1) INTRODUCTION:
• Summarise company’s activities and business model
– What does it sell? Where? To whom? With what competitive advantage? • Main markets served by company – by region, product, customer type
• Typical features which MIGHT affect your company:
– Demographics, social trends, consumer behaviour, fashion, changes in global trading patterns, environmental issues
• Avoid lengthy history and descriptions
• Use short, sharp summary of what drives this business)
– Company’s business model – which markets drive its revenue and profit?
2) SECTOR REVIEW:
– the market forces driving demand, supply, competition, prices, costs & margins in the sectors which contribute most of the company’s revenue and profits
• Sector comments must be relevant to company’s operations
• Identify two to four key market forces driving demand
• Understand how competition works in sector
• Reach clear conclusion on likely future directions
• Reach clear conclusions about specific market forces
• Support those conclusions with statistical evidence
• Do NOT simply download economic and sector data without explaining how it affects sector prospects
3) COMPANY ASSESSMENT:
– company’s competitive position in sector, past performance relative to peers (using financial ratio analysis), key drivers of future trading, conclusion on their likely direction and impact on financial forecasts
• Assess historic performance and future prospects
• Analyse 5-year trends in financial ratios:
– Has it improved or deteriorated in recent years?
– Have there been any volatile movements – what may have caused them?
– Is the company reliable in delivering sustained earnings growth?
– Or is it poised for recovery from a low point? Or unlikely to recover?
• Compare company’s performance with sector peers
– Has it performed better or worse than its peers?
– Are its finances stronger or weaker than its peers?
– Has it been operated more efficient than its peers?
4) FORECASTING:
– translate trading assumptions into sales, costs, income & cash flow forecasts
FORECASTS FOR:
• Revenue from demand, price & competitor analysis
• Expenses from assessment of supplier pressures and movement in operating overheads
• Net income & earnings from tax, debt & interest rates
• Dividend from earnings and payout ratios
• Cash flow from working capital and depreciation accruals
• Balance sheet from accruals, retained earnings and cash flow
5) VALUATION:
– translate forecasts into DCF & DDM valuations relative to share price, and Price Multiples relative to peers
Absolute Valuation Methods / Intrinsic Value
• Convert dividend forecast into DDM
• Convert free cash flow forecast into DCF
Relative Valuation Methods / Price Multiples
• First-year forecast of sales, earnings & book value of equity
• Calculate ratios of:
– P/E
– P/Sales
– P/Book
• Compare with peer company ratios
6) RECOMENDATION AND CONCLUSION:
• If wide variations (>15%) between these valuations, check assumptions
– does cash flow over/understate by using too high/low depreciation charge?
– does dividends over/understate by using too high/low payout ratio?
• If after re-examination values still widely divergent, explain why
• Compare each valuation with current share price to identify Buy (valuation > share price) or a Sell
(share price > valuation)
Criteria for marking the reports
USE OF DATA
• How well have you used data to compile an INDEPENDENT view of company prospects, accessing websites of:
– Company & its competitors
– Industry bodies
– Government statistics and reports
– Financial and economic reports
LOGIC, ARGUMENT & FINANCIAL FORECASTS
• Logical argument to support assessment of company prospects
• Accuracy and clear exposition of company’s financial forecasts
• Independent thinking to link research data to conclusion
• Presentation of argument, financial forecasts and valuation