unCL81Aln1? AswaLh uamodaran hup://www.damodaran.com Aswath Damodaran 1 2 lnLrlnslc value: 1hree 8aslc roposluons ! 1he value of an asseL ls Lhe presenL value of Lhe expecLed cash ows on LhaL asseL, over lLs expecLed llfe: ! roposluon 1: lf lL" does noL aecL Lhe cash ows or alLer rlsk (Lhus changlng dlscounL raLes), lL" cannoL aecL value. ! roposluon 2: lor an asseL Lo have value, Lhe expecLed cash ows have Lo be posluve some ume over Lhe llfe of Lhe asseL. ! roposluon 3: AsseLs LhaL generaLe cash ows early ln Lhelr llfe wlll be worLh more Lhan asseLs LhaL generaLe cash ows laLer, Lhe lauer may however have greaLer growLh and hlgher cash ows Lo compensaLe. Aswath Damodaran 2 3 1he fundamenLal deLermlnanLs of value. What are the cashows from existing assets? - Equity: Cashows after debt payments - Firm: Cashows before debt payments What is the value added by growth assets? Equity: Growth in equity earnings/ cashows Firm: Growth in operating earnings/ cashows How risky are the cash ows from both existing assets and growth assets? Equity: Risk in equity in the company Firm: Risk in the rms operations When will the rm become a mature irm, and what are the potential roadblocks? Aswath Damodaran 3 Current Cashow to Firm EBIT(1-t)= 5344 (1-.35)= 3474 - Nt CpX= 350 - Chg WC 691 = FCFF 2433 Reinvestment Rate = 1041/3474 =29.97% Return on capital = 25.19% Expected Growth in EBIT (1-t) .30*.25=.075 7.5% Stable Growth g = 3%; Beta = 1.10; Debt Ratio= 20%; Tax rate=35% Cost of capital = 6.76% ROC= 6.76%; Reinvestment Rate=3/6.76=44% Terminal Value 5 = 2645/(.0676-.03) = 70,409 Cost of Equity 8.32% Cost of Debt (3.72%+.75%)(1-.35) = 2.91% Weights E = 92% D = 8% Op. Assets 60607 + Cash: 3253 - Debt 4920 =Equity 58400 Value/Share $ 83.55 Riskfree Rate: Riskfree rate = 3.72% + Beta 1.15 X Risk Premium 4% Unlevered Beta for Sectors: 1.09 3M: A Pre-crisis valuation Reinvestment Rate 30% Return on Capital 25% Term Yr $4,758 $2,113 $2,645 On September 12, 2008, 3M was trading at $70/share First 5 years D/E=8.8% Cost of capital = 8.32% (0.92) + 2.91% (0.08) = 7.88% Year 1 2 3 4 5 EBIT (1-t) $3,734 $4,014 $4,279 $4,485 $4,619 - Reinvestment $1,120 $1,204 $1,312 $1,435 $1,540 , = FCFF $2,614 $2,810 $2,967 $3,049 $3,079 Aswath Damodaran 4 Current Cashflow to Firm EBIT(1-t) : Rs 20,116 - Nt CpX Rs 31,590 - Chg WC Rs 2,732 = FCFF - Rs 14,205 Reinv Rate = (31590+2732)/20116 = 170.61%; Tax rate = 21.00% Return on capital = 17.16% Expected Growth from new inv. .70*.1716=0.1201 Stable Growth g = 5%; Beta = 1.00 Country Premium= 3% Cost of capital = 10.39% Tax rate = 33.99% ROC= 10.39%; Reinvestment Rate=g/ROC =5/ 10.39= 48.11% Terminal Value 5 = 23493/(.1039-.05) = Rs 435,686 Cost of Equity 14.00% Cost of Debt (5%+ 4.25%+3)(1-.3399) = 8.09% Weights E = 74.7% D = 25.3% Discount at Cost of Capital (WACC) = 14.00% (.747) + 8.09% (0.253) = 12.50% Op. Assets Rs210,813 + Cash: 11418 + Other NO 140576 - Debt 109198 =Equity 253,628 Value/Share Rs 614 Riskfree Rate: Rs