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Valuation Summary

Core Content

This document is a comprehensive overview of valuation principles and techniques used by the UBS-IB Global Valuation Group. It outlines the concept of value, its importance in investment decisions, and the various methods used to assess it.

Main Points

What is Value?

• Value exists and is influenced by organisational capital, which includes management expertise, skilled workers, desirable products/services, and favorable public opinion.
• Market prices reflect value to some extent, but not all investors agree on the value of an asset.
• Value matters in the long run, as the market tends to converge with intrinsic value over time.

How is Value Determined?

• The volatility of prices is linked to uncertainty in estimating value.
• Investors consider various firm characteristics such as sales, margins, growth rates, asset utilization, earnings, cash flows, tax rates, and capital structure.
• Value is not solely based on accounting earnings or Earnings/Price ratio.

Differences Between Equity and Credit Investors

• Equity investors receive returns through dividends and price increases, with little control over the latter.
• Creditors focus on cash flow, ability to refinance, and repayment schedules, with a greater emphasis on security-specific factors like maturity and coupon.

Investment Considerations

• The return is not always equal to the yield, as it depends on holding period, reinvestment of coupons, and price changes.
• Investment banking plays a role in aligning valuations with market prices when they diverge.

Key Techniques

Valuation Methods

• Market-based methods: Include multiples such as EV/sales, EV/EBITDA, EV/OpFCF, and others.
• Model-based methods: Include DCF (Discounted Cash Flow) and EVA (Economic Value Added).

DCF and EVA

• DCF involves forecasting cash flows and discounting them to present value using a weighted average cost of capital (WACC).
• EVA measures the economic profit of a company by comparing net operating profit after taxes (NOPAT) to the cost of capital.

Example: Swisscom Valuation

• DCF valuation for Swisscom in 2005:

  • WACC: 6.1%
  • Terminal value: CHF 50,239
  • Terminal FCF: CHF 2,512
  • Terminal FCF multiple: 20.0
  • DCF enterprise value: CHF 50,576
  • DCF equity value: CHF 51,051
  • DCF value per share: CHF 694

• Implied multiples for Swisscom show various ratios and their relative performance over time.

Sector Approaches to Valuation

• Different sectors use various valuation techniques:
  • Equity value multiples: PE, Price to cash earnings, etc.
  • Enterprise value multiples: EV to sales, EV to EBITDA, EV to OpFCF, etc.
  • Other methods: Yield measures, multiples combined with growth and return on capital, DCF-based techniques.

Role of an Analyst

• Detective: Identify facts and form theories.
• Critic: Highlight shortcomings and suggest improvements.
• Judge: Render decisions based on fundamental and relative value.
• Fortune teller: Predict security prices and spreads.

Forecasting Responsibilities

• Return components are forecasted by different teams:
  • Unconditional factor return by asset allocation teams.
  • Conditional factor return by strategists.
  • Unconditional idiosyncratic return by models.
  • Conditional idiosyncratic return by analysts.
  • Beta by risk models or analysts.

Risk vs. Return

• Investors require a certain level of return to be reasonably confident in a stock's future performance.
• For example, a stock with 30% annual volatility may need an expected return of around 20% to be confident of a positive return in one year.

Conclusion

Valuation is a complex process that involves understanding the relationship between market price and intrinsic value, considering various financial and market factors, and using both market-based and model-based techniques. The role of an analyst is to analyze, critique, judge, and predict, while the market tends to reflect value over the long term.