1. Equity Valuation Process • Valuation? • The Scope of Equity Valuation • Stock Selection • Extracting Market Expectations • Evaluation of Corporate Events/Business Strategies/Private Businesses • Rendering Fairness Opinion • Communication with share holders and analysts

2. Equity Valuation Process • Valuation and Portfolio Management • Planning • Setting investment objectives • Internal and external constraints • Investment strategy • Issues with benchmark • Active vs. passive management • Execution • Portfolio composition decision • Portfolio implementation decision • Feedback • Performance evaluation • Portfolio revision

3. Equity Valuation Process • Valuation Concepts and Models • The Process • Understanding the business • Industry structure, regulation, competitiveness, strategies. • Forecasting company performance • Internal and external constraints • Selecting appropriate valuation model • Dividend growth, uneven growth, CF, FCF,… • Converting forecasts to a valuation • Assumptions • Making the investment recommendation

4. Equity Valuation Process • Understanding the Business • Industry structure • Underlying economic and technical structure • Size and growth over time • Recent development (technical, financial, management, regulatory…) • Supply / demand imbalance • Competitiveness • Current market share • Growth/trend in market share

5. Equity Valuation Process • Understanding the Business • Competitive strategy • Cost leadership • Product differentiation • Focus – targeted market segment with cost focus or product differentiation • Execution of strategies • Competent execution of strategies

6. Equity Valuation Process 2. Forecasting company performance involves forecasts of macroeconomic environment and firm’s own financial characteristics. • Macro Environment • Top-down method • International, national, industry, company … • Bottom- up method • Aggregate individual company forecasts into industry forecast to finally macroeconomic forecasts. • Problems with assumptions

7. Equity Valuation Process • Financial Forecasting • Qualitative and quantitative factors in forecasting • Quality of Earnings! • Identify appropriate risk factors • Quality of accounting disclosure • High management/director/audit firm turnover • History of securities law violation • Excessive pressure to make revenue targets • Compensation structure

8. Equity Valuation Process 3. Selecting appropriate valuation model • Intrinsic Value – derived after complete understanding of the asset’s investment characteristics. To be successful, accurate forecasts and appropriate valuation model is essential. • What is Abnormal return (also known as alpha)?

9. Equity Valuation Process What is Abnormal return or Ex anteα? Ex anteα = E(HPR) – RR E(HPR) = sum of expected capital gains and investment income. RR = Fair or equilibrium return given its level of risk. How to calculate RR – CAPM or FF? Explain.

10. Equity Valuation Process What is Abnormal return or Ex postα? Ex postα = Actual (HPR) – Contemporaneous RR Actual (HPR) = sum of actual capital gains and investment income. Contemporaneous RR is based on the current market condition.

11. Equity Valuation Process 3. Selecting appropriate valuation model • Absolute Valuation Models – used in determining asset’s intrinsic value • Discounted CF model • Discounted FCF to equity model • Discounted FCF to the Firm model • Dividend Discount model • Residual Income model

12. Equity Valuation Process 3. Selecting appropriate valuation model c. Other Value Measures • Going-concern value – appropriate assumption for publicly traded companies. They have long lives. • Liquidation value – if dissolved now and assets sold individually. • For a profitable going concern, value added by assets plus human capital must > liquidation value • Persistently unprofitable businesses – the relationship is reversed. • Reason for LBO, going private, divestiture. • Liquidation value is the Fair Value.

13. Equity Valuation Process 3. Selecting appropriate valuation model d. Relative Valuation Models – used in determining value of a going concern relative to that of another asset • Earnings multiplier (P/E) model – low P/E vs. high P/E • Sales multiplier (P/S) model • Cash flow multiplier (P/CF) model

14. Equity Valuation Process 3. Selecting appropriate valuation model e. Use of appropriate discount rate • Types of risk prmia to be included • Controlling ownership position – Control premium • Non-publicly traded stock – marketability premium • Publicly traded but less depth/breadth – Liquidity premium

15. Equity Valuation Process 4. Performing valuation Analyst’s Role • Collecting, organizing, analyzing, and communicating corporate information • Help their clients achieve investment objective • Contribute to efficient functioning of capital market • Benefit the supplier of capital by monitoring management performance.

16. Equity Valuation Process 5. The Report See separate outline