Riskfree Rate= 5% + Beta 1.20 X Mature market premium 4.5% Unlevered Beta for Sectors: 1.04 Firm!s D/E Ratio: 33% Tata Motors: April 2010 Reinvestment Rate 70% Return on Capital 17.16% 45278 21785 23493 + Lambda 0.80 X Country Equity Risk Premium 4.50% Country Default Spread 3% X Rel Equity Mkt Vol 1.50 On April 1, 2010 Tata Motors price = Rs 781 Rs Cashflows Average reinvestment rate from 2005-09: 179.59%; without acquisitions: 70% Growth declines to 5% and cost of capital moves to stable period level. Year 1 2 3 4 5 6 7 8 9 10 EBIT (1-t) 22533 25240 28272 31668 35472 39236 42848 46192 49150 51607 - Reinvestment 15773 17668 19790 22168 24830 25242 25138 24482 23264 21503 FCFF 6760 7572 8482 9500 10642 13994 17711 21710 25886 30104 Aswath Damodaran 5 Aswath Damodaran 6 Forever Terminal Value= 1881/(.0961-.06) =52,148 Cost of Equity 12.90% Cost of Debt 6.5%+1.5%=8.0% Tax rate = 0% -> 35% Weights Debt= 1.2% -> 15% Value of Op Assets $ 15,170 + Cash $ 26 = Value of Firm $14,936 - Value of Debt $ 349 = Value of Equity $14,847 - Equity Options $ 2,892 Value per share $ 35.08 Riskfree Rate: T. Bond rate = 6.5% + Beta 1.60 -> 1.00 X Risk Premium 4% Internet/ Retail Operating Leverage Current D/ E: 1.21% Base Equity Premium Country Risk Premium Current Revenue $ 1,117 Current Margin: -36.71% Sales Turnover Ratio: 3.00 Competitive Advantages Revenue Growth: 42% Expected Margin: -> 10.00% Stable Growth Stable Revenue Growth: 6% Stable Operating Margin: 10.00% Stable ROC=20% Reinvest 30% of EBIT(1-t) EBIT -410m NOL: 500 m Term. Year 2 4 3 5 1 6 8 9 10 7 9a. Amazon in January 2000 Amazon was trading at $84 in January 2000. Dot.com retailers for rrst 5 years Convetional retailers after year 5 Used average interest coverage ratio over next 5 years to get BBB rating. Pushed debt ratio to retail industry average of 15%. From previous years Sales to capital ratio and expected margin are retail industry average numbers All existing options valued as options, using current stock price of $84. !"#$ "& '()*$+ ,-./01 ,-./01 ,-./01 ,-./01 ,-./01 ,-.2-1 ,,./21 ,,.231 ,0./41 ,0.501 !"#$ "& 678$ 4.001 4.001 4.001 4.001 4.001 9.401 9.951 9.391 9.501 9.001 :&$7;<$=> ?"#$ "& @78$ 4.001 4.001 4.001 3.9,1 5.-01 5.091 5.021 2./41 2.441 2.551 !"#$ "& !=A*$=B ,-.421 ,-.421 ,-.421 ,-.4C1 ,-.4,1 ,-.,C1 ,,.3-1 ,,.041 ,0.2/1 /.3,1 !"#"$%" '()*+, -./0//1 -//0//1 2.0//1 ./0//1 3/0//1 4.04/1 4/05/1 -.06/1 -/07/1 60//1 !"#"$%"8 492:3 ; .9.7. ; :9225 ; -5966- ; -:9/.: ; 439764 ; 47924: ; 3394-- ; 3692:7 ; 3:9//6 ; <="(>+?$@ A>(@?$ B-303.1 B-0671 50-61 20/71 70.51 :0421 :0651 :0741 :0:-1 :0:.1 CDEF B;323 B;:5 ;5/2 ;-9/37 ;-9647 ;494-4 ;49267 ;3946- ;39656 ;39773 CDEFG-B+H B;323 B;:5 ;5/2 ;72- ;-9/.7 ;-9537 ;-92:: ;49--: ;4932/ ;49.45 B !"?$#"8+I"$+ ;6// ;:62 ;-954/ ;-9663 ;-9.53 ;-9677 ;-924- ;-96-: ;-9363 ;:6- JKJJ B;:3- B;-9/45 B;:7: B;2.7 B;5/7 B;-63 ;-22 ;64. ;-9-25 ;-9277 !" #$%&#! ' $)*))" '#%$&+ ',%!