IFRS-Equity Valuation I

Objetivo:

Identify and understand theequity valuation according toIFRS.

Understand the financialinformation

Contenido 1. Starting the Valuation Process

2. Financial Reporting

3. Ethical and Professional Standards

4. Valuation Gold and Required Return

5. Cost of Capital and Required Return from an Equity

6. Financial information

INTRINSIC VALUE

The intrinsic value of any asset is the value of the

asset given a hypothetically complete understanding of

the asset ’ s investment characteristics.

𝑉𝑒 − 𝑃 = 𝑉 − 𝑃 + (𝑉𝑒 − 𝑉)

Control VariablesMispricing

Oportunities

In estimating value, a going - concern

assumption is the assumption that the

company will continue its business

activities into the foreseeable future.

An alternative to a company ’ s going –

concern value is its value if it were

dissolved and its assets sold individually,

known as its liquidation value.

GOING-CONCERN AND LIQUIDATION VALUE

Fair market value is the price at which an asset (or

liability) would change hands between a willing buyer

and a willing seller when the former is not under any

compulsion to buy and the latter is not under any

compulsion to sell.

The concept of value to a specific buyer taking

account of potential synergies and based on the

investor ’ s requirements and expectations is called

investment value .

FAIR MARKET VALUE AND INVESMENT VALUE

1. Selecting Stocks

2. Inferring (Extracting) Market Expectations

3. Evaluating Corporate Events

4. Rendering Fairness Opinion

5. Evaluation Business Strategies and Models

6. Communicating with Analyst and

Shareholders

7. Appraising private businesses

8. Share-Based Payment (Compensation)

APPLICATIONS OF EQUITY VALUATIONS

1. Understanding the Business

2. Forecasting Company Performance

3. Selecting the appropriate valuation model

4. Converting forecast to a valuation

5. Applying the valuation conclusions

VALUATIONS PROCESS

Understanding the Business as a whole…

1. Understand the economic and Industry Context

2. Company’s Strategy

3. Company’s Previous Financial Performance

4. Analysis of Financial Reports

5. Source of Information

6. Considerations in Using Accounting Information

Basis for Forecasting Performance

Based on two main points…

1. Economic environment

2. Company’s own operating and financial

Characteristics

Methodologies:

1. Top-Down Forecasting

2. Bottom-Down Forecasting

2. FORECASTING COMPANY PERFORMANCE

Types of models

1. Absolute Valuation Models

2. Relative Valuation Models

3. Valuation of the Total Entity and Its Components

4. Issues in Model Selection and Interpretation

3. SELECTING THE APPROPRIATE VALUATION MODEL

4. CONVERTING FORECAST TO A VALUATION

1. Sensitivity Analysis

2. Situational Adjustments

5. CONCLUSIONS AND RESPONSABILITIES

1. Sell-side Analyst

2. Buy-side Analyst

Contenido 1. Starting the Valuation Process

2. Financial Reporting

3. Ethical and Professional Standards

4. Valuation Gold and Required Return

5. Cost of Capital and Required Return from an Equity

6. Financial information

Reporting implies COMMUNICATING…

Results

Conclusions

Recommendations

Re

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.

Users

Investment Committee

Analyst

Investment Management

Portfolio Manager

Retail or Institutional

Clients

Analyst and Researcher

Use

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ep

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ing…

.

TimelyInformation

• Up to date and pertinent information

Clear and Incisive

Language

• No ambiguity, key data clearly specified

Objective and well researched

• Key assumptions and risk implications clearly identified

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Facts Vs Opinions

• Distinguishes clearly between facts and opinions and do not misrepresent them.

Consistency

• Analysis, Forecast, Valuation and Recommendation must be consistent

Enough Content

• Information must be enough to allow a reader to critique the valuation

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State Riskiness

• State key risk factors involved in an investment company

Disclosures

• Disclose any potential conflict of interest faced by the analyst whether its company as well as limitations inside the research done.

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Section Purpose Content Comments

Table of Contents Show report’s organizationConsistent with narrative in sequence and language

This is typically used in very long research reports only

Summary and Investment Conclusion

• Communicate the large picture

• Communicate major specific conclusions of the analysis

• Recommend an investment course of action

• Capsule description of the company

• Major recent developments

• Earnings projections• Other Major Conclusions• Valuation Summary• Investment Action

An executive summary may be called simply “Summary”

Business Summary

• Present the Company in more detail

• Communicate a detailed understanding of the company’s economics and current situation

• Provide and explain specific forecasts

• Compnay descrption to the divisional level

• Industry analysis• Competitive analysis• Historical performance• Financial forecast

Reflects the first and second steps of the valuation process.

Financial forecasts should be explained adequately and reflect quality of earnings analysis.

