1) Analyse company’s business activities
Use your own explanation of how company’s business model works – DO NOT COPY COMPANY’S STATEMENTS
2) Identify key drivers of business model and competitiveness,
Use independent data on company’s markets.
Assess future prospects for these markets.
3) Compile financial ratios for performance, efficiency, liquidity and solvency for company and at least three competitors
Ratio analysis over the past five years
Comparing these ratios – draw your own conclusions, NOT just descriptions
4) Detailed forecasts of income statement and balance sheet for next five years and in perpetuity
Justify your forecast and support with statistics
5) Apply valuation techniques, with full spreadsheet support (see tutorials)
Capital Asset Pricing Model (CAPM),
Discounted Dividend Model (DDM),
Discounted Cash Flow (DCF),
Relative price multiples of earnings and cash flow.
Structure of the Project
Summary:
equity data, company fundamentals, prospects, valuation & recommendation
Introduction:
Company’s business model – which markets drive its revenue and profit?
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
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
Forecasting
translate trading assumptions into sales, costs, income & cash flow forecasts
Valuation:
translate forecasts into DCF & DDM valuations relative to share price, and Price Multiples relative to peers
Recommendation & conclusion
Summary
Show key data on share price & performance, valuation price & ratios and investor recommendation
1) Two to three statements which explain your forecasts for the company’s revenue, income and cash flow
2) Key economic and market forces driving company’s prospects
3) How this translates into valuation, target price & recommendation
Introduction to company
1) 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
Sector review
1) Sector comments must be relevant to company’s operations
2) Identify two to four key market forces driving demand
3) Understand how competition works in sector
4) Reach clear conclusion on likely future directions
5) Reach clear conclusions about specific market forces
6) Support those conclusions with statistical evidence
-Do NOT simply download economic and sector data without explaining how it affects sector prospects
Company assessment
1) Assess historic performance and future prospects
2) 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?
3) 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?
Translating assessment into forecasts
FORECASTS FOR:
1) Revenue from demand, price & competitor analysis
2) Expenses from assessment of supplier pressures and movement in operating overheads
3) Net income & earnings from tax, debt & interest rates
4) Dividend from earnings and payout ratios
5) Cash flow from working capital and depreciation accruals
6) Balance sheet from accruals, retained earnings and cash flow
Translating forecasts into valuation
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
Conclusion & recommendation
1) 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?
2) If after re-examination values still widely divergent, explain why
3) Compare each valuation with current share price to identify Buy (valuation > share price) or a Sell (share price > valuation)