CORPORATE FINANCE SPRING 2014 Aswath Damodaran Ponderous Thoughts

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CORPORATE FINANCE: SPRING 2014 Aswath Damodaran

CORPORATE FINANCE: SPRING 2014 Aswath Damodaran

Ponderous Thoughts, or maybe not There are few facts and lots of opinions. 1.

Ponderous Thoughts, or maybe not There are few facts and lots of opinions. 1. a. b. The real world is a messy place. 2. a. b. 3. 4. Even the givens (cash & risk free rate) are not With accounting and market numbers, all bets are off. Money making firms can become money losers Companies can be restructured/ given facelifts Models don’t compute values and optimal paths. You do. Change is the only constant. 2

The Breakdown in the Classical Objective Function STOCKHOLDERS Have little control over managers Lend

The Breakdown in the Classical Objective Function STOCKHOLDERS Have little control over managers Lend Money BONDHOLDERS Managers put their interests above stockholders Managers Significant Social Costs SOCIETY Some costs cannot be traced to firm Bondholders can get ripped off Delay bad Markets make news or mistakes and provide misleading can over react information FINANCIAL MARKETS 3

I. Where does the power lie? Spring 2014: Power Distribution 60% 50% 40% No

I. Where does the power lie? Spring 2014: Power Distribution 60% 50% 40% No Power Some Power 30% Lots of Power 20% 10% 0% All Firms US firms Non-US firms 4

II. Who is your marginal investor? From Spring 2013 90% 80% 70% 60% 50%

II. Who is your marginal investor? From Spring 2013 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Large Small Individual Institution Insiders 5

III. Risk Profiles and Costs of Equity 6

III. Risk Profiles and Costs of Equity 6

Beta: The Standard Approach 7

Beta: The Standard Approach 7

Regression Estimation Approaches Spring 2014: Beta Approach Used 284 300 250 200 150 100

Regression Estimation Approaches Spring 2014: Beta Approach Used 284 300 250 200 150 100 15 3 50 0 Regression Bottom-up Other Typical reasons 1. My company is unique. I cannot find comparable firms. 2. My company is in only one line of business 3. My bottom-up beta is too different from my regression beta 8

Beta Distribution Spring 2014: Beta Distribution 80 Average Median High Low 70 Beta 1.

Beta Distribution Spring 2014: Beta Distribution 80 Average Median High Low 70 Beta 1. 09 1. 07 2. 9 0. 28 60 50 40 30 20 10 0 < 0. 5 -0. 7 - 0. 9 - 1. 1 - 1. 3 - 1. 5 -1. 75 -2 >2 9

Jensen’s Alpha Distribution Average Median High Low Alpha 16% 5% 1310% Keurig Green Mountain

Jensen’s Alpha Distribution Average Median High Low Alpha 16% 5% 1310% Keurig Green Mountain -379% AMD 10

R Squared Average Median High Low R squared 33% 20% 69% Intuitive Surgical 0%

R Squared Average Median High Low R squared 33% 20% 69% Intuitive Surgical 0% Many 11

Cost of Capital 12

Cost of Capital 12

Distribution of Current Market Value Debt Ratios 13

Distribution of Current Market Value Debt Ratios 13

IV. The Quality of Investments: The Firm View 14

IV. The Quality of Investments: The Firm View 14

Return Spreads 15

Return Spreads 15

VI. The Optimal Financing Mix Actual versus Optimal Debt Ratios 120 Optimal debt ratio

VI. The Optimal Financing Mix Actual versus Optimal Debt Ratios 120 Optimal debt ratio Average 31. 26% Median 30. 00% High 90. 00% Samsung, HP, Darden, Conoco Low 0. 00% 17 firms 100 80 Optimal 60 Actual 40 20 0 0% 0. 01% -10% 10 - 20% 20 - 30% 30 - 40% 40 - 50% 50 - 60% 60 - 70% 70 - 80% 80 - 90% 16

d re ve or m e to an th 30 % 40 70 le

d re ve or m e to an th 30 % 40 70 le d 80 er re 0% 20 -3 0% -2 % 10 90 Ov ve le er Ov d re ve le er Ov an 10 th 10 % 0% 10 -2 0% 20 -3 % % 40 -4 0 30 > th an d re ss le d re ve ve le er Ov d re ve le er Ov rle de Un rle de Un Under versus Over Levered Firms 100 Average Median Low High Under or over levered -10. 49% -7. 33% -67. 86% Samsung 27. 00% Shutterfly 60 50 40 2008 30 2010 20 2012 2014 10 0 17

VIII. The Right Kind of Financing 18

VIII. The Right Kind of Financing 18

IX. Measuring Potential Dividends 19

IX. Measuring Potential Dividends 19

Dividends versus FCFE Average Median Low High FCFE/Dividends 66. 65% 12. 49% 0. E+0

Dividends versus FCFE Average Median Low High FCFE/Dividends 66. 65% 12. 49% 0. E+0 2164. 00% 20

X. Valuation: Match up cashflows and discount rates… 21

X. Valuation: Match up cashflows and discount rates… 21

Getting to equity value per share Approach used To get to equity value per

Getting to equity value per share Approach used To get to equity value per share Discount dividends per share at the cost of Present value is value of equity per share equity Discount aggregate FCFE at the cost of equity Present value is value of aggregate equity. Subtract the value of equity options given to managers and divide by number of shares. Discount aggregate FCFF at the cost of capital PV = Value of operating assets + Cash & Near Cash investments + Value of minority cross holdings -Debt outstanding = Value of equity -Value of equity options =Value of equity in common stock / Number of shares 22

Value versus Price Average Median Low High Under or over valuation 56. 88% 21.