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Section Purpose Content Comments

RisksAlert readers to the risk factors in investing in the security

• Possible negative industry developments

• Possible negative regulatory and legal developments

• Possible negative company developments

• Risk in the forecast• Other risks

Readers should have enough information to determine how the analyst is defining and assessing the risks specific to investing in the security

Valuation• Communicate a clear and

careful valuation

• Description of model(s) used

• Recapitulation of inputs• Statement of conclusions

Readers should have enough information to critique the analysis.

Historical and Pro Forma Tables

• Organize and present data to support the analysis in the Business Summary

This is generally a separate section in longer research reports only. Many reports fold all or some of this information into the Business Summary section.

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Users

CODE OF ETHICS

REMEMBER: “Just as well-written report cannot

compensate for a poor analysis, a poorly written

report can detract from the credibility of an excellent

analysis. Writing an effective research report is a

challenging task.” (Pinto , Henry, Robinson,

Stowe, & Rath, 2010)

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Contenido 1. Starting the Valuation Process

2. Financial Reporting

3. Ethical and Professional Standards

4. Valuation Gold and Required Return

5. Cost of Capital and Required Return from an Equity

6. Financial information

Does ETHIC matter?

Key Aspects

Responsibility

Priority

Judgement

Encourage

Updating

IntegrityC

FA

co

de

of E

thic

s…

.

CF

A c

od

eS

tru

ctu

re…

.

Co

de

of

Eth

ics Professionalism Knowledge of Law – Independence and

Objectivity – Misrepresentation -Misconduct

Integrity Of Capital Markets Material non public Information – Market Manipulation

Duties to Clients Loyalty, Prudence and Care – Fair Dealing –Suitability – Performance Presentation –Preservation of Confidentiality

Duties to Employers Loyalty – Additional Compensation Arrangements – Responsibilities of Supervisors

Investment Analysis, Recommendations and Actions

Diligence and Reasonable Basis –Communication with Clients and Prospective Clients – Record Retention

Conflicts of Interest Disclosure of Conflicts – Priority Transactions – Referral Fees

Responsibilities as a CFA Conduct as Members and Candidates in the CFA program – Reference to CFA Institute, the CFA Designation and the CFA Program

Highlights:

• Relationship between the Code Standards and

Applicable Law

• Participation in or Association with Violations by Others

• Investment Products and Applicable Laws

Pro

fessio

nalism

…. A. Knowledge of the Law

“Members and Candidates must understand and comply

with all applicable laws, rules, and regulations (Including

the CFA institute Code of Ethics and Standards of

Professional Conduct) of any government, regulatory

organization, licensing agency, or professional association

governing their professional activities. In the event of

conflict, Members and Candidates must comply with more

strict law, rule or regulation. Members and Candidates

must not knowingly participate or assist in and must

dissociate from any violation of such laws, rules, or

regulations”

Highlights:

• Buy-Side Clients

• Fund Manager Relationships

• Investment Banking Relationships

• Public Companies

• Credit Rating Agency Opinions

• Issuer-Paid Research

• Travel Funding

Pro

fess

ion

alism

…. B. Independence and Objectivity

“Members and Candidates must use reasonable care and

judgement to achieve and maintain independence and

objectivity in their professional activities. Members and

Candidates must not offer, solicit, or accept any gift,

benefit, compensation, or consideration that reasonable

could be expected to compromise their own or another’s

independence and objectivity”

D. Misconduct

“Members and Candidates must not engage in any

professional conduct involving dishonesty, fraud or deceit

or commit any act that reflects adversely on their

professional reputation, integrity or competence”

Highlights:

• Impact on investment Practice

• Plagiarism

• Worked completed for employer

C. Misrepresentation

“Members and Candidates must not knowingly make any

misrepresentations relating to investment analysis,

recommendations, actions, or other professional activities”P

rofe

ss

ion

alism

….

RECOMMENDATIONS FOR

COMPLIANCE

Pro

fess

ion

alism

….

A. Knowledge of law

• Stay Informed

• Review Procedures

• Maintain current files

B. Independence and Objectivity

• Protect the integrity of opinions• Create a restricted list• Restrict special cost arrangements• Limit gifts• Restrict Investments• Review Procedures• Independence Policy• Appointed Officer

C. Misrepresentation

• Factual Presentation

• Qualification Summary

• Verify Outside Information

• Maintain Webpages

• Plagiarism Policy

D. Misconduct

• Code of ethics

• List of violations

• Employee References

Highlights:

• Defining Diligence and Reasonable Basis

• Using Secondary and Third Party Research

• Quantitatively Oriented Research

• Selecting External Advisers and Subadvisers

• Group Research and Decision Making

A. Diligence and Reasonable Basis

“Members and Candidates must:

1. Exercise diligence, independence and thoroughness in

analysing investments recommendations, and taking

investment actions

2. Have a reasonable and adequate basis, supported by

appropriate research and investigation, for any

investment analysis, recommendation, or action”

Inve

stm

en

ta

na

lys

isre

co

me

nd

ati

on

sa

nd

ac

tio

ns

….

