FINM7401 Finance

Briefly describe the equity valuation method examined in each paper. write a brief summary of the data, methodology and findings. Note: marks will be allocated for correct grammar and clear and logical writing.Provide a reference list of the two papers you have reviewed in part (1). Note that your reference list will only include two papers, not all the references within the papers. 

 

Provide a short summary of the company. In your summary include the company name,principal activity, date and amount of all dividends paid in 2016. These fields must come from Bloomberg. 

Using the month-end share prices, calculate the monthly return on this stock for each month January 2016 to December 2016. You must provide 12 return numbers. Also calculate the overall annual return for 2016 (we will call this the required return). Show all your workings and give your answers as a decimal rounded to two decimal places. List and justify any assumptions you have made.

There are various accounting methods that can be used for valuation of the equity of business entity however mostly dividend discount model is used practically. By considering this aspect, provided part of the study is focused on the description of two other model that can be used for equity valuation. This model are analysed by considering research paper from Journal of Business Finance & Accounting to attain better understanding of subject matter

Equity valuation method

Abnormal Earnings Growth Model

The abnormal earnings valuation model is one of the significant method used for determination of worth of a company on the basis of their book value and earnings. It is also considered to be the residual income model, which evaluate whether decisions of management that are either result in better or worse performance of the company. In accordance with this model, investors are required to pay higher than book value if earnings are higher in comparison to expectations and vice versa.

Equity valuation using multiples

This method is also known as a comparable approach in which there should be a similarity in equity with other equities of similar class. In this method, the value of the company is determined by making a comparison of it with their rivals in the similar industry. The discrepancy in value is considered as an opportunity. It shows that valued equity is undervalued and can be considered valid till there is an increase in value. Primary market multiples include enterprise multiple,  price to book (P/B) price to earnings (P/E), enterprise value to sales (EV/S), and price to free cash flow (P/FCF). For better indication, analysts can consider their comparison of margin levels.  

Brief summary of research papers

The Valuation Accuracy of Equity Value Estimates Inferred from Conventional Empirical Implementations of the Abnormal Earnings Growth Model

Considered study is focused on providing a solution to issue of metamorphoses among firms and the impact on valuations on the basis of its multiples. Research scholars in this study scrutinise the magnitude to which multiples based on industry disregard supplementary information specific to business and to develop measures for identification of peer groups which are equivalent or can be used for comparison with the target firm. In addition to this, the study made a comparison of enactment of different methods which controls for differences between firms.

The study concludes that variances between business entities result in systematic errors in the estimation of the value of different multiples. However, considered errors are said to be consistent with selected hypotheses in the research study, economically substantial, statistically significant, unswerving among different value drivers and viable over time (Henschke & Homburg, 2009). In accordance with the researchers, prediction of these errors can be made in an accurate manner by making a comparison of financial ratios of the target firm with its peer group. This study shows that in a situation where there is adequate control over differences between firms that there will be an improvement in accuracy of valuation and all selected value drivers for the study perform almost equally well.

Equity Valuation Using Multiples: Controlling for Differences Between Firms

In this study, researchers had made a comparison of valuation methods in terms of the accuracy of equity valuation that estimates secondary from pragmatic applications of the abnormal earnings growth model with the residual income model. The finding of this study shows  that estimations made by OJ  usually underachieve the estimates of  RIV. Further, increase the forecast horizon for the OJ estimates from two to five years will make a significant improvement in their valuation accuracy. However, in relation to the RIV estimates, the valuation accuracy of the OJ estimates will remain lower even if five-year forecast horizon is used (Jorgensen & et.al., 2011). In the last part of the study, comparison of predicted accounting profitability is made with actual accounting profitability is done to determine that the lower valuation accuracy of the OJ approximations is attributable to the empirical assumptions in regards to the future earnings growth beyond the forecast horizon.

By considering the common approach of using industry membership to form peer groups, significant systematic errors has been found in the valuation estimates attained from various value drivers. All 23 investigated methods in research study used for governing for differences between firms will lead to enhancements in the accuracy of valuation. Additionally, Study concludes that all considered value drivers yield similar value estimates when accounting is adequately done for compensating differences in financial ratios and consequently execute practically likewise well. Finally, the study concludes that that industry is not sole a crucial criterion for selection of peers while controlling for differences in financial ratios.

References

Journals

Henschke, S. & Homburg, C., (2009). Equity Valuation Using Multiples: Controlling for Differences Between Firms. Journal of Business Finance & Accounting.

Jorgensen, B & et.al. (2011). The Valuation Accuracy of Equity Value Estimates Inferred from Conventional Empirical Implementations of the Abnormal Earnings Growth Model: US Evidence. Journal of Business Finance & Accounting, Vol. 38, Issue 3-4, pp. 446-471.