Value versus Price Average Median Low High Under or over valuation 56. 88% 21. 44% 0. 000 1578. 26% 23

Ways of changing value… 24

Ways of changing value… 24

25 Aswath Damodaran

25 Aswath Damodaran

26 Aswath Damodaran

26 Aswath Damodaran

So, how do you explain the price? Its all relative. . 27

So, how do you explain the price? Its all relative. . 27

Most undervalued stocks!! 28

Most undervalued stocks!! 28

The Triple Whammy: Underlevered, Cash Buildup and Under valued? Company AGCO AMCX Apple Chevron

The Triple Whammy: Underlevered, Cash Buildup and Under valued? Company AGCO AMCX Apple Chevron CISCO Coca-Cola e. Bay Express, Inc. Francesca's Fuji. Film Holdings Corporation Google Gran Tierra Energy HP Intel Intuitive Surgical LVMH Michael Kors Newmont Mining NOV Qualcomm Samsung Schlumberger Tyson Foods, Inc Verizon Viacom World Fuel Services Zuo. An Power 1 1 0 1 0 0 0 1 0 0 1 1 1 Jensen's Alpha -8. 58% 6. 08% 77. 00% 26. 20% -0. 50% -0. 80% -5. 25% 5. 10% -9. 77% 2. 10% ROC WACC 5. 85% 15. 42% 54. 23% 22. 61% 6. 51% 2. 27% 0. 58% 1. 41% 7. 78% 16. 86% -0. 04% 0. 06% 3. 44% -0. 19% -6. 40% -10. 21% 1. 16% 33. 02% -7. 80% 17. 00% -2. 98% 1. 43% -0. 10% 22. 84% -0. 2517 -1. 27% 20. 13% -1. 00% 5. 74% 6. 26% 15. 31% 4. 94% 98. 12% 5. 11% 1. 63% 54. 62% 9. 73% 2. 85% 8. 81% 8. 30% 11. 46% 10. 25% 2. 60% 20. 92% 1 0 2 0 0 1. 11% 32. 30% -31. 14% Current Debt ratio 22. 36% 31. 10% 3. 79% 3. 35% 7. 63% 11. 81% 16. 60% 6. 18% 49. 43% 22. 29% 24. 13% 2. 29% 7. 80% 27. 40% 9. 73% 0. 14% 15. 97% 3. 06% 35. 70% 16. 60% 0. 25% 5. 38% 9. 80% 18. 43% 34. 08% 39. 74% 26. 01% 16. 76% 12. 14% Optimal Debt Ratio Dividends FCFE 50. 00% 57. 5 241. 6 80% 0 $29, 584. 00 80. 00% 35912 120184 70. 00% 27172 48729 60. 00% 9532 9537. 14 50. 00% 3310. 00 5458. 00 30. 00% 21732 54026 40. 00% 0 2036 80. 00% 0 70. 98 80. 00% 32. 97 111. 02 40. 00% $18, 291 $73, 592 50. 00% 20. 00% 30. 00% 50. 00% 20. 00% 50. 00% 40. 00% 90. 00% 50% 70. 00% 60. 00% 50% 80. 00% 40 2, 681, 154 801 30809 0 136. 7 $900. 20 $9, 644. 40 3913 5744 2027. 9 2152 1242 € 6, 143. 60 0 $397. 60 $448 1999 203 249. 29 1450. 8 5790. 2 $1, 226. 14 $11, 231. 18 $15, 169. 00 $29, 784. 00 304 3708 5936 18918 51031 71987 509 3703 17. 32 87. 12 0 $90 Value/share $166. 41 $(7. 34) $720. 97 $1, 293. 71 $148. 94 26. 73 $40. 91 $61. 11 $17. 68 $27. 69 Price/Share $55. 15 $58. 00 $585. 54 $592. 58 $118. 91 23. 03 $31. 80 $50. 54 $14. 62 $16. 27 $4, 956. 22 $589. 56 $9. 28 $35. 88 $37. 51 $487. 66 € 176. 46 116. 25 $51. 73 $91. 77 $88. 81 $2, 475, 433. 50 $99. 91 $49. 89 $55. 08 $78. 27 $101. 64 $49. 96 $6. 82 $2, 570. 00 $518. 73 $7. 25 $32. 23 $26. 30 $363. 50 € 140. 10 91. 82 $24. 02 $77. 87 $79. 50 $1, 350, 000. 00 $69. 10 $38. 44 $47. 60 $48. 49 $83. 64 $43. 17 $1. 70 29

First Principles 30

First Principles 30

Objectives of this class If you get the big picture, the details will come

Objectives of this class If you get the big picture, the details will come (sooner or later) Tools are useful but only in the larger context of answering bigger questions. Corporate finance is not so bad !!! 31

And don’t forget your CFEs… 1. This course was mentally challenging/intellectually stimulating. 1 2

And don’t forget your CFEs… 1. This course was mentally challenging/intellectually stimulating. 1 2 3 4 5 6 No-brainer! 2. 7 Brilliant insights! This course was demanding of my time. 1 2 3 4 5 What work? 6 7 Haven’t slept all semester. 3. This course provided me with tools and information that I will find useful in the future. 1 2 3 4 5 6 Only in prison 4. Completely relevant Overall evaluation of the course 1 2 3 4 Horrible! ( I want my money back) 5. 5 6 7 6 7 Stupendous! The instructor was organized and well prepared for class. 1 2 3 4 Had trouble finding classroom 6. 5 Scarily efficient! The instructor communicated his/her ideas and material well. 1 2 3 4 Garbled gobbledygook! 7. 5 Should have own TV show The instructor was enthusiastic about his/her subject matter. 1 2 3 4 5 Dead man talking! 8. 6 7 I am a convert Overall evaluation of the instructor 2 Dog! 7 3 4 5 6 7 Star! 32