-- '$++ '$%--$ Aswath Damodaran 7 Terminal year (11) EBIT (1-t) $1,849 - Reinvestment $ 416 FCFF $1,433 Terminal Value 10 = 1433/(.08-.027) = $27.036 Cost of capital = 11.32% (.983) + 5.16% (.017) = 11.22% 90% advertising (1.44) + 10% info svcs (1.05) Risk Premium 6.15% Operating assets $9,611 + Cash 375 + IPO Proceeds 1000 - Debt 207 Value of equity 10,779 - Options 805 Value in stock 9,974 / # of shares 574.44 Value/share $17.36 Cost of Debt (2.7%+5.3%)(1-.40) = 5.16% Stable Growth g = 2.7%; Beta = 1.00; Cost of capital = 8% ROC= 12%; Reinvestment Rate=2.7%/12% = 22.5% Cost of Equity 11.32% Weights E = 98.31% D = 1.69% Riskfree Rate: Riskfree rate = 2.7% + Beta 1.40 X On October 5, 2013, Twitter had not been priced yet, but the company's most recent acquisition suggested a price of about $20/share. Cost of capital decreases to 8% from years 6-10 D/E=1.71% Twitter Pre-IPO Valuation: October 5, 2013 Revenue growth of 55% a year for 5 years, tapering down to 2.7% in year 10 Pre-tax operating margin increases to 25% over the next 10 years Sales to capital ratio of 1.50 for incremental sales Starting numbers 75% from US(5.75%) + 25% from rest of world (7.23%) 2012 1ralllng 2013 8evenues $316.9 $448.2 CperaLlng lncome -$77.1 -$92.9 Ad[ Cp lnc $4.3 lnvesLed CaplLal $349.1 CperaLlng Margln 0.96 Sales/CaplLal 0.82 ! " # $ % & ' ( ) !* +,-,./,0 &)$1' 2 !4*'&1( 2 !4&&)1! 2 "4%('1! 2 $4*!*1* 2 %4')&1* 2 '4''!1# 2 )4&*&1( 2 !*4('!1! 2 !!4!&$1& 2 56,789:.; <.=>?, "#1# 2 &"1* 2 !#&1# 2 "'#1% 2 %"*1# 2 ()!1% 2 !4#("1" 2 !4)#)1' 2 "4$%&1# 2 "4')!1" 2 56,789:.; <.=>?, 8@9,7 98A,0 "#1# 2 &"1* 2 !#&1# 2 "&%1# 2 #&$1" 2 &!$1" 2 )#'1! 2 !4")#1( 2 !4&!!1$ 2 !4(**1# 2 +,:.-,09?,.9 !&$1# 2 "%$1' 2 #)$1( 2 &!"1* 2 )$(1& 2 !4!)*1' 2 !4#!&1( 2 !4""#1' 2 ($"1( 2 !)%1' 2 BCBB D!$!1*E 2 D!)"1'E 2 D"%(1%E 2 D#$&1&E 2 D%($1$E 2 D%'&1%E 2 D#')1'E 2 '*1* 2 '&(1% 2 !4&*$1& 2 8 1he sources of uncerLalnLy ! Estimation versus Economic uncertainty ! Estimation uncertainty reects the possibility that you could have the wrong model or estimated inputs incorrectly within this model. ! Economic uncertainty comes the fact that markets and economies can change over time and that even the best medals will fail to capture these unexpected changes. ! Micro uncertainty versus Macro uncertainty ! Micro uncertainty refers to uncertainty about the potential market for a rms products, the competition it will face and the quality of its management team. ! Macro uncertainty reects the reality that your rms fortunes can be affected by changes in the macro economic environment. ! Discrete versus continuous uncertainty ! Discrete risk: Risks that lie dormant for periods but show up at points in time. (Examples: A drug working its way through the FDA pipeline may fail at some stage of the approval process or a company in Venezuela may be nationalized) ! Continuous risk: Risks changes in interest rates or economic growth occur continuously and affect value as they happen. 9 Assessing uncertainty ! 8ank Lhe four rms ln Lerms of uncerLalnLy (leasL Lo mosL) ln your esumaLe: " 3M ln 2007 " 1aLa MoLors ln 2010 " Amazon ln 2000 " 1wluer ln 2013 WlLh each company, speclfy Lhe Lype of uncerLalnLy LhaL you face:
