Cash Is King Chapter 5 Review FIN 690 Steve Ruesch April 09, 2003
Chapter 5 - Cash Is King Quote from an expert in the field “Everything we do should increase the Net Present Value of the company” Mo Vaziri (April 02,2003)
Chapter 5 - Cash Is King Valuation Methods Traditional Accounting Measurements Balance Sheet (On and Off) Income Statement Statement of Owners Equity Statement of Cash Flows New Paradigm Free Cash Flow Cost of Investing Return on Invested Capital
Chapter 5 - Cash Is King Manner in which market functions 1) Changes in value are linked more closely to changes in expectations than to absolute performance. In 1997 Intel reported 19% earnings growth and stock declined 6.3% because of 23% forecast.
Chapter 5 - Cash Is King Relationship between TRS and Expected Performance (p.75) See Exhibit 5.1 on page 75
Chapter 5 - Cash Is King Manner in which market functions 2) Valuation levels are linked to return on invested capital and growth. Authors conducted a survey of 340 large companies Five year growth Five year average spread (ROIC vs Opportunity Cost of Capital) Average Market/Book Value
Chapter 5 - Cash Is King Relationship between Market Values, Spread, and Growth (p.76) See Exhibit 5.2 on page 76
Chapter 5 - Cash Is King Market-to-Book Regressions (p.76) See Exhibit 5.3 on page 76
Chapter 5 - Cash Is King More Regression Analysis for you Statisticians… (p.77) See Exhibit 5.4 on page 77
Chapter 5 - Cash Is King More Regression Analysis for you Statisticians… (p.77) See Exhibit 5.5 on page 77
Chapter 5 - Cash Is King Manner in which market functions 3) The market sees through cosmetic earnings effects and focuses on underlying economic results. Not fooled easily by creative accounting Accounting methods used in different countries. Inventory Valuation methods Mergers and Aquisitions
Chapter 5 - Cash Is King German Industrial Company - Hoechst Year German accounting (DM million) U.S accounting (DM million) Difference (percent) 19951,709(57)NM 19962,1141,324-37% 19971, %
Chapter 5 - Cash Is King Inventory Valuation Choice of accounting method affects both earnings and cash flow – in opposite directions. In periods of rising prices: LIFO = lower earnings, lower income taxes, higher after-tax cash flow. FIFO = just the opposite.
Chapter 5 - Cash Is King Inventory Valuation (cont) (p.79) See Exhibit 5.6 on page 79
Chapter 5 - Cash Is King Mergers and Acquisitions Purchase: Price Paid – Book Value = Goodwill (amortized over 40 years) Pooling of Interests: Reported at Book Value with no amortization. Earnings are higher without amortization
Chapter 5 - Cash Is King Mergers and Acquisitions (cont) (p.80) See Exhibit 5.7 on page 80
Chapter 5 - Cash Is King Manner in which market functions 4) The market puts great weight on long- term results, not just short-term performance. Internet Companies – valued very high even without earnings or products to sell. Dividends as percentage of stock price. Market reacts favorably to increases in investment Changes in Leverage
Chapter 5 - Cash Is King Present Value of Expected Dividends (p.82) See Exhibit 5.8 on page 82
Chapter 5 - Cash Is King New R&D Projects Announced (p.83) See Exhibit 5.9 on page 83
Chapter 5 - Cash Is King Long-Term Investment Type of InvestmentSample Size Cumulative 2-day market adjusted return (percent) Capital Expenditures Product Strategies R&D Expenditures Joint Venture Formations Total Sample
Chapter 5 - Cash Is King Market values CASH, not earnings Exchange and Stock Swap Transactions EPS impact does not matter Change in Leverage matters Decrease in Leverage = negative share price reaction
Chapter 5 - Cash Is King Is the Stock Market Efficient? Some managers claim that the market behaves irrationally. Does ‘efficient’ mean “Get it Right”? What are the implications for investors and corporate managers?
Chapter 5 - Cash Is King THANK YOU! Accounting Earnings