Are you trying to identify what is ‘priced in’ to the current stock price or to work out a terminal value in a DCF analysis? A target valuation multiple calculation may be the answer. We present a simple interactive model. Many dismiss valuation multiples as being too simplistic; however, multiples are just DCF in disguise. We demonstrate that you can derive a price earnings ratio with the same value drivers as you would use in a discounted equity cash flow model.| The Footnotes Analyst
Swiss pharma company Novartis provides investors with its own calculation of an EV/EBITDA multiple. However, in our view, the EV is inconsistent with EBITDA. We review the company’s calculation and suggest amendments to ensure it better captures the value of Novartis’ core business. To derive useful valuation multiples, you must be consistent. Our main adjustment to the Novartis calculation relates to the value of their stake in fellow Swiss pharma company Roche.| The Footnotes Analyst
Target valuation multiples that are implied by key value drivers are a great way to better understand equity valuation and how the characteristics of a company affect value. The approach incorporates the same links with underlying value drivers on which DCF is based, but in a simplified way that is more intuitive than a full DCF model. Our target multiple model can be used to estimate a deserved valuation multiple for a company, sector or index, to reverse engineer returns or growth implied b...| The Footnotes Analyst
Defined benefit pension schemes create two leverage effects - financial leverage due to the debt like nature of pension deficits and asset allocation leverage if pension assets are not matched with pension liabilities. In DCF valuation these effects must be correctly, and consistently, included in both the discount rate and free cash flow. We use an interactive model to demonstrate four possible DCF approaches based on enterprise and equity cash flows. Our preferred approach is based on enter...| The Footnotes Analyst
One of the errors we encounter when reviewing DCF models concerns valuation date and cashflow timing adjustments. Although the effect may not always be that material, getting these adjustments wrong undermines the credibility of DCF valuations. We explain the correct application of valuation date adjustments, the necessary amounts for the enterprise to equity bridge, and how to roll-forward values to derive 12-month price targets. We also provide a downloadable model to illustrate these diffe...| The Footnotes Analyst
Most investors make extensive use of operating profit to assess company performance and as a starting point for valuation. But operating profit, like many company-provided subtotals, is not defined by IFRS; it is largely up to companies to decide what subtotals to include and even what to call them. However, the IASB may soon bring an end to this operating profit ‘free for all’. The proposal will lead to significant changes to the presentation of financial statements, notably the income s...| The Footnotes Analyst
In the alphabet soup of investment metrics, a new variant on EBITDA has appeared in some IFRS based company presentations – EBITDA-AL, with the ‘AL’ meaning ‘after leases’. But does the new measure make any sense? And why use EBITDA-AL rather than the established EBITDA or EBITDAR? All ‘earnings-before’ measures create comparability issues, omit key components of operating performance, and should be interpreted with caution. We think EBITDA-AL is worse than EBITDA, which never w...| The Footnotes Analyst
Stock-based compensation grants to employees in 2020 are likely to be affected by the changes to share prices and reduction in profitability currently being experienced by many companies. However, the impact on the related expense and on reported profit may not be what you might expect. For most companies, stock-based compensation is a ‘sticky’ expense that is only indirectly or partially affected current period changes. Limited disclosure in financial statements makes forecasting this ex...| The Footnotes Analyst
The capitalised lease liability of an inflation-linked lease does not include expected inflation. This results in a lower liability and lower initial expense compared with an equivalent lease with no inflation link. The IFRS 16 figures are updated as the inflation uplift occurs, but these catch-up adjustments create a profit ‘headwind’. We estimate that Tesco’s inflation linked leases result in a pre-tax profit headwind of about 2.2 percentage points of growth. If inflation were include...| The Footnotes Analyst
The underlying rationale and conceptual basis for the equity method of accounting for investments in associates is unclear. Equity accounting can be regarded as either the cost-based measurement of an investment or as a quasi (one-line) form of consolidation – but neither is particularly helpful for investors. We explain the limitations of the equity method and advocate measuring all investments in associates at fair value, consistent with other minority equity holdings. This results in a m...| The Footnotes Analyst
Residual income based valuations are a useful alternative to the more common discounted cash flow. While both approaches must produce the same answer for a given set of assumptions and value drivers, we think it can be easier to derive realistic inputs using the residual income approach, considering the focus on return on investment. However, residual income also poses challenges. The approach requires ‘clean surplus’ accounting, return inputs must allow for accounting distortions due to ...| The Footnotes Analyst