1. Equity Valuation adapted by
November 13, 2012
Budi Frensidy
PERTEMUAN 10
ANALISIS KEUANGAN

2. Course Outline Foundation and Fundamentals
Macroeconomic, Industry, and Company Analysis
Equity Valuation
Discounted Cash Flow (Present Value) Model
Relative Methods (Price Multiple)
Hybrid Method
Price/Earning Ratio in Detail
Valuation of Speculative Stocks

3. Foundation and Fundamentals

4. Time Value of Money When are you offered to receive today:
Rp 900 thousand and b. Rp 1 million,
Which one will you choose?
How about:
To receive Rp 900 thousand today and
To erceive Rp 1 million a year from now

5. Present and Future Value
The above alternatives have different time dimensions namely today and one year from now. To equalize the time unit of both, we can:
Calculate the future value of Rp 900,000 and compare it to Rp 1 million or
Calculate the present value of Rp 1 million one year from now and compare it to Rp 900,000 today
If i = 10%, then:
Rp 900,000 today is equivalent to (1.1)(Rp 900,000) = Rp 990,000 a year from now
Rp 1 million a year from now is equivalent to Rp 1 million/(1.1) = Rp 909,091 today

6. Formula for Single Amount
PV = FV (1 + i)–n
FV = PV (1 + i)n
PV = present value
FV = future value
i = interest rate/period
n = number of periods
Which one, do you think, is more often used?

7. Basic Principles of Investments
To compare between value and price
We search for any assets, whether in real sector or in the financial market, whose value is much higher than the price  value for money
Value is worth or what we get and price is cost or what we pay
The problem is, price is available but value is unobservable
Buy what you know and know what you buy
We should be able to differentiate zero-sum games from non-zero sum games

8. Three Markets and Kinds of Investments
Goods and services market or real sector
Investment in business, property, gold, art collection, or other tangible asset
Financial market (holding only paper claim)
Money market: Time deposit, certificate of deposit, SBI, CP
Capital market: stock, bond, mutual fund
Derivative market
Labor market
Human investment: further study, training, workshop, seminar

9. Three Main Variables Goods and services market Financial market
Price  Microeconomic theory or price theory
Financial market
Interest rate (or its synonyms such as discount rate, yield, and return)  Mathematics of interest rate or mathematics of finance and Investments
Labor market
Wages and salary

10. Valuation - Definition
Valuation is a process or calculation done to get the value of an asset
Knowledge of valuation techniques is worth billions of rupiahs as it can be used for any assets such as business ventures, boarding houses or real estates, bonds, and stocks
At least three variables/inputs are needed for any valuation. They are future cash flows, timing of the cash flows, and the risk of the asset
The risk of an asset is often represented by the discount rate that is used

11. Assignment 1 - Valuation Exercises
Calculate the value (fair price) of the following asset:
A zero-coupon bond with the par value Rp1 billion due in 5 years if the required yield is 8%
2. A 9% coupon bond paid semiannually if the investor requires 10% and the nominal value is Rp100 million due in 4 years
3. The royalty that pays annually Rp40 million to the author. Use the relevant discount rate
4. The pension allowance that pays Rp3 million monthly
5. A boarding house that generates yearly cash flow of Rp50 million that grows 3% per year

12. The Power of Compound Interest
Albert Einstein: I do not know the seven wonders of the world but I know the eighth. That is the power of compound interest
Rp1 million can become Rp1 billion in 38 years if the annual return is 20%
Rule of 72: In order for a sum of money to double, the return times the time needed is always 72
P becomes 2P i * n= 72
n = or i =

13. Rule of 72
If the interest rate is 8% p.a., then it takes 9 years to make Rp100 million into Rp200 million
If the annual return is 12% p.a., then it takes only 6 years to double any amount, from Rp1 billion into Rp2 billion, for example

14. Macroeconomic, Industry, and Company Analysis

15. The Top-Down Approach Economy/Market Analysis Industry Analysis
Economic growth, inflation, exchange rate, and fiscal & monetary policies have a major impact on overall stock prices
Industry Analysis
Industries undergo significant changes over time
Different industries have different responses to different points in the business cycle
Company Analysis
This is done to identify the best companies in a promising industry