Highlights:

• Informing Clients of the Investment Process

• Different Forms of Communication

• Identifying Limitations of Analysis

• Distinction between Facts and Opinions in Reports

B. Communication with Clients and Prospective Clients

“Members and Candidates must:

1. Disclose to clients and prospective clients the basic format and

general principles of the investment processes they use to

analyse investments, select securities, and construct portfolios

and must promptly disclose any changes that might materially

affect those processes.

2. Use reasonable judgment in identifying which factors are

important to their investment analyses, recommendations, or

actions and include those factors in communications with clients

and prospective clients.

3. Distinguish between fact and opinion in the presentation of

investment analyses and recommendations”

Inve

stm

en

ta

na

lys

isre

co

me

nd

ati

on

sa

nd

ac

tio

ns

….

Highlights:

• Records are property of the Firm

• Local Requirements

C. Record Retention

“Members and Candidates must develop records to

support their investment analyses, recommendations,

actions, and other investment-related communications

with clients and prospective clients”

Inve

stm

en

ta

na

lys

isre

co

me

nd

ati

on

sa

nd

ac

tio

ns

….

A. Diligence and Reasonable Basis

• Establish a policy

• Develop detailed guidance for analyst

• Develop measurable criteria for assessing

the quality of research

• Develop detailed guidance that establishes

minimum levels of scenarios

• Develop Measurable criteria for assessing

outside providers

• Adopt a standardized set of criteria for

evaluating the adequacy of external

advisers.

Inve

stm

en

ta

na

lys

isre

co

me

nd

ati

on

sa

nd

ac

tio

ns

….

C. Record Retention

• Archive research notes

and other documents,

that support investment-

related communication

B. Communications with

Clients and Prospective

Clients

• Highly depends on case-by-

case review.

Highlights:

• Disclosure of Conflicts to Employers

• Disclosure to Clients

• Cross-Departmental Conflicts

• Conflicts with Stock Ownership

• Conflicts as a Director

A. Disclosure of Conflicts

“Members and Candidates must make full and fair disclosure of all

matters that could reasonably be expected to impair their

independence and objectivity or interfere with respective duties to their

clients, prospective clients and employer. Members and Candidates

must ensure that such disclosures are prominent, are delivered in

plain language and communicate the relevant information effectively”

Co

nfl

icts

of

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t

Highlights:

• Avoiding Potential Conflicts

• Personal Trading Secondary to Trading for Clients

• Standards for Non-public Information

• Impact on All Accounts with Beneficial Ownership

Co

nfl

icts

of

inte

res

t

B. Priority of Transactions

“Investment transactions for clients and employers must

have priority over investment transactions in which a

Member or Candidate is the beneficial owner”

C. Referral Fees

“Members and Candidates must disclose to their employer,

clients, and prospective clients, as appropriate, any

compensation, consideration, or benefit received from or paid to

others for the recommendation of products or services ”

A. Disclosure of Conflicts

• Members and Candidates should

disclose special compensation

arrangements with the employer that

might conflict with client interest.

C. Referral Fees

• Encourage employers to develop

procedures related to referral

fees.

B. Priority of Transactions

• Limited Participation in

equity IPOs.

• Restrictions on private

placements.

• Establish

blackout/restricted periods.

• Reporting Requirements

(holdings with own

benefits, Confirmation of

transactions and

Preclearance procedures).

• Disclosure of policies.

Contenido 1. Starting the Valuation Process

2. Financial Reporting

3. Ethical and Professional Standards

4. Valuation Gold and Required Return

5. Cost of Capital and Required Return from an Equity

6. Financial information

Return and Risk Premium

𝑟 =𝐷𝐻+𝑃𝐻𝑃0

− 1 =𝐷𝐻𝑃0

+𝑃𝐻 − 𝑃0𝑃0

Retu

rnco

ncep

tsHolding Period Return (HPR)

Dividend Yield Price Appreciation Return

𝑟 =𝐷𝑒+𝑃𝑒𝑃0

− 1 =𝐷𝑒𝑃0

+𝑃𝑒 − 𝑃0𝑃0

Realized and Expected (HP) ReturnR

etu

rnco

ncep

ts

Dividend YieldPrice Appreciation Return

Retu

rnco

ncep

tsRequired Return

Expected Return from Intrinsic ValueR

etu

rnco

ncep

ts

𝑅𝑅 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒 =𝑌𝑒𝑎𝑟 − 𝑎ℎ𝑒𝑎𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒+ 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒

