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Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

Book Description

Analysis and insights from top thought leaders on a pivotal topic in investing and asset management

Valuation is the cornerstone for investment analysis, and a thorough understanding and correct application of valuation methodologies are critical for long-term investing success. Edited by two leading valuation experts from CFA Institute, this book brings together the insights and expertise of some of the most astute and successful investment minds of the past 50 years. From Benjamin Graham, the "father of value investing," to Aswath Damodaran, you'll learn what these investment luminaries have to say about investment valuation techniques, including earnings and cash flow analysis.

  • Features the best thinking on valuation from the industry's masters on the topic, supplemented with dozens of fascinating and instructive real-world examples

  • Comprehensively discusses special valuation situations, such as real options, employee stock options, highly leveraged firms, corporate takeovers, and more

  • Supplies you with the tools you need to successfully navigate and thrive in the ever-changing financial markets

  • Is being produced with the full support and input of CFA Institute, the world's leading association of investment professionals

Table of Contents

  1. Cover
  2. Contents
  3. Title
  4. Copyright
  5. Foreword
  6. Introduction
  7. Part I: Valuation Perspectives: Then and Now
    1. Chapter 1: Two Illustrative Approaches to Formula Valuations of Common Stocks
      1. Notes
    2. Chapter 2: Seeking a Margin of Safety and Valuation
      1. Two Basic Investment Goals
      2. The Price of Money is Fake
      3. The Future is Uncertain
      4. Dealing With Macro Risk
      5. Owning An Enterprise Preserves Purchasing Power
      6. Seek A Margin of Safety
      7. Flexibility to Look Different
      8. Conclusion
      9. Question and Answer Session
      10. Note
  8. Part II: Valuation Methodologies
    1. Chapter 3: Company Performance and Measures of Value Added
      1. Foreword
      2. Acknowledgments
      3. Introduction
      4. Traditional Measures of Performance
      5. Measures of Value Added
      6. Comparison of Alternative Performance Measures
      7. Conclusions
      8. Appendix 3A: The Firm’s Cost of Capital
      9. Appendix 3B: Net Present Value and Internal Rate of Return
      10. Glossary
      11. Notes
      12. References
    2. Chapter 4: The Affordable Dividend Approach to Equity Valuation
      1. Affordable Dividends
      2. Affordable vs. Conventional Dividends
      3. Significance of Difference
      4. Book Value vs. Economic Value Weights
      5. Conclusion
      6. Notes
    3. Chapter 5: Discounted-Cash-Flow Approach to Valuation
      1. The DCF Formula
      2. Estimation of Cash Flows
      3. Discount Rate
      4. Terminal Value
      5. Conclusion
      6. Question and Answer Section
      7. Note
    4. Chapter 6: Equity Securities Analysis Case Study: Merck & Company
      1. Recent Annual Reports
      2. Fundamentals of The U.S. Pharmaceutical Industry
      3. Tasks To Be Completed
      4. Appendix 6A: Merck & Company Financial Data
      5. Appendix 6B: Statistical Data: Pharmaceutical Industry
      6. Appendix 6C: Competitive Strategy Analysis Framework
      7. Appendix 6D: Review of The Dupont Financial Ratio Analysis Method
      8. Appendix 6E: Selected Valuation Methods
      9. Guideline Answers: The Merck Case
    5. Chapter 7: Traditional Equity Valuation Methods
      1. Purpose
      2. Shortcuts
      3. Traditional Valuation Methods
      4. P/B
      5. P/S
      6. P/E
      7. DDM
      8. Screening
      9. Fundamental Analysis
      10. Conclusion
      11. Question and Answer Session
    6. Chapter 8: A Simple Valuation Model and Growth Expectations
      1. The Gordon and Gordon Model
      2. A Simple Finite-Growth Model
      3. The Model and Market Expectations
      4. Evaluating The Reasonableness of A P/E
      5. Overpricing of High-P/E Stocks
      6. Conclusion
      7. Appendix 8A: Comparison of New Model With Gordon and Gordon Model
      8. Acknowledgments
      9. Notes
      10. References
    7. Chapter 9: Franchise Valuation under Q-Type Competition
      1. Single-Phase No-Growth Model
      2. Q-Type Competitive Equilibrium
      3. A General Decay Model
      4. The PV-Equivalent ROE
      5. Basic Two-Phase Growth Model
