EUROPE LANDSCAPE: CROSSING NETWORKS AND COMPETING EXCHANGES HAVE HAD LITTLE SUCCESS IN CAPTURING SHA

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Stock Valuation in Practice
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Email pichai_at_pssec.co.th 23 ?????? 2549
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?????????????????????? Investment Approach
Equity Market
???????????????????????????? Investment Approach
Debt/Money Market
Macroeconomic Forecasts Market Forecasts
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??????????????????????
INPUT
INPUT
?????????????????????????????? (Risk/Return
Analysis)
?????????????????????????????? (Risk/Return
Analysis)
Scenario Analysis Return Projection Risk
Evaluation
?????????????????????????
Relative Market Valuation
?????????????????????????
OUTPUT
OUTPUT
????????????????????? (Investment Policy)
????????????????????? (Investment Policy)
OUTPUT
OUTPUT
Industry Trend Profitability Financial Strength
Valuation
Duration Convexity Sectors and Issuers
???????????????/?????????? ?????????? (Sector/Secu
rities Selection)
???????????????/?????????? ?????????? (Sector/Secu
rities Selection)
Prudent Management Quality of Accounts Avoiding
the Losers Picking the Winners
???????????????????? (Portfolio Construction)
???????????????????? (Portfolio Construction)
???????? Maximizing Return at Assumed Risk
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??????????????????????????????

• Top down approach, 3 ?????????????????????????????
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• Bottom-up approach, ??????????????????????????????
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Does the 3-Step Process Work? Academic Studies
Show

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  ???? ????????????? ?????? ???????????????
• ????????????????????????? ???????? ?????????????
  ??????????Required Rate of Return
  ????????????????????????

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SET PER and Real GDP Growth
The rate of change is important
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Source SET, BoT
Correlation between SET PER and GDP Growth
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????????????????.???????????????????
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Interest Coverage Ratio and D/E Ratio for listed
non-financial corporations
Unit Billion baht
Corporate Earnings H1/2006 249 Billion Baht
(USD 6.4 Billion)
Source SETSMART as of 30 June 2006 Remark
Since Q3/2001, earning included both SET and MAI
Source SET Note Quarterly Corporate Update
Quarter 3/2006
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SET is strongly (74) correlated to regional
market
Annual YOY change between SET index and MSCI
Asia Ex-Japan
Source SET, Bloomberg
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2523
2533
2543
2547
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????? BISNEWS
????? ???????????. ????????? British Petroleum
(BP) ????????????

• ???????????????????????????????????????????? 78.4
  ??????/??????? ?????????????????? 20 ?????? 2
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  ????? 2 ????????????????? ????????????????????????
  ???????????????? ???????? Supply Concerns
  ??????????????????????? ???????? ???????????

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• ???????????????? 1 ????????????????????????
  0.03 ???????????????????????????? 0.09
• ???????????????????????? 20 ?????? 2
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?????????????? ??? ?????????????????????????????
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INVESTMENT OUTLOOK 2H06
Source Bloomberg as of 31 August 2006
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Market Cap./GDP ??? SET ??????????????????????????
????????????
Remark - GDP from Blloomberg and Market Cap.
from WFE
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? ?.?. 06 Market Cap ????????????? 33
?????????????????????
Source World Federation of Exchange Note
Thailand market capitalization includes SET mai
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Risk Premium ?????????????????????????????
INVESTMENT OUTLOOK 2H06

• Risk Premium ????????????????????????????????????
  ???????????? Earning Yield ??? Bond Yield
• ?????????????????????????? 7.2
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Earning Yield ??????????????
Bond Yield 10 ??????????
Source BISNEWS as of July 26, 2006
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Why do industry analysis?

• Is there a difference between the returns for
  alternative industries during specific time
  period?
• Will an industry that performs well in one period
  continue to perform will in the future?
• Can we use past relationships between the market
  and an individual industry to predict future
  trends for their industry?
• Is there a difference in the risk for alternative
  industries?
• Does the risk for individual industries constant
  over time?

