Business Analysis and Valuation

Analyst needs to identify :

accounting measures the firm uses to capture core business constructs

the policies that determine how the measures are implemented

the key estimates embedded in these policies

capitalization of R&D

depreciation policy

restructuring charges

pension assumptions

Business analysis

Accoutning and financial analysis

Forecasting and valuation

Asset distortions

Liability distortions

Equity distortions

Ownership > 50% -> Accouting treatment: Subsidiaries accounts are consolidated

Associate: significant influence (but not control) -> Accounting treatment: equity accounting - the investment is subsequently adjusted to reflect the investor's share of the associate's profit

ownership under 20%

held-for trading (fair value)

available for sale (fair value)

held to maturity

Level 1: For quoted instruments obtain market price at the reporting date

Level 2: For unquoted instruments, use prices for similar instruments or most

recent transactions

Level 3: For unquoted instruments without similar market prices, estimate the

value using a valuation technique

1. Operating management

2. Investment management

3. Financing strategy

Analyst's focus: analysts generally forecast earnings

FCF and AE models: require more structure – less structural inconsistencies

Difficulties in forecasting dividends for non-dividend paying firms

Dividend payout not related to value

Terminal value implications: RI valuation model uses book value of equity as

“anchor” less weight on (uncertain) terminal value

competition restricts the firm’s ability to

generate abnormal returns