul></ul>
  14. 14. Estimating Expected Earnings Per Share <ul><li>Estimating aggregate operating profit margins </li></ul><ul><ul><li>Capacity utilization rate </li></ul></ul><ul><ul><li>Unit labor costs </li></ul></ul><ul><ul><li>Rate of inflation </li></ul></ul><ul><ul><li>Foreign competition </li></ul></ul>
  15. 15. Estimating Expected Earnings Per Share <ul><li>Estimating depreciation expense </li></ul><ul><ul><li>time series trends </li></ul></ul><ul><ul><li>estimate based on property, plant, and equipment </li></ul></ul><ul><ul><ul><li>sales and turnover </li></ul></ul></ul><ul><ul><ul><li>depreciation </li></ul></ul></ul>
  16. 16. Estimating Expected Earnings Per Share <ul><li>Estimating interest expense </li></ul><ul><ul><li>debt levels </li></ul></ul><ul><ul><ul><li>total assets </li></ul></ul></ul><ul><ul><ul><li>expected capital structure </li></ul></ul></ul><ul><ul><li>interest rates </li></ul></ul><ul><ul><li>subtract result from EBIT to estimate EBT </li></ul></ul>
  17. 17. Estimating Expected Earnings Per Share <ul><li>Estimating the tax rate </li></ul><ul><ul><li>depends on future political action </li></ul></ul><ul><ul><li>multiply (1-T) times the EBT per-share to estimate the net income per share </li></ul></ul>
  18. 18. Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Determinants of the earnings multiplier </li></ul><ul><ul><li>Dividend payout ratio </li></ul></ul><ul><ul><li>required rate of return on common stock </li></ul></ul><ul><ul><li>the expected growth rate of dividends for the stocks </li></ul></ul>
  19. 19. Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Estimating the required rate of return (k) </li></ul><ul><ul><li>inversely related to the earnings multiplier </li></ul></ul><ul><ul><li>determined by risk-free rate, expected inflation, and the risk premium for the investment </li></ul></ul><ul><li>Estimating the dividend payout ratio (D/E) </li></ul><ul><ul><li>active decision or residual outcome? </li></ul></ul><ul><ul><li>time series plots </li></ul></ul><ul><ul><li>long-run perspective </li></ul></ul>
  20. 20. Estimating the Earnings Multiplier for a Stock Market Series <ul><li>Estimating an Earnings Mutiplier: An Example </li></ul><ul><ul><li>The Direction of Change Approach </li></ul></ul><ul><ul><li>Specific Estimate Approach </li></ul></ul><ul><li>Calculating an Estimate of the Value for the Market series </li></ul>
  21. 21. Other Relative Valuation Ratios <ul><li>Price to book value ratio (P/BV) </li></ul><ul><li>Price to cash flow ratio (P/CF) </li></ul><ul><li>Price to sales ratio (P/S) </li></ul>
  22. 22. Analysis of World Markets <ul><li>Individual country analysis </li></ul><ul><ul><li>analyze economy and security markets before analyzing alternative industries or companies </li></ul></ul><ul><ul><li>macro techniques </li></ul></ul><ul><ul><li>micro techniques </li></ul></ul><ul><ul><li>technical analysis </li></ul></ul><ul><ul><li>top down approach </li></ul></ul>
  23. 23. The Internet Investments Online <ul><li>www.ms.com </li></ul><ul><li>www.yardeni.com </li></ul><ul><li>www.nabe.com </li></ul><ul><li>www.agedwards.com </li></ul>

×