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The Business Cycle and Industry Sectors

• Economic trends
• Cyclical changes Ups and downs of the business
  cycle
• Structural changes For example,
• transitions in US. from a manufacturing to a
  service economy
• demographics changes.
• lifestyles how people live, work, form
  households, consume, enjoy leisure, and educate
  themselves
• Downsizing
• Technology
• Politics and regulations

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Thai population by age to total population,
percent
In 1990
In 2005

• Source National Statistics Office
• In 1990, age distribution of Thai people leaned
  toward adolescence
• In 2005, working groups are seen dominating
  while the old rising

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The Stock Market and the Business Cycle
Rotation strategy Switching from one industry to
another over the course of a business cycle.
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Sales Forecasts Using Industry Life Cycle Analysis
Rate of Sales Growth or
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ENERGY SECTOR Historically Thailands energy
demand grew at 1.40x GDP growth
Unlike developed countries, Thailand needs more
energy to keep its economy running.
During 1985-2001, the ratio of energy demand to
the GDP growth was higher than those in developed
countries, which was below 1.0x.
Energy consumption per dollar of gross domestic
product, Btu
Energy demand growth and GDP growth (1985-2001),
times
Source Energy Ministry
Source Energy Ministry
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ENERGY SECTOR Power consumption is the key
growth factor for other energy sources
With strong GDP growth going forward, EGAT
forecasts peak power demand to expand by 7.3
during 2004-11 and by 6.5 during 2012-16.
Power demand grew at 1.35x GDP growth during
1990-2003 and 1.89x during 2000-04.
Peak electricity demand and GDP growth, percent
Peak electricity demand, 000 megawatts
Source EGAT
Source EGAT
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Firm Competitive Strategies Five competitive
Forces
Potential Entrants
Threat of New Entrants
Industry Competitors Rivalry among Existing
Firms
Bargaining Power of Suppliers
Suppliers
Buyers
Threat of Substitute Products or Services
Substitutes
Source Adapted/reprinted with the permission of
The Free Press, a division of Simon and Schuster,
from Competitive Strategy Techniques for
Analyzing Industries and Competitors, by Michael
E. Porter.
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SWOT Analysis

• Strength good customer service, high-quality
  products, strong brand image, customer loyalty,
  market leadership, strong financial resources,
  etc.
• Weakness poor financial resource
• Opportunity new market or product segment,
  growing market for the firms product, shrinking
  competition, favorable FX shifts.
• Threat an increase in industry competition,
  buyers or suppliers seeking to increase their
  bargaining power, new technology

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BCG Growth-Share Matrix
High
Question marks
stars
Maket Growth Rate (cash usage)
dogs
cash cows
Low
Relative Market Share (cash generation)
High
Low
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Valuation
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?????????????? (book value)
?????? (sales)
Replacement Value
????????? (net income)
Liquidation Value
??????????? (cash flow)
Net Asset Value
????????? (dividend)
???????????????? (free cash flow)
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Valuation Parameters

• Commonly used approaches
• Relative (no meaning on its own)
• PER (Price / Earnings Ratio)
• PBV (Price / Book value Ratio)
• EV / EBITDA (Enterprise value / Earnings
  before interest, tax, depreciation and
  amortization)
• Absolute (has meaning on its own)
• DCF (Discounted Cash Flows)
• Dividend yield (Dividends / Price)
• NAV (Net Asset Value)
• Replacement cost (Cost of building a new
  production facility)
• Liquidation value (Proceeds raised from
  liquidation)
• DDM (Dividend discount model)
• EVA (Economic Value Added)
• Mixed
• Sum-of-parts (Combinations of some of the
  above)
• EBIT/Years to backlog (Used in Contractors)

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Valuation Theory The value of any asset is the
PV of the assets expected future cash inflows.

• Estimate the stream of expected returns.
• Estimate the required rate of return (RRR)
• RRR (1Real rate)(1Inflation premium)(1risk
  premium)
• Approx. RRR Real rate Inflation premium risk
  premium
• Note Risk premium can be broken down into
• a. Internal sources of risk (diversifiable)
  business risk, financial risk, liquidity risk, FX
  risk, and country risk.
• b. External source of risk market risk
  (non-diversifiable)
• RRR by CAPM Risk free Beta stock (Market
  return Risk free)
• Investment decision process
• If estimated value gt Market price, Buy
• If estimated value lt Market price, Sell

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PER

• PER Stock Price / Forward looking EPS
• A measure of how many years it will take for the
  cost of the stock be paid back by current
  forecast earnings
• Advantage
• Most widely used
• Easy to derive and understand
• Best explains stock volatility
• Problems
• Has no meaning on its own
• Profits or Core profits We are buying an
  on-going business
• Fully diluted or Not Fully diluted Better to
  err on the conservative side
• Accounting differences Sometimes hard to
  reconcile valuation
• Can be used with only profitable companies
• Does not tell us about growth prospects

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Dividend Discounted Model (DDM)

• P
•  
• ??????
• P ????????????????????????????
• Dt ???????????????? t ??? t 1,2,3, ? ??? D1
  D0 (1g)
• D2 D1 (1g)
• ke ??????????????????????????????????????
  (required rate of return)

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Estimating the Inputs.

