Intrinsic
Undervalued: value >
market price
Intrinsic
Fairly valued: value =
market price
Intrinsic
Overvalued: value <
market price
DEALING WITH UNCERTAINTY
Confidence in
intrinsic value
estimate
Uncertainties
related to model
appropriateness
and the correct
value of inputs
MAJOR CATEGORIES OF EQUITY
VALUATION MODELS
Dt FCFEt
V0 V0
t 1 (1 r ) t
t 1 (1 r ) t
PREFERRED STOCK VALUATION (NON-
CALLABLE, NON-CONVERTIBLE SHARES)
D0 $5.50
Perpetual V0 $91.67
r 0.06
n
Dt F
V0
t 1( 1 r ) ( 1 r )
Maturity t n
at time 12
GBP2.00 GBP20.00
period n V0 t
GBP31.01
t 1( 1 0.041) ( 1 0.041)
12
THE EFFECT OF OPTIONS ON THE PRICE
OF A PREFERRED SHARE
May be
Lower share
Call option exercised by
price
the issuer
May be
Retraction Higher share
exercised by
(put) option price
the investor
THE GORDON GROWTH MODEL
Assumptions:
Dividends are the correct metric to use for valuation
purposes.
The dividend growth rate is forever: It is perpetual and
never changes.
The required rate of return is also constant over time.
The dividend growth rate is strictly less than the required
rate of return.
D0 (1 g )t D0 (1 g ) D1
V0
t 1 (1 r ) t
rg rg
EUR5.00(1 0.04)
V0 EUR130
0.08 0.04
WHEN IS THE GORDON GROWTH MODEL
MOST APPROPRIATE FOR VALUING EQUITY?
Dividend- Insensitive to
paying the business
company cycle
Use the
Mature
Gordon
growth phase
growth model
ESTIMATING A LONG-TERM GROWTH
RATE
Use
multistage
dividend
discount
model
THE TWO-STAGE DIVIDEND DISCOUNT
MODEL
Dividends grow at rate gS for n years and rate gL
thereafter:
D0 1 g S
n t
Vn
V0
t 1 (1 r ) t
(1 r ) n
Dn 1
Vn
r gL
Dn 1 D0 1 g S 1 g L
n
THE TWO-STAGE DIVIDEND DISCOUNT
MODEL
(CONTINUED FROM PREVIOUS SLIDE)
D1 $5.00(1 0.10) $5.50
D2 $5.00(1 0.10) 2 $6.05
D3 $5.00(1 0.10) 3 $6.655
D4 $5.00(1 0.10) 3 (1 0.05) $6.98775
$6.98775
V3 $69.8775
0.15 0.05
$5.50 $6.05 $6.655 $69.8775
V0
1 0.15 (1 0.15) 2
(1 0.15) 3
(1 0.15) 3
V0 $59.68
PRICE MULTIPLES
Fundamentals or
cash flow predictions
Discounted cash
flow model
Justified value of a
multiple
JUSTIFIED FORWARD P/E FOR NESTL
Required Rate of Return = 12 percent
Constant Dividend Dividend Payout Ratio
Growth Rate 40.0% 42.5% 45.0% 47.5% 50.0%
7.0% 8.0 8.5 9.0 9.5 10.0
7.5% 8.9 9.4 10.0 10.6 11.1
8.0% 10.0 10.6 11.3 11.9 12.5
8.5% 11.4 12.1 12.9 13.6 14.3
9.0% 13.3 14.2 15.0 15.8 16.7
9.5% 16.0 17.0 18.0 19.0 20.0
10.0% 20.0 21.3 22.5 23.8 25.0
10.5% 26.7 28.3 30.0 31.7 33.3
D1 algebra P0 D1 / E1 p 0.45
P0 12.9
rg E1 rg r g 0.12 0.085
THE METHOD OF COMPARABLES
Method of
comparables
Comparison to Comparison to
past or benchmark or
average values peer group
PRICE-TO-SALES RATIO DATA FOR MAJOR
AUTOMOBILE MANUFACTURERS (2009)
Company P/S
General Motors 0.01
Ford Motor 0.14
Daimler 0.27
Nissan Motor 0.32
Honda Motor 0.49
Toyota Motor 0.66
P/E DATA FOR CANON
Sources: EPS and P/E data are from Canons website: www.canon.com.
P/E is based on share price data from the Tokyo Stock Exchange.
ENTERPRISE VALUE MULTIPLES
Market value
Market Market value Cash and Enterprise
capitalization
of preferred
of debt equivalents value
stock
Enterprise
EBITDA EV/EBITDA
value (EV)
EV/OPERATING INCOME DATA FOR NINE
MAJOR MINING COMPANIES
Operating
Ticker EV Income (OI)
Company Symbol (C$ millions) (C$ millions) EV/OI
BHP Billiton BHP 197,112.00 9,794.00 20.1
Rio Tinto RIO 65,049.60 7,905.00 8.2
Anglo American AAL 48,927.30 6,208.00 7.9
Barrick Gold ABX 35,288.00 1,779.00 19.8
Goldcorp G 28,278.00 616.66 45.9
Newmont Mining NEM 22,040.80 1,385.00 15.9
AngloGold Ashanti AU 19,918.30 362.00 55.0
Alcoa AA 17,570.40 4,166.00 4.2
Freeport-McMoRan Copper & Gold FCX 11,168.40 2,868.75 3.9
Source: www.miningnerds.com
ASSET-BASED VALUATION
Intangible assets