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Asset Allocation 101 - Equities
- 1. EQUITIES All rights reserved. UlaAcademics
- 2. NOW, THAT WEHAVE THE OVERVIEW OUT OF THE WAY.. Equities is one of the most accessible type of investments; you see them mentioned in the newspapers, in media outlets, books, in conversations... But do you know that penetration rate of Equities is still relatively low globally? LET’S DIVE INTO EQUITIES, WELCOME! LETS GET STARTED
- 3. LIST OF CONTENT PRESENTATION Whatare equities? OVERVIEW OF EQUITIES 01 Defining the concept.. CAPITAL STRUCTURE 02 Valuing intrinsic worth of a company.. EQUITY VALUATION 03 Assessing how a company performs against peers.. RELATIVE VALUATION 04 05 Final discussion and next steps.. CONCLUSION
- 4. OVERVIEW OF EQUITIES Equitiesessentially allows one to have a small ownership stake in the company.. You may not get direct access to the company’s cashflows or have a stake in its assets (unlike bond holders..) but you participate in the upside of the company; whatever earnings it makes.. Now, you have to differentiate between MARKET VALUE and BOOK VALUE; while Company ABC may cost $5 a share to buy (for instance if you invested $100, you will get 20 shares excluding transaction costs.. with $5 being the MARKET PRICE you see on CNBC for instance.. ) it’s BOOK VALUE PER SHARE may be higher or lower than $5.. What is book value then? Well, Book Value of the company refers to Value of Total Assets - Total Liabilities.. Why would a company trade below or above its Book Value Per Share then? If Company ABC’s Book Value Per Share is $7, why is it trading only at $5? Well, this could be because market is undervaluing the company or expects its Book Value per share to be revised downwards in the near future.. According to the Efficient Market Hypothesis, this however, should not be happening and should be corrected by market forces very soon.. BOOK VALUE VERSUS MARKET VALUE
- 5. CAPITAL STRUCTURE Let’s takea short detour to touch briefly on the topic of capital structure.. This is important in the context of Corporate Finance and boils down to the idea of a misalignment of interests between debt and equity holders.. Now, debt holders (depending on seniority but assuming Senior Secured and Unsecured) are ranked higher than equity holders which imply in the event of bankruptcy, bond holders get paid before equity holders; with Senior Secured holders even having access to specific assets of the company.. Therefore when a company is facing a distressed situation, Equity Holders are incentivized to encourage the company to take on more risks to turn their situation around whereas Debt Holders are incentivized to get the company to preserve its assets as much as possible.. I KNOW, WE ARE TALKING ABOUT INVESTMENTS
- 6. EQUITY VALUATION For years,we have sought a way to quantitatively access our decisions to invest in a company.. Afterall, there should be a solid rationale behind such decisions.. Aswath Damodaran, a professor at New York University popularize some of the modern- day valuation models such as DCF (Discounted Cashflow Model), and derivatives such as FCFF (Free Cashflow to Firm) and FCFE (Free Cashflow to Equity) (no more acryonyms we promise!) In general, without diving into the details, the models try to assess the INTRINSIC WORTH of a company via projected ‘earnings’ of the company - discounting its Projected Cashflows by some Discount Rate.. Dividing the end figure by number of shares in case of FCFE, allows one to have a sense of amount of Free Cash Flow attributed to each share.. AH, THIS IS THE MILLION DOLLAR QUESTION.. LIQUIDITY LEVEL: 4 ****
- 7. TIME OUT! Turns outFinance is based on a old saying - A bird in the hand is worth more than 2 in the bush... That means money today is worth more than money tomorrow so for me to be indifferent between receiving money today and tomorrow, i must be compensated with ‘interest’ if i receive the money tomorrow... Similarly, a company’s Cashflows in the distant future must be discounted to its Present Value.. THE TIME VALUE OF MONEY WHAT IS DISCOUNT RATE?
- 8. TIME OUT! It iswidely believed that Benjamin Graham was the ‘Father’ of fundamental value analysis and whose works have influenced major investors of today such as Warren Buffet.. One famous book here is ‘The Intelligent Investor’.. Do give it a read if you are interested in Security Analysis and Value Investing.. FATHER OF FUNDAMENTAL VALUE.. BENJAMIN GRAHAM INTRINSIC WORTH OF A COMPANY..
- 9. RELATIVE VALUATION Well, comparingone company’s performance with its peers seem intuitive enough.. Even without realizing we often compare Google’s performance with other Technology giants, Bank of America’s performance with JP Morgan and so on.. This is called RELATIVE VALUATION; we find comparables to a company and gauge how the company has performed against a group of peers on financial metrics such as Return on Assets (R0A), Earnings per Share (EPS), Return on Equity (ROE) and so on.. Now choosing comparables for a company is somewhat an Art but besides being in the same industry, we also ideally want them to be engaged in broadly similar products or services and be broadly similar in size.. COMPARING A COMPANY WITH ITS PEERS..
- 10. CONCLUSION Let’s recap ourlearnings.. Please visit the next module in this Investing 101 course.. ! Book value versus Market Value LEARNING ONE: Time Value of Money LEARNING TWO: Equity Valuation - Intrinsic Worth and Value Investing LEARNING THREE: Relative Valuation - Comparison with Peers LEARNING FOUR:
- 11. UNTIL THE NEXT TIME! AllRights Reserved. Ula Academics.