!"#$%&' )*+#%+"& ", )-"&"#.- /.-," ", /%-," 0.*-,121 ", !"&+&3"3* 3M (2007) 1aLa MoLors (2010) Amazon (2000) 1wluer (2013) 10 unhealLhy ways of deallng wlLh uncerLalnLy ! Paralysis & Denial: When faced with uncertainty, some of us get paralyzed. Accompanying the paralysis is the hope that if you close your eyes to it, the uncertainty will go away ! Mental short cuts (rules of thumb): Behavioral economists note that investors faced with uncertainty adopt mental short cuts that have no basis in reality. And here is the clincher. More intelligent people are more likely to be prone to this. ! Herding: When in doubt, it is safest to go with the crowd.. The herding instinct is deeply engrained and very difcult to ght. ! Outsourcing: Assuming that there are experts out there who have the answers does take a weight off your shoulders, even if those experts have no idea of what they are talking about. 11 1en suggesuons for deallng wlLh uncerLalnLy. 1. Less ls more (Lhe rule on deLall..) (8evenue & margln forecasLs) 2. 8ulld ln lnLernal checks on reasonableness. (relnvesLmenL and 8CC) 3. use Lhe osemng prlnclple (rlsk free raLes & lnauon aL 1aLa MoLors) 4. uraw on economlc rsL prlnclples (1ermlnal value aL all Lhe companles ) 3. use Lhe markeL" as a cruLch (equlLy rlsk premlums, counLry rlsk premlums) 6. use Lhe law of large numbers (8eLa for all companles 7. uon'L leL Lhe dlscounL raLe become Lhe recepLacle for all uncerLalnues. 8. ConfronL uncerLalnLy, lf you can 9. uon'L look for preclslon 10. ?ou can llve wlLh mlsLakes, buL blas wlll klll you. Aswath Damodaran 11 12 1. Less ls more 12 Principle of parsimony: Estimate fewer inputs when faced with uncertainty. Use auto pilot approaches to estimate future years 13 A Lougher Lask aL 1wluer Aswath Damodaran 13 My estimate for 2023: Overall market will be close to $200 billion and Twitter will about 5.7% ($11.5 billion) 14 2. 8ulld ln lnLernal" checks for reasonableness. Aswath Damodaran 14 Check total revenues, relative to the market that it serves Your market share obviously cannot exceed 100% but there may be tighter constraints. Are the margins and imputed returns on capital reasonable in the outer years? 15 lollow up proposluons on growLh. ! lf you accepL Lhe proposluon LhaL growLh has Lo come from elLher lncreased emclency (lmprovlng reLurn on caplLal on exlsung asseLs) and new lnvesLmenLs (relnvesLmenL raLe & reLurn on caplLal): ! Plgh growLh ls easy Lo dellver, hlgh quallLy growLh ls more dlmculL. ! Scallng up ls hard Lo do, l.e., growLh ls more dlmculL Lo susLaln as companles geL larger. Aswath Damodaran 15 16 3. use conslsLency LesLs. ! Whlle you can noL grade a valuauon on correcLness" (slnce dlerenL analysLs can make dlerenL assumpuons abouL growLh and rlsk), you can grade lL on conslsLency. ! lor a valuauon Lo be conslsLenL, your esumaLes of cash