16. The Economy and the Market
Business Cycle--recurring pattern of expansion and contraction
Business cycles can be accurately categorized only after the fact
“Market” refers to the overall activity of the equity markets (e.g. IHSG)

17. The Market and the Business Cycle
Stock market generally leads the economy
Stock market tends to turn before the economy does
The market ability to predict recoveries is better than its ability to predict recessions

18. Main Macroeconomic Indicators
Real GDP growth  growth of earnings, profitability, and dividend
Income per capita (purchasing power of the people and the number of middle income group)
Inflation  risk-free rate (SBI), government & corporate bond yield, discount rate, GDP nominal
Exchange rate  profitability of many corporations

19. Valuing the Market
To value the market, the simplest and probably most effective methodology is to analyze
corporate earnings
the multiplier, or P/E ratio
Market req. return: Risk free + Market risk premium = 5.8% + 6.7% = 12.5%
Expected growth: Real GNP growth + Expected inflation = 6.1% + 4.7% = 10.8%
Average dividend payout ratio: 30%
Justified P/E of the Market: 30%/(12.5% %) = 17.6
Sensitive to the assumption
Compare to actual P/E of the market

20. Industry Analysis Business Cycle: mainly to identify risk
Industry Life Cycle: mainly for forecasting growth
Porter’s Industry Competitive Advantage Analysis: mainly for forecasting profitability

21. Business Cycle and Industry Sectors
Economic trends and government regulation can and do affect industry performance
By identifying and monitoring key assumptions and variables, we can monitor the economy and gauge the implications of new information on our economic outlook and industry analysis

22. Business Cycle and Industry Sectors
Cyclical or Structural Changes
Cyclical changes in the economy arise from the ups and downs of the business cycle
Structural changes occur when the economy undergoes a major change in organization or how it functions
Rotation strategy is when one switches from one industry group to another over the course of a business cycle
See Exhibit on the next page

24. Business Cycle Analysis
Business cycle analysis is done to forecast risk
Industries can perform differently depending upon the stage of the business cycle
Defensive industries are the least volatile – Low risk
Cyclical industries are most volatile--they are hurt more when the economy declines – High risk
Interest-sensitive industries are particularly sensitive to expectations about change in interest rates

25. Business Cycle & Industry Sectors
Economic Variables and Different Industries
Inflation
Higher inflation is generally negative for stocks
Interest Rates
For example, financial and housing industries will be adversely affected by high interest rates
International Economics
Economic growth in world regions or specific countries benefits industries with a large presence in the areas
Consumer Sentiment
The performance of consumer cyclical industries will be affected by changes in consumer sentiment

26. Sector Rotation
Portfolio is adjusted by selecting companies that should perform well for the stage of the business cycle
Peaks – natural resource extraction firms
Contraction – defensive industries such as pharmaceuticals and food
Trough – capital goods industries
Expansion – cyclical industries such as consumer durables

27. Sector Rotation

28. Structural Economic Changes
Demographics
Lifestyles
Technology
Politics and regulations

29. Industry Life Cycle
The industry life cycle describes the stages that most industries go through
Pioneering stage--rapid growth in demand, shakeout of companies
Expansion stage--survivors grow and prosper, become more stable
Stabilization stage--growth moderates, things are reasonably stable
Decline--a fourth stage, decline, is possible

30. Industry Life Cycle The pioneering stage: Three stage growth
May offer the highest potential returns, but with the largest risks
The expansion stage:
Two stage growth
Is probably of most interest to investors-growth is rapid but orderly
The stabilization stage:
Constant growth (assuming no declining stage)
Investors interested primarily in capital gains may avoid the stabilization stage

32. Qualitative Aspects of Industry Analysis
Porter’s analysis of competitive strategy is useful for predicting industry’s profitability
Porter’s five basic competitive factors:
threat of new entrants
bargaining power of buyers
rivalry between existing competitors
threat of substitute products
bargaining power of suppliers

33. Company Analysis Expected profitability and its determinants
Estimating dividend policy
Risk and its determinants
Expected growth

34. The Importance of Earnings
There is a close association between earnings changes and stock price changes
Growth in reported earnings has been shown to affect stock prices significantly, some say around two thirds
Other factors that affect stock prices are net foreign fund, exchange rate, and regional indexes

