Investments: Principles of Portfolio and Equity Analysis

CHAPTER 10

EQUITY VALUATION: CONCEPTS AND BASIC TOOLS

John J.Nagorniak, CFA

Foxboro, MA, U.S.A.

Stephen E.Wilcox, CFA

Mankato, MN, U.S.A.

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

• Evaluate whether a security, given its current market price and a value estimate, is overvalued, fairly valued, or undervalued by the market.
• Describe major categories of equity valuation models.
• Explain the rationale for using present value of cash flow models to value equity and describe the dividend discount and free cash flow to equity models.
• Calculate the intrinsic value of a noncallable, nonconvertible preferred stock.
• Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate.
• Identify companies for which the constant growth or a multistage dividend discount model is appropriate.
• Explain the rationale for using price multiples to value equity and distinguish between multiples based on comparables versus multiples based on fundamentals.
• Calculate and interpret the following multiples: price-to-earnings, price to an estimate of operating cash flow, price-to-sales, and price-to-book value.
• Explain the use of enterprise value multiples in equity valuation and demonstrate the use of enterprise value multiples to estimate equity value.
• Explain asset-based valuation models and demonstrate the use of asset-based models to calculate equity ...