Moving into part two of equity analysis, the material introduces more calculations than part one. Candidates will see a number of formulas that are commonly applied when valuing stocks. It is important not only to know the formulas, but also to able to interpret them and understand their respective strengths and weaknesses. Building on the […]
Equity Analysis Part 2
Porter’s Five Competitive Forces
A firm’s profitability is heavily influenced by the overall strength of its industry. One approach for evaluating an industry structure is Porter’s Five Competitive Forces: Force 1: Threat of New Entrants The easier it is to enter an industry, the more competitive that industry becomes. Increased competition tends to depress profit margins. If the industry […]
Industry Analysis
This article will describe elements of industry analysis beyond Porter’s Five Competitive Forces. Sample Steps for an Industry Analysis Industry Life Cycle Industries tend to follow a natural progression which can be outlined as follows: 1) Pioneer Stage: a high degree of uncertainty at this point. The product is unproven and cash flow is most […]
Supply and Demand Analysis
Supply Analysis Commonly demand analysis is the greater concern when analyzing and industry, but supply analysis is not without its useful insights. The story of supply is largely told by knowing an industry’s capacity and the degree to which it is over or under-utilized. If the analyst knows that capacity is being highly utilized, then […]
Financial Projections in Emerging Markets
Introduction Emerging markets present tremendous opportunities to investors as their growth prospects are much higher than mature economies. However, emerging markets also present valuation challenges to analysts as their stock markets may have lower liquidity, financial disclosure requirements can be low, and political situations can be unstable. Making Nominal and Real Financial Projections in Emerging […]
Cost of Capital in Emerging Markets
Cost of Equity CAPM can be used to estimate the cost of equity capital for an emerging market. Note however, if the country is not very well integrated into the global capital market system, then CAPM may be an unsuitable technique, so be mindful of this qualifier when reading the item set. Start by creating […]
Cash Flows: Dividends vs. Free Cash Flows vs. Residual Income
When calculating the present value of a company, an analyst can choose between dividends, free cash flows, and residual income to derive the stock’s intrinsic price. Each of these cash flows has advantages and drawbacks. Dividends These direct cash payments are a key component of an investor’s returns. Dividend Advantages: Typically more stable than earnings; […]
Dividend Discount Model (DDM)
If James Brown is the “Godfather of Soul”, then the dividend discount model could be considered the “Godfather of Equity Valuation”. Many of the approaches used today can trace their roots to DDM. The basic thesis of the DDM is that the value of a common stock to an investor is the present value of […]
Gordon Growth Model (GGM)
The GGM is a variation on the standard DDM that allows the analyst to assume that dividends will grow in perpetuity at a constant rate. V0 = Div1 /(rce – gdiv) Div1 = D0 * (1 + gdiv) = future period dividend payment rce = by now you should know this! In an exam problem […]
Present Value of Growth Opportunities (PVGO)
A stock’s valuation can be heavily influenced by future growth expectations. As a company generates positive earnings and retains these earnings, its book value of equity increases; however, in order for the positive retained earnings to create wealth for investors, the company’s return on equity must exceed its cost of equity. In theory, when a […]