35. The Quality of Earnings
Some EPS figures are better than others
Quality assessments are difficult to make and require considerable expertise
Nevertheless, smart investors look behind the basic numbers and try to spot problems with a company’s financial data

36. Analyzing a Company’s Profitability
EPS = ROE * book value per share
ROE = PBV / PER
ROE = ROA * financial leverage
ROA is the return on assets, net income divided by total assets
ROA = Net profit margin * assets turnover
Financial leverage can be measured as total assets divided by stockholders’ equity
Evaluate the persistency of ROE

37. Expected Growth Rate Estimating Growth From Fundamentals Determined by
the growth of earnings
the proportion of earnings paid in dividends
In the short run, dividends can grow at a different rate than earnings if the firm changes its dividend payout ratio
Earnings growth is also affected by earnings retention and equity return
g = (Retention Rate) x (Return on Equity)
= RR x ROE

38. Expected Growth Rate x x x = Breakdown of ROE Margin Turnover Leverage
Profit Total Asset Financial
Margin Turnover Leverage = x
Equity
Common
Assets
Total
Sales
Income
Net
ROE = x x

39. Expected Growth Rate
The first operating ratio, net profit margin, indicates the firm’s profitability on sales
The second component, total asset turnover is the indicator of operating efficiency and reflect the asset and capital requirements of business
The final component measures financial leverage. It indicates how management has decided to finance the firm

40. The Sustainable Growth Rate
Analysts often calculate the sustainable growth rate in earnings and dividends
g = ROE x (1 – payout ratio)
Investors cannot simply use the current or past internal growth rate for EPS to reliably predict the future
Basing a projection on one year’s results can result in a faulty projection

41. Evaluating Profitability
Competitive Advantage if (Benefits – Costs) > (Benefits – Costs)Competitors
Maintaining competitive advantage:
Barriers to imitation
Learning curve

42. Fundamental vs Technical Analysis
Fundamental Analysis
Technical Analysis
Hope
Reality
Analysis about macro- & microeconomy, industry, and company (expected) performance
Chart analysis (chartist)
Financial statements as the main input for analysis
Does not depend on F/S, but on the technical indicators and patterns of price and volume
Main approach
Alternative approach
Long term
Short term
Ignoring the market or investors’ sentiment
Considering the market psychology and investors’ sentiment
To answer why to buy
To answer when to buy
Focus on stock selection
Focus on market timing
Suitable for passive investors (with buy and hold strategy)
Suitable for active investors who constantly trade
Using the ratios PER, PBV, ROE, PEG, EV/EBITDA
Using the terms resistance and support level, overbought and oversold
Believing that the market is efficient but weak
Believing that the market if not efficient at all
Bringing stabilization effect
Causing destabilization

43. Passive Stock Strategies
Natural outcome of a belief in efficient markets: Stock prices equal intrinsic values
No active strategy should be able to beat the market on a risk-adjusted basis
Emphasis is on minimizing transaction costs and time spent in managing the portfolio
Expected benefits from active trading or analysis less than the costs

44. Passive Stock Strategies
Buy-and-hold strategy
Belief that active management will incur transaction costs and involve inevitable mistakes
No attempt to select under- or overvalued securities
Important initial selection needs to be made
Functions to perform: reinvesting income and adjusting to changes in risk tolerance

45. Active Stock Strategies
Some stocks are mispriced
Assumes the investor possesses some advantage relative to other market participants
Most investors favor this approach despite evidence about efficient markets
Identification of individual stocks as offering superior return-risk tradeoff
Selection part of a diversified portfolio

46. Active Stock Strategies
Majority of investment advice geared to selection of stocks
Security analyst’s job is to forecast stock returns
Estimates provided by analysts
expected change in earnings per share, expected return on equity, and industry outlook
Recommendations: Buy, Hold, or Sell

47. Kegiatan dan Forum SCL Discovery Learning:
Dosen menjelaskan secara rinci bagian 1 penilaian saham.
Mahasiswa diminta untuk terjun ke dunia riil memahami secara rinci bagian 1 penilaian saham.
Dosen memberikan evaluasi, sebagai guide adalah bahan ajar dalam hybrid learning.