Notes from all lectures in the 2021/2022 college year. For me, these notes helped me to pass the course. There may be a number of Dutch sentences in the summary to make it clearer or easier to understand.
Financial Statement Analysis and Valuation
Lecture 1 – Valuation drivers
What is accounting?
- Accounting is a language to measure and communicate firm performance.
What is financial statement analysis?
- FSA is about analyzing a firm’s accounting information to learn about its true
performance.
Three steps of equity valuation
Understanding the past
1. Value drivers
2. Understanding business
3. Ratio analysis
Forecasting the future
4. Information collection
5. Forecasting
Valuation
6. Equity valuation
7. Capita selecta
Understanding the past
Goal: "Understanding a firm’s financials in the context of its business strategy and the
industry and economy it operates in"
Understand the business
- What does the firm make? How is it made? Who buys it?
- Why are competitors, what type of industry is the firm operating in? Where is the
industry heading to?
Accounting analysis
- Check how the business is mapped into the numbers
- Do numbers reflect the economics of the business well?
Ratio analysis
- Understand key strengths and weaknesses of the firm’s strategy
- Identify key drivers of value
- Spot any irregularities
Forecasting the future
Goal: forecasting the firm’s value creation in the future
Information collection
- Based on your understanding of the past, collect information to broaden your view
and inform your predictions
Forecasting
- Framing the forecasting problem using the same ratios as
we used for understanding the past
, - Starting with sales, build a structured forecast
- Use pro-forma statements to anchor your valuation inputs and double-check how
reasonable your forecasts are
Net present value (NPV)
Q: What is the maximum you are willing to pay for an investment that you expect to yield
EUR 100 for three years while a comparable risky investment is expected to return 8% per
year?
A:
Value
The value of an equity interest is based on the present value of the expected future cash
dividends to be received.
Discounted dividends
The divided discount formula is rarely used directly
- Dividends don’t directly reflect performance
- Dividends are to a large extent discretionary
- Many firms do not pay dividends right now, but promise to pay later
o Dividend irrelevance theorem
o Need to forecast things very far in the future.
Periodic return and re-investment
Earnings-based valuation model
,Price at time T0 (today) is the function of 2 things. CE0 (past of the firm), E0 (expectations
regarding the future). Difference between RoE and expected RoE, main driver, discounted at
r.
*) Does not always hold completely. CE: book value of common equity. NI: net income. RoE:
Return on equity (NI/CE).
Clean Surplus Accounting: All gains and loss go through income statement
Dirty Surplus Accounting: Gain and loss items in equity statement.
Valuation drivers
Core value drivers
Direct inputs are the core value drivers
Key drivers of a firms core value.
If G, R and RoE don’t change, you have a good benchmark.
Structured approach to valuation
1. Understanding the past (using financials)
2. Forecasting future (using financials)
3. Valuation (using financials)
, Trying drivers to value
Value drivers according to analystst covered by Yahoo!Finance:
- Profitability
EPS from $-0.58 to $5.45 in 2020
- Growth
Expected 5yr earnings growth 114.30%
- Risk
Market beta of 0.58
Core drivers: profitability (RoE)
Return on equity is the key profitability measure
- RoE is the Rol for equity investors
- Return on investment (Rol):
“Good” RoE?
- RoE is the rate of return that equity owners get
- RoE must be higher than the opportunity cost (r) in order to generate value.
- We call these opportunity cost (r) “expected return” or “cost of equity capital”
Only if RoE > r does a firm create value.
Core drivers: investment growth (g)
10% RoE on €100 vs. 10% RoE on €1,000,000
- Profitability is only part of the picture
- Amount of capital invested is crucial too
- Investment depreciates and becomes obsolete.
o Investment needs to grow to expand the business
o Investment in new assets to not become obsolete and stay competitive.
Investments: cyclical, regional, structural
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