FIN 3310 Analysis of Securities FIN 4320 Security

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø June 15 (1) Introduction: Types of Analysis – What Drives Security Prices? (2) Why Study Security Analysis/Key Definitions (Page xii, Page 1) (3) Valuation Process: Five Steps (Page 7) § § § Understand the Business Forecast Company Performance: Pro Formas! Select Appropriate Valuation Models Convert Forecasts to Valuation (Apply the Models) Apply the Valuation Conclusions (4) Alternative Valuation Models: Intrinsic Value = Willing-to-Pay (WTP) § Absolute Valuation Models (Page 18) § § § Dividend Discount Model (DDM) FCFF: Free Cash Flow to Firm Model FCFE: Free Cash Flow to Equity Model Residual Income Models (Page 19) Relative Valuation Models (e. g. , P/E Ratio Comparison) Page 20 Total Entity and Components of the Corporation (e. g. Breakup Value) Page 22 1

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø June 15: Continued (5) Types of Analysis (Page 26) § § Sell-Side: Does Research/Makes Stock Recommendations Buy-Side: Uses Research/Makes Asset Allocation/Buy Decisions/No. Shares (6) Format of a Research Report (Page 31, Exhibit 1 -2) Ø June 17 (7) Review Homework: Page 35 Problems #2, 6 (8) Computing Required Return: Introduction (Page 37, 39). Alpha (Page 40) (9) Gordon Models (Page 43) § § Required Return Estimate (Equation 2 -3 b) Intrinsic Value = WTP: Willing-To-Pay (Equation 2 -3 a) (10) Equity Risk Premium Required Return Estimate (Page 44) (11) Capital Asset Pricing Model (CAPM) Required Return Estimate (Page 57) § § Equation 2 -4 (Page 44 & 57) Adjusted Beta β: Equation 2 -8 (Page 59) 2

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø June 22 (12) Review Homework: Page 80 Problems #2, 3 a (13) Fama-French-Model(FFM)1993: Three Factors (Website #36 & Page 65) RMRF: Return on Market Less Risk-Free Return SMB: Small minus Big HML: High minus Low FFM: Equation 2 -11 (Page 66) § § (14) Pastor and Stambaugh (PSM) 2003: LIQ (Liquidity) Factor (Page 69) § § § Equation 2 -12 (Page 69) FFM/PSM In-Class Exercise Wharton Research Data Services (WRDS) See Website #95 and Newmont Mining (NEM) Example on Canvas (15) Bond Yield Plus Risk Premium Model (BYPRP): Page 73 Equation 2 -13 § See Website #22 c (FINRA: Financial Industry Regulatory Authority) (16) Weighted Average Cost of Capital (WACC) Page 76 Equation 2 -14 (17) Summary of Required Return (r) Models (next slide) 3

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø June 22: Continued (18) Summary of Required Return Models Model Page Equation 44 2 -3 b 44, 57 2 -4 Fama-French (FFM) 66 2 -11 Pastor-Stambaugh (PSM) 69 2 -12 Bond Yield Plus Risk Premium 73 2 -13 Gordon Cost of Equity CAPM For Research Report: § § § Compute at Least Three (3) Required Return Models You Should Weight The Results of Your Three Models The Key is Justification for Your Weighting! 4

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø June 24 (19) Review Homework: Page 81 Problems #4, 5, 6 (20) Key Definitions of Cash Flows § § Dividends (D) (Page 87) Free Cash Flow to the Firm (FCFF): Pre-Debt Cash Flow (Page 90) Free Cash Flow to Equity (FCFE): Post-Debt Cash Flow (Page 91) Residual Income (RI) (Pages 91 -92) (21) Gordon Dividend Discount Models (DDM): Page 85 Equation #3 -1 § § With Terminal Stock Price: Page 94 Equation #3 -2 Without Terminal Stock Price: Page 97 Equation #3 -10 (22) Two-Stage DDM: Page 113 Equation #3 -19 (23) Summary: DDM Used When (Page 88) § § § Company Has Historical Dividend Track Record Company Dividends Relate to Company Earnings Investor Has Non-Control Perspective (e. g. , Small Ownership) 5