ows have Lo be conslsLenL wlLh your dlscounL raLe denluon. ! LqulLy versus llrm: lf Lhe cash ows belng dlscounLed are cash ows Lo equlLy, Lhe approprlaLe dlscounL raLe ls a cosL of equlLy. lf Lhe cash ows are cash ows Lo Lhe rm, Lhe approprlaLe dlscounL raLe ls Lhe cosL of caplLal. ! Currency: 1he currency ln whlch Lhe cash ows are esumaLed should also be Lhe currency ln whlch Lhe dlscounL raLe ls esumaLed. ! nomlnal versus 8eal: lf Lhe cash ows belng dlscounLed are nomlnal cash ows (l.e., reecL expecLed lnauon), Lhe dlscounL raLe should be nomlnal Aswath Damodaran 16 17 1aLa MoLors: ln 8upees and uS dollars (1.125)*(1.01/1. 04)-1 = .0925 Aswath Damodaran 17 18 4. uraw on economlc rsL prlnclples and maLhemaucal llmlLs. ! When dolng valuauon, you are free Lo make assumpuons abouL how your company wlll evolve over ume ln Lhe markeL LhaL lL operaLes, buL you are noL free Lo vlolaLe rsL prlnclples ln economlcs and maLhemaucs. ! uL dlerenLly, Lhere are assumpuons ln valuauon LhaL are elLher maLhemaucally lmposslble or vlolaLe rsL laws of economlcs and cannoL be ever [usued. Aswath Damodaran 18 19 And Lhe excess reLurn" eecL. Aswath Damodaran 19 !"#$%& ()*+", )#"& -. /#"# .*"*)0 12#3*4 /+56&) 0 $70,409 433,686! $26,390 $23,111 1 $70,409 433,686! $28,263 $24,212 2 $70,409 433,686! $30,393 $23,679 3 $70,409 433,686! $33,394 4 433,686! $37,618 3 433,686! $43,334 $32,148 8lskfree raLe 3.72 3 6.60 2.70 8ClC 6.76 10.39 20 12.00 CosL of caplLal 6.76 10.39 9.61 8.00 20 3. use Lhe markeL as a cruLch. L8 as an lllusLrauon
Historical premium Aswath Damodaran 20 Arithmetic Average Geometric Average Stocks - T. Bills Stocks - T. Bonds Stocks - T. Bills Stocks - T. Bonds 1928-2012 7.65% 5.88% 5.74% 4.20% 2.20% 2.33% 1962-2012 5.93% 3.91% 4.60% 2.93% 2.38% 2.66% 2002-2012 7.06% 3.08% 5.38% 1.71% 5.82% 8.11% January 1, 2013 S&P 500 is at 1426.19 Adjusted Dividends & Buybacks for base year = 69.46 In 2012, the actual cash returned to stockholders was 72.25. Using the average total yield for the last decade yields 69.46 Analysts expect earnings to grow 7.67% in 2013, 7.28% in 2014, scaling down to 1.76% in 2017, resulting in a compounded annual growth rate of 5.27% over the next 5 years. We will assume that dividends & buybacks will tgrow 5.27% a year for the next 5 years. After year 5, we will assume that earnings on the index will grow at 1.76%, the same rate as the entire economy (= riskfree rate). 76.97 81.03 85.30 89.80 Expected Return on Stocks (1/1/13) = 7.54% T.Bond rate on 1/1/13 = 1.76% Equity Risk Premium = 7.54% - 1.76% = 5.78% 73.12 Data Sources: Dividends and Buybacks last year: S&P Expected growth rate: S&P, Media reports, Factset, Thomson- Reuters 1426.19 = 73.12 (1+r) + 76.97 (1+r) 2 + 81.03 (1+r) 3 + 85.30 (1+r) 4 + 89.80 (1+r) 5 + 89.80(1.0176) (r !.0176)(1+r) 5 Country Risk Premiums July 2013 Black #: Total ERP Red #: Country risk premium AVG: GDP weighted average Angola 3.40 11.13 8enln 8.23 14.00 8oLswana 1.63 7.40 8urklna laso 8.23 14.00 Cameroon 8.23 14.00 Cape verde 6.73 12.30 LgypL 12.00 17.73 Cabon 3.40 11.13 Chana 6.73 12.30 kenya 6.73 12.30 Morocco 4.13 9.88 Mozamblque 6.73 12.30 namlbla 3.38 9.13 nlgerla 3.40 11.13 8wanda 8.23 14.00 Senegal 6.73 12.30 SouLh Afrlca 2.33 8.30 1unlsla 4.73 10.48 Zambla 6.73 12.30 45,.