      6. Conclusion
      7. Notes
      8. References
    8. Chapter 10: Value Enhancement and Cash-Driven Valuation Models
      1. Discounted Cash Flow and Estimates
      2. Estimation Issues
      3. Value Creation
      4. Economic Value Added
      5. Conclusion
      6. Question and Answer Session
    9. Chapter 11: FEVA: A Financial and Economic Approach to Valuation
      1. Principle of One Value
      2. Solving The Circularity Problem
      3. FEVA
      4. Conclusion
      5. Appendix 11A: Derivation of FEVA Formula
      6. Notes
      7. References
    10. Chapter 12: Choosing the Right Valuation Approach
      1. Equity Valuation in Perspective
      2. Choosing A Better Comparable
      3. Summary
      4. Question and Answer Session
      5. Notes
    11. Chapter 13: Choosing the Right Valuation Approach
      1. Defining The Valuation Problem
      2. Asset/Cost Approaches
      3. Market Approaches
      4. Income Approaches
      5. Contingent Claims Approach: Option Valuation Method
      6. Conclusion
      7. Question and Answer Session
      8. Notes
    12. Chapter 14: Valuing Illiquid Common Stock
      1. Value of Liquidity
      2. Stock Return Volatility
      3. Case Study
      4. Conclusion
      5. Notes
      6. References
  9. Part III: Earnings and Cash Flow Analysis
    1. Chapter 15: Earnings: Measurement, Disclosure, and the Impact on Equity Valuation
      1. Foreword
      2. Acknowledgments
      3. Dedication
      4. Introduction
      5. Evidence On The Relevance of Earnings To Valuation
      6. The Reporting of Earnings and Equity Valuation
      7. How Buy-Side Equity Analysts Use Earnings in Valuation
      8. Conclusion
      9. Notes
      10. References
    2. Chapter 16: Cash Flow Analysis and Equity Valuation
      1. FCF Approach
      2. Problems With Earnings Focus
      3. FCF Analysis for Stock Valuation
      4. FCF Example
      5. Conclusion
      6. Question and Answer Session
    3. Chapter 17: Accounting Valuation: Is Earnings Quality an Issue?
      1. Earnings Measures and Valuation
      2. Empirical Tests of Earnings Quality
      3. Policy Implications
      4. Notes
      5. References
    4. Chapter 18: Earnings Quality Analysis and Equity Valuation
      1. Why Analyze Earnings Quality?
      2. Impact of Earnings Surprises
      3. Defining Earnings Quality
      4. Simple Accruals Example
      5. Decomposing Earnings
      6. Conclusion
      7. Question and Answer Session
    5. Chapter 19: Is Cash Flow King in Valuations?
      1. Multiples-Based Valuation
      2. Prior U.S. Evidence: Dominance of Earnings
      3. International Sample
      4. International Results
      5. Conclusion
      6. Appendix 19A: Variable Definitions
      7. Notes
      8. References
  10. Part IV: Option Valuation
    1. Chapter 20: Employee Stock Options and Equity Valuation
      1. Foreword
      2. Preface
      3. Employee Stock Option Basics
      4. Expected Cost of Options
      5. Footnote Disclosure
      6. Patterns of Option Exercise
      7. Option Value to Employees
      8. Impact On Cash Flow and Valuation
      9. Summary and Application
      10. Appendix 20A: Selected Disclosures From Dell Computer’s 2002 Annual Report
      11. Notes
      12. References
    2. Chapter 21: Employee Stock Option Valuation with an Early Exercise Boundary
      1. Heuristic Models of A Voluntary Early Exercise Boundary
      2. Comparison of L, M, and μ Models
      3. Conclusion
      4. Acknowledgments
      5. Notes
      6. References
  11. Part V: Real Options Valuation
    1. Chapter 22: Real Options and Investment Valuation
      1. Foreword
      2. Preface
      3. Introduction
      4. Valuation Models: Traditional Versus Real Options
      5. A Framework For The Valuation of Real Options
      6. Getting Real About Real Options
      7. Pitfalls and Pratfalls in Real Options Valuation
      8. Empirical Evidence on The Use and Accuracy of Real Options Valuation
      9. Summary and Conclusions
      10. Appendix 22A: Further Illustrations of Real Options in Investment Projects
      11. Appendix 22B: Binomial Example of The Hokie Company’s Investment Opportunity
      12. Glossary
      13. References
    2. Chapter 23: Real-Options Valuation for a Biotechnology Company
      1. New-Drug Development
      2. Agouron Pharmaceuticals
      3. Assumptions
      4. Valuation Methods
      5. Results
      6. Conclusion
      7. Note
      8. References
  12. About the Contributors
  13. Index