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø June 29 (24) (25) (26) (27) (28) (29) Catch-Up from June 24 H-Model (Page 117) Three-Stage DDM (Page 119) Calculating the Growth Rate (g) (Page 128) Review Homework: Page 137 Problems #2, 4 Summary of Dividend Valuation Models Model Page Equation 94 3 -2 One-Stage DDM Without Terminal Stock Price 97 3 -10 Two-Stage DDM 113 3 -19 H-Model 117 3 -20/Excel BB One-Stage DDM With Terminal Stock Price Three-Stage DDM 119 Example 3 -17, p. 119 6

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø July 1 (30) Review Homework: Page 138 Problems #10, 26 (31) Introduction to Free Cash Flows (Page 146) (32) Definition of Free Cash Flows § § FCFF: Equation 4 -7 (Page 151) FCFE: Equation 4 -9 (Page 163) (33) Forecasting FCFF and FCFE (Page 172) (34) FCFE Single-Stage Model (Page 150/Equation 4 -6) (35) FCFE Two-Stage Model (Page 186/Equation 4 -17) (36) FCFE Three-Stage Model (Page 193/Example 4 -19) Ø July 6 (37) Catch-Up from July 1: Working Capital and FCFE Models § CFA Institute Definition “Working Capital: ” Page 152 -153, Example 4 -2 (38) Review Homework: Page 197 Problems #2, 5 (39) Introduction to Residual Income Models (Page 210) (40) Residual Income: § § Terminal Value (TV): Page 215/Equation 5 -3 & Team DU, NEM Page 22 Stock Price: Page 226/Equation 5 -6 & Example 5 -13 Pages 241 -243 7

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø July 8 (41) Miscellaneous: Marginal Tax Rates (Page 77) Non-Recurring Items (Page 248) (42) Review Homework § § Page 252 Problems #1, 2, 6 b Page 254 Problems #16 a, b, c (43) Summary of Free Cash Flow and Residual Income Models (Page 232) Model Page Equation FCFE Single-Stage* 150 4 -6 FCFE Two-Stage* 186 4 -17 FCFE Three-Stage* 193 Example 4 -19 Residual Income with Terminal Value* 215 5 -3 (Example: Newmont Mining, Team DU, p. 22) Residual Income with Stock Forecast* 226 5 -6 (Example 5 -13, p. 241) *Per Share Computation. Divide Results by No. of Common Shares Outstanding. 8

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø July 13 (44) Reminder of Thomson One for Research Reports (45) Review for Exam I (30% of Course Grade) § Ø July 15 § 20 -25 Multiple Choice Problems 4 -5 Problems (46) Exam I: 30% of Course Grade Ø July 20: Research Reports Due July 22 (47) Introduction to Relative Valuation (Page 258) (48) Price to Earnings (P/E) (Pages 262 -263) (49) Types of P/Es § § Trailing P/E (Page 264) Forward P/E (Page 264) (50) Review Microsoft (MSFT) and Value Line (See Guide Pages 14 -15) (51) Justified Forward and Justified Trailing P/Es (Pages 275 -276) (52) Historical P/Es: Regress to Historical Average Levels (P. 290/Example 6 -15) 9

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø July 22: Research Reports Due! (53) (54) (55) (56) (57) Review Homework: Page 348 Problems #6, 9 Price to Book Value (P/B) (Page 295) Price to Sales (P/S) (Page 306) Price to Cash Flow (P/FCFE) (Page 312) Enterprise Value to EBITDA (EV/EBITDA) (Page 321) § § Trailing P/E Forward P/E (58) Merrill Lynch Institutional Factor Survey (Page 341, Exhibit 6 -30) (59) Summary of Relative Valuation Models (next slide) 10