-% 6789: ;;7<6: Andorra 1.93 7.70 AusLrla 0.00 3.73 8elglum 1.20 6.93 Cyprus 16.30 22.23 uenmark 0.00 3.73 llnland 0.00 3.73 lrance 0.43 6.20 Cermany 0.00 3.73 Creece 10.13 13.88 lceland 3.38 9.13 lreland 4.13 9.88 lsle of Man 0.00 3.73 lLaly 3.00 8.73 LlechLensLeln 0.00 3.73 Luxembourg 0.00 3.73 MalLa 1.93 7.70 neLherlands 0.00 3.73 norway 0.00 3.73 orLugal 3.40 11.13 Spaln 3.38 9.13 Sweden 0.00 3.73 SwlLzerland 0.00 3.73 1urkey 3.38 9.13 uk 0.43 6.20 =7 )3,"$1 ;>7??: <78@: Argenuna 10.13 13.88 8ellze 14.23 20.00 8ollvla 3.40 11.13 8razll 3.00 8.73 Chlle 1.20 6.93 Colombla 3.38 9.13 CosLa 8lca 3.38 9.13 Lcuador 12.00 17.73 Ll Salvador 3.40 11.13 CuaLemala 4.13 9.88 Ponduras 8.23 14.00 Mexlco 2.33 8.30 nlcaragua 10.13 13.88 anama 3.00 8.73 araguay 3.40 11.13 eru 3.00 8.73 Surlname 3.40 11.13 uruguay 3.38 9.13 venezuela 6.73 12.30 A%+& 4#1,.-% B78C: 87<8: Canada 0.00 3.73 unlLed SLaLes 0.00 3.73 D",2E 4#1,.-% 9799: 67@6: Albanla 6.73 12.30 Armenla 4.73 10.48 Azerbal[an 3.38 9.13 8elarus 10.13 13.88 8osnla 10.13 13.88 8ulgarla 3.00 8.73 Croaua 4.13 9.88 Czech 8epubllc 1.43 7.18 LsLonla 1.43 7.18 Ceorgla 3.40 11.13 Pungary 4.13 9.88 kazakhsLan 3.00 8.73 LaLvla 3.00 8.73 LlLhuanla 2.33 8.30 Macedonla 3.40 11.13 Moldova 10.13 13.88 MonLenegro 3.40 11.13 oland 1.63 7.40 8omanla 3.38 9.13 8ussla 2.33 8.30 Serbla 3.40 11.13 Slovakla 1.63 7.40 Slovenla 4.13 9.88 uganda 6.73 12.30 ukralne 10.13 13.88 )7 )3,"$1FG3**.% B7;B: H7HH: 8ahraln 2.33 8.30 lsrael 1.43 7.18 !ordan 6.73 12.30 kuwalL 0.90 6.63 Lebanon 6.73 12.30 Cman 1.43 7.18 CaLar 0.90 6.63 Saudl Arabla 1.20 6.93 uAL 0.90 6.63 /.IIJ1 )%*2 ;7BH: @7;B: AusLralla 0.00 3.73 Cook lslands 6.73 12.30 new Zealand 0.00 3.73 43*2,%J.% K DL 9799: 67@6: 8angladesh 3.40 11.13 Cambodla 8.23 14.00 Chlna 1.20 6.93 ll[l 6.73 12.30 Pong kong 0.43 6.20 lndla 3.38 9.13 lndonesla 3.38 9.13 !apan 1.20 6.93 korea 1.20 6.93 Macao 1.20 6.93 Malaysla 1.93 7.70 Maurluus 2.33 8.30 Mongolla 6.73 12.30 aklsLan 12.00 17.73 apua nC 6.73 12.30 hlllpplnes 4.13 9.88 Slngapore 0.00 3.73 Srl Lanka 6.73 12.30 1alwan 1.20 6.93 1halland 2.33 8.30 vleLnam 8.23 14.00 4*.% ;7@@: @76?: 6. uraw on Lhe law of large numbers. ! 1o esumaLe Lhe beLa for 1aLa MoLors ! unlevered beLa for auLomoblle company = 0.98 ! u/L rauo for 1aLa MoLors = 33.87 ! Marglnal Lax raLe ln lndla = 33.99 ! Levered beLa = 0.98 (1+ (1-.3399)(.3387)) = 1.20 22 Aswath Damodaran 23 7. uon'L leL Lhe dlscounL raLe become Lhe recepLacle for all your uncerLalnLy. Aswath Damodaran 23 24 ConLrasung ways of deallng wlLh survlval rlsk. ! 