• The required rate of return (ke) nominal
  risk-free rate equity risk premium
• Note Academic studies show that market risk
  premium is between 2.5-6, reflecting changes in
  business risk, financial risk, liquidity risk, FX
  risk, and country risk.
• 2) Expected growth rate of dividends
• g RR ROE
• Note RR is the earning retention ratio, so
  (1-RR) is the dividend payout ratio
• 3) Breaking down ROE
• ROE (profit margin) (total asset turnover)
  (financial leverage)
• (Net Income/Sales) (Sales/Total Assets)
  (Total Assets/Equity)

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Relative Valuation Techniques P/E Ratio

• How does the DDM relate to the P/E Ratio?
• Start with the DDM
• 2) Dividing both sides of the equation by next
  years projected earnings (E1) gives

Thus, P/E Ratio is determined by 1) The expected
dividend payout ratio (dividends/earning) 2) The
required rate of return on the stock (ke) 3) The
expected growth rte of dividends (g)
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??????????????????????????????????????? P/E Ratio
Impact P/E Ratio
1. g 2. k 3. ??? k-g ????? Dividend payout
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Why do Firm and Industry PER differ from the
Market PER?

• Retention and dividend payout ratios differ among
  firms, industries, and the market.
• Risk premiums differ among firms, industries, and
  the market.
• Business risk is a function of relative sales
  volatility and operating leverage
• Financial risk varies depending on industry use
  of debt and leases.
• Liquidity risk is influenced by industry and firm
  size
• FX risk and country risk also exists for firms
  with international exposure.

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PBV

• PBV Price / Book value
• Advantage
• Easy to derive and understand
• Replaces PER when there is no EPS
• More commonly used in financials
• Relatively easy to adjust for abnormal items or
  events
• Sometimes used to mean NAV
• Problems
• Has no meaning on its own
• Book value does not necessarily reflect economic
  value
• Can be manipulated by differences in accounting
  policies
• Poorly explains share price volatility
• Provides no information on quality of book value
  nor earnings prospects

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EV/EBITDA

• EV / EBITDA Enterprise value / Earnings before
  interest, tax, depreciationamortization
• Enterprise Value Current market cap Current
  debt value
• Advantage
• Measures value against cash flow
• Measures value of firm
• Overcomes differences in accounting policies
• Well suited for comparing businesses irrespective
  of capital structure
• Well suited for cross-border comparison
• Problems
• Not easily understood by unsophisticated retail
  investors
• Provides valuation of firm but says nothing about
  equity value
• Has no meaning on its own

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DCF

• DCF Discounted cash flows (Net Present Value or
  NPV)
• Advantage
• An absolute valuation technique
• Long term value captured
• P/CF ratio has grown in prominence and use
  because many observers contend that a firms cash
  flow is less subject to manipulation than its
  earnings per share and because cash flows are
  widely used in the PV of cash flow models.
• Problems
• Most subject to abuse
• Long term assumptions maybe questionable
• Terminal value, when and what assumptions are
  critical
• Consistency in use of discount rates and discount
  cash flows
• Discount rate WACC (Weighted average cost of
  capital) Weighted average cost of debt equity
• Expected return on debt and equity
• Equity risk premium estimates
• Beta estimates (daily / weekly / monthly)

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Difficulties of discount rate
TSI \ Mktreturn0205.xls

• WACC Weighted Cost of Capital (discount rate)
• Cost of debt
• Expected or current costs of debt
• Expected or current credit rating
• Expected or current risk free rate interest rate
• Cost of equity
• Required return on equity
• Should equity risk premium change with interest
  rates?
• Beta estimates

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Less common approaches

• Dividend Yield
• Has been popular in the past few years
• Expected to become less popular with rising
  interest rates and expected cut in payout as
  investment cycle rises
• DDM (Discount Dividend Model)
• Probably the most conservative approach
• But not very popular as it suffers same weakness
  as DCF
• Replacement costs
• Sometimes used to value undervalued
  capital-intensive industries
• Should we buy a company based on historical costs
  or future returns?
• Sum of the parts
• Used with holding companies or conglomerates....
• ..some of those subsidiaries may be listed
• EBIT (Profit) / Years of backlog
• Created for contractors

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Fundamental analysis

• Constraints
• Valuation, the most crucial part, is often
  subjective
• Cannot explain short-term volatility
• A time-consuming process
• Other influencing factors
• Management
• Vision / Strategy
• Transparency / Governance
• Disclosures / Consistency
• ....and the extent of such influence is increasing

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Banking Sector still traded at post-crisis low

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• ?????????????????????? P/B ??????
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Property ?????????????

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  ??????????? ?????????????????????? 50
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Key Valuation
Bank
Property
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