Categories of Equity Valuation Models
Three major categories of equity valuation models are as follows:
Estimated Value and Market Price
By comparing estimates of value and market price, an analyst can arrive at one of three conclusions: The security is undervalued, overvalued, or fairly valued in the marketplace. In practice, the conclusion is not so straightforward. Analysts must cope with uncertainties related to model appropriateness and the correct value of inputs. An analyst’s final conclusion depends not only on…
Forecasting Capital Investments and Capital Structure
Projections for long-term assets are based on cash flow statement and income statement projections, because net PP&E and intangible assets on the balance sheet primarily increase due to capital expenditures and decrease due to depreciation and amortisation expenses. Capital expenditures can be broken down into maintenance capital expenditures necessary to sustain the current business and…
Forecasting Operating Expenses and Working Capital
Cost of Sales and Gross Margins Cost of sales (cost of goods sold, or COGS) is typically the single largest cost for companies that make and/or sell products. SG&A Expenses SG&A expenses are the other main type of operating costs. In contrast to cost of sales, SG&A expenses often have a less direct relationship with…
Forecasting Revenues
Forecast Objects for Revenues Forecast objects for revenues are typically either top-down or bottom-up drivers, as discussed in the earlier module on company analysis. Common top-down forecast objects include “growth relative to GDP growth” and “market growth and market share.” Separating Recurring and Non-Recurring Revenue or Revenue Growth Forecast Approaches for Revenues
Competitive Positioning
All companies have a competitive strategy, whether intentional or not. An intentional strategy results from company-wide planning, performance measurement, and feedback loops to sharpen the strategy. An unintentional strategy results from various teams within a firm pursuing their own incentives, doing whatever they did in prior years, or following industry or professional norms. An unintentional…
Industry Survey
Industry Size and Historical Growth Rate Industry size is typically measured by total annual sales from the product or customer perspective, which is not necessarily all sales of each industry constituent. Except for some industries that are dominated by large, publicly traded companies (e.g., autos, smartphones, airlines, pharmaceuticals), industry size will often include a potentially…
Industry Classification
Third-Party Industry Classification Schemes Early third-party industry classification schemes such as SIC, NACE, and ISIC were devised by government agencies, tended to be country-specific, and grouped companies by their production characteristics into industries such as agriculture, manufacturing, distribution, retail, and services. GICS, ICB, and TRBC also have slightly different rules for companies operating in multiple…
Use of Industry Analysis
Why Analyse an Industry Many industry participants have similar business models. They often compete in the same or similar product markets as sellers and in factor markets as buyers, so they tend to be exposed to the same demand and supply opportunities and risk factors. As will be discussed later with Porter’s Five Forces model,…
Capital Investments and Capital Structure
Sources and Uses of Capital Evaluating Capital Investments and Capital Structure Returns on invested capital over the longer run, compared with investors’ required rates of return, can be used to evaluate whether management has used investors’ capital wisely. Risks related to the capital structure can be measured using leverage and coverage ratios, credit ratings by…