1he venLure CaplLal approach: ln Lhe venLure caplLal approach, you hlke Lhe dlscounL raLe" well above whaL would be approprlaLe for a golng concern and Lhen use Lhls LargeL" raLe Lo dlscounL your exlL value" (whlch ls esumaLed uslng a muluple and forward earnlngs). ! value = (lorward Larnlngs ln year n * LxlL muluple)/ (1+ LargeL raLe) n ! 1he declslon Lree approach: ! value Lhe buslness as a golng concern", wlLh a raLe of reLurn approprlaLe for a golng concern". ! LsumaLe Lhe probablllLy of survlval (and fallure) and Lhe value of Lhe buslness ln Lhe evenL of fallure. ! value = Colng concern value (robablllLy of survlval) + Llquldauon value (robablllLy of fallure) Aswath Damodaran 24 Aswath Damodaran 25 26 8. ConfronL uncerLalnLy, lf you can. Aswath Damodaran 26 27 WlLh Lhe consequences for equlLy value. Aswath Damodaran 27 28 9. uon'L look for preclslon.. ! no mauer how careful you are ln gemng your lnpuLs and how well sLrucLured your model ls, your esumaLe of value wlll change boLh as new lnformauon comes ouL abouL Lhe company, Lhe buslness and Lhe economy. ! As lnformauon comes ouL, you wlll have Lo ad[usL and adapL your model Lo reecL Lhe lnformauon. 8aLher Lhan be defenslve abouL Lhe resulung changes ln value, recognlze LhaL Lhls ls Lhe essence of rlsk. Aswath Damodaran 28 Forever Terminal Value= 1064/(.0876-.05) =$ 28,310 Cost of Equity 13.81% Cost of Debt 6.5%+3.5%=10.0% Tax rate = 0% -> 35% Weights Debt= 27.3% -> 15% Value of Op Assets $ 8,789 + Cash & Non-op $ 1,263 = Value of Firm $10,052 - Value of Debt $ 1,879 = Value of Equity $ 8,173 - Equity Options $ 845 Value per share $ 20.83 Riskfree Rate: T. Bond rate = 5.1% + Beta 2.18-> 1.10 X Risk Premium 4% Internet/ Retail Operating Leverage Current D/E: 37.5% Base Equity Premium Country Risk Premium Current Revenue $ 2,465 Current Margin: -34.60% Reinvestment: Cap ex includes acquisitions Working capital is 3% of revenues Sales Turnover Ratio: 3.02 Competitiv e Advantages Revenue Growth: 25.41% Expected Margin: -> 9.32% Stable Growth Stable Revenue Growth: 5% Stable Operating Margin: 9.32% Stable ROC=16.94% Reinvest 29.5% of EBIT(1-t) EBIT -853m NOL: 1,289 m $24,912 $2,302 $1,509 $ 445 $1,064 Term. Year 2 4 3 1 5 6 8 9 10 7 1 2 3 4 5 6 7 8 9 10 Revenues $4,314 $6,471 $9,059 $11,777 $14,132 $16,534 $18,849 $20,922 $22,596 $23,726 EBIT -$545 -$107 $347 $774 $1,123 $1,428 $1,692 $1,914 $2,087 $2,201 EBIT(1-t) -$545 -$107 $347 $774 $1,017 $928 $1,100 $1,244 $1,356 $1,431 - Reinvestment $612 $714 $857 $900 $780 $796 $766 $687 $554 $374 FCFF -$1,157 -$822 -$510 -$126 $237 $132 $333 $558 $802 $1,057 Debt Ratio 27.27% 27.27% 27.27% 27.27% 27.27% 24.81% 24.20% 23.18% 21.13% 15.00% Beta 2.18 2.18 2.18 2.18 2.18 1.96 1.75 1.53 1.32 1.10 Cost of Equity 13.81% 13.81% 13.81% 13.81% 13.81% 12.95% 12.09% 11.22% 10.36% 9.50% AT cost of debt 10.00% 10.00% 10.00% 10.00% 9.06% 6.11% 6.01% 5.85% 5.53% 4.55% Cost of Capital 12.77% 12.77% 12.77% 12.77% 12.52% 11.25% 10.62% 9.98% 9.34% 8.76% Amazon.com January 2001 Stock price = $14 9b. Amazon in January 2001 Aswath Damodaran 29 30 1o lllusLraLe: ?our mlsLakes versus markeL mlsLakes.. $0.00 $10.00 $20.00 $30.00 $40.00 $50.00 $60.00 $70.00 $80.00 $90.00 2000 2001 2002 2003 Time of analysis Amazon: Value and Price Value per share Price per share Aswath Damodaran 30 31 10. ?ou can make mlsLakes, buL Lry Lo keep blas ouL.. ! When you are wrong on lndlvldual company valuauons, as you lnevlLably wlll be, recognlze LhaL whlle Lhose mlsLakes may cause Lhe value Lo be very dlerenL from Lhe prlce for an lndlvldual company, Lhe mlsLakes should average ouL across companles. ! uL dlerenLly, lf you are an lnvesLor, you have can make Lhe law of large numbers" work for you by dlverslfylng across companles, wlLh Lhe degree of dlverslcauon lncreaslng as uncerLalnLy lncreases. ! lf you are blased" on lndlvldual company valuauons, your mlsLakes wlll noL average ouL, no mauer how dlversled you geL. ! 8ouom llne: ?ou are beuer o maklng large mlsLakes and belng unblased Lhan maklng smaller mlsLakes, wlLh blas. Aswath Damodaran 31 32 And don'L forgeL: lL ls noL [usL Lhe value LhaL you are uncerLaln abouL. INTRINSIC VALUE PRICE Value Price THE GAP Is there one? Will it close? Drivers of intrinsic value - Cashows from existing assets - Growth in cash ows - Quality of Growth Drivers of price - Market moods & momentum - Surface stories about fundamentals Tools for pricing - Multiples and comparables - Charting and technical indicators - Pseudo DCF Tools for intrinsic analysis - Discounted Cashow Valuation (DCF) - Intrinsic multiples - Book value based approaches - Excess Return Models Tools for "the gap" - Behavioral nance - Price catalysts Drivers of "the gap" - Information - Liquidity - Corporate governance Value of cashows, adjusted for time and risk Aswath Damodaran 32 And here ls how lL plays ouL. 33 Aswath Damodaran My valuation of Apple with revenue growth of 6% (Normal, !=3%), target pre-tax margin of 30% (Uniform,25%-35%) and cost of capital of 12.5% (Triangle, 11-14%). There is a 90% chance that Apple is undervalued at $440/share. The value process My valuation of Apple in January 2013 0.0 10.0 20.0 30.0 40.0 30.0 60.0 70.0 80.0 90.0 1 monLh 6 monLhs 1 year 3 years 10 years ME1 N,.-.&O N,"-1**P 4$$J1 Cap wldens Cap sLays same Cap narrows 34 SLraLegles for managlng Lhe rlsk ln Lhe closlng" of Lhe gap ! 1he karmlc" approach: ln Lhls one, you buy (sell shorL) under (over) valued companles and slL back and walL for Lhe gap Lo close. ?ou are lmpllclLly assumlng LhaL glven ume, Lhe markeL wlll see Lhe error of lLs ways and x LhaL error. ! 1he caLalysL approach: lor Lhe gap Lo close, Lhe prlce has Lo converge on value. lor LhaL convergence Lo occur, Lhere usually has Lo be a caLalysL. ! lf you are an acuvlsL lnvesLor, you may be Lhe caLalysL yourself. ln facL, your acL of buylng Lhe sLock may be a sumclenL slgnal for Lhe markeL Lo reassess Lhe prlce. ! lf you are noL, you have Lo look for oLher caLalysLs. Pere are some Lo waLch for: a new CLC or managemenL Leam, a blockbusLer" new producL or an acqulsluon bld where Lhe rm ls LargeLed. Aswath Damodaran 34