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 (59) Summary of Selected Relative Valuation Models Model Page Equation Trailing P/E* “…the standard method…” 264 Narrative Definition Justified Trailing P/E** 276 6 -2 Forward P/E* 264 Narrative Definition Justified Forward P/E** 275. 6 -1 Justified Price Using Historical P/E** 290 6 -3/Example 6 -15 Price to Book (P/B)* 295 6 -4 Justified Price to Book (P/B)** 304 6 -4 Price to Sales (P/S)* . 306 Narrative Definition Justified Price to Sales (P/S)** 310 6 -6 Price to Cash Flow (P/CF)* & Justified Price to Cash Flow** 316 Example 6 -30 Price to Free Cash Flow to Equity (P/FCFE)*& Justified P/FCFE** 316 Example 6 -30 Enterprise Value to EBITDA (EV/EBITDA)* 321 Narrative Definition 11

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø July 27 (60) Review Homework: Page 350 Problems #12, 13 (61) Introduction to Private Company Valuation (Page 354) (62) Estimating the Required Return for Private Company Valuation § § Expanded CAPM (Page 371, Example 7 -4) Risk-Free plus Premiums/Build-Up Method (Page 371, Example 7 -5) (63) Valuation Approaches (Page 360) § § § Income Approach Market Approach Asset-Backed Approach (64) Income Approach: Capitalized Cash Flow Method (CCM) (Page 373) (65) Market Approach: Private Company Valuation (Page 377) § § § Guideline Public Company Method (GPCM): Publicly-Traded Multiples Guideline Transaction Method (GTM): Acquisitions (Public or Private) Prior Transaction Method (PTM): Stocks Traded Within Private Company (66) Asset-Based Approach: FMV Assets – FMV Liabilities (Page 385) (67) Valuation Discounts and Premiums (Page 388) 12 § Discount for Lack of Control (DLOC), Discount for Lack of Marketability (DLOM)

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 (68) Summary: Private Company Valuation Model Page Equation Required Return: Expanded CAPM 371 Exhibit 7 -4 Required Return: Risk Free Rate Plus Premiums 371 Exhibit 7 -5 Capitalized Cash Flow Methods (CCM) 373 7 -1, 7 -2 Guideline Public Company Method (GPCM) 380 Example 7 -5 Guideline Transactions Method (GTM) 384 Exhibit 7 -12, 7 -13 Guideline Prior Transaction Method (PTM) 384 Narrative Definition Asset-Based Valuation 385 Narrative Definition Discount for Lack of Control (DLOC) 388 Example 7 -8, Exhibits 7 -15, 7 -16 Discount for Lack of Marketability (DLOM) 389 “ 13

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø July 29 (69) Review Homework: Page 397 Problems #2, 3 (70) Introduction to Technical Analysis § § (71) (72) (73) (74) (75) We will Review Five Methods (#71 - #75) Use: www. stockcharts. com (Website #60) Candlestick Charting Moving Average Relative Strength Index (RSI) Money Flow Index (MFI) Bollinger Bands Note: Behavioral Analysis Readings for August 3 (Mon) on Canvas 14

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø August 3 (76) Introduction to Behavioral Analysis (77) The January Effect: Small Stocks Do Well in January (78) The Winner’s Curse: People Pay More Than Asking Price for Home § (79) (80) (81) (82) (83) (84) (85) Sherbo: “…Greater Fool Theory…” Investment Anchoring: If Stock Dropped, Then it Will Recover Mental Accounting: All Money is Not Equal Confirmation Bias: We Hear Only Good News About Our Stocks Hindsight Bias: Monday Morning Quarterbacking Herd Behavior: “Everyone” is Buying the Twitter IPO” Overconfidence: I Don’t Make Mistakes Prospect Theory: We Value Gains and Losses Differently Ø August 5 (86) Research Report Presentations (Schedule on Canvas) 15

FIN 3310 Analysis of Securities FIN 4320 Security Analysis & Valuation Summer 2015 Ø August 10 (87) Class Evaluations. Bring Laptop. (88) Review for Exam II (Final): 35% of Course Grade § 25 Multiple Choice/4 -5 Problems Ø August 12: Exam II (Final) 16