𝐼𝑛𝑡𝑟𝑖𝑛𝑠𝑖𝑐 𝑉𝑎𝑙𝑢𝑒 =𝑌𝑒𝑎𝑟 − 𝑎ℎ𝑒𝑎𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑

𝑅𝑅 − 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒

“Reflects compensation for delaying consumption” and more

advanced contexts implies an additional compensation for the risk

of the cash flow

Discount Rate

Internal Rate of Return (IRR)

Retu

rnco

ncep

ts

𝑅𝑅𝐸 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑖𝑠𝑘 − 𝐹𝑟𝑒𝑒 𝑅𝑒𝑡𝑢𝑟𝑛 + 𝐸𝑅𝑃

Required Return on Equity (RRE)

“Is the incremental return (Premium) that investors

require for holding equities rather than a risk-free asset”

Equity Risk PremiumE

qu

ity

Ris

kP

rem

ium

Eq

uit

yR

isk

Pre

miu

mTwo Scopes for Analysis…

Forward-Looking Estimates:

Uses models based on expectations and consensus, it also

has some limitations and make particular assumptions

(Both discussed later).

Historical Estimates:

Uses historical information to perform analysis, has some

limitations and make particular assumptions (Both discussed

later).

Two approaches for both…E

qu

ity

Ris

kP

rem

ium

Eq

uit

yR

isk

Pre

miu

mHistorical Estimates

Forward-Looking EstimatesE

qu

ity

Ris

kP

rem

ium

• Data Availability and Suitability

• Structure and characteristics of data provided

• Proxies and common used variables (Discussion)

Colombian Equity Market Insight:

Historical and Forward-Looking Estimates:

• Main Assumptions

• Selection and allocations (E.g. IGBC VS COLCAP)

Common issues in Practice…E

qu

ity

Ris

kP

rem

ium

Contenido 1. Starting the Valuation Process

2. Financial Reporting

3. Ethical and Professional Standards

4. Valuation Gold and Required Return

5. Cost of Capital and Required Return from an Equity

6. Financial information

Required Return on

Equity

CAPM Multifactor

Fama-French and PSM

Build-Up

𝑅𝑅𝐸𝑖 = 𝑅𝑖𝑠𝑘𝐹𝑟𝑒𝑒𝑅𝑒𝑡𝑢𝑟𝑛 − 𝛽𝑖(𝐸𝑅𝑃)

CAPM

• Equilibrium: Demand = Supply

• Risk Averse (Investor Profile)

• Systemic Risk Req

uir

ed

Retu

rn

Sensitivity

• Time Series Length

• Index (Proxy)

Req

uir

ed

Retu

rn 𝛽𝑈 =1

1 +𝐷𝐸

𝛽𝑒

𝛽′𝑒 = 1 +𝐷′

𝐸′ 𝛽𝑈

Leveraged and Unleveraged Beta

• Private Companies

• Incorporates Leverage RiskSensitivity

Req

uir

ed

Retu

rn

• Private Companies

• Incorporates Leverage Risk

Fama-French

Req

uir

ed

Retu

rnPSM EXTENSION

Req

uir

ed

Retu

rnBuild-Up

• Size

• Market Value

• Sector

• Minor Interest

Multifactor

Req

uir

ed

Retu

rn

• Default Risk

• Sensitivity of Profitability

(Business cycle)

• Leverage

Yield to Maturity Extension

Req

uir

ed

Retu

rnExchange Rates

WA

CC

WACC Construction

• Market Value

• Time Horizon

• Capital Structure

Debt Cost

Equity Cost

• Considerations in proxies selection

• Time-Horizon Consistency

• Econometric Models

Considerations

• Theoretical Issues and Limitations

WA

CC

In Practice

Contenido 1. Starting the Valuation Process

2. Financial Reporting

3. Ethical and Professional Standards

4. Valuation Gold and Required Return

5. Cost of Capital and Required Return from an Equity

6. Financial information

“The role of financial reporting by companies

is to provide information about a company’s

performance, financial position, and changes

in financial position that is useful to a wide

range of users in making economic decisions”

(IAS, 1;9).

Fin

an

cia

lan

aly

sis

Scope of Financial Analysis

• Evaluating an equity investment for inclusion in a portfolio.

• Evaluating a merger or acquisition candidate

• Evaluating a subsidiary or operating division of a parent company

• Deciding whether to make a venture capital or other private equity

investment

• Determining the creditworthiness of a company in order to decide

whether to extend a loan to the company and if so, what terms to

offer

• Extending credit to a customer

• Examining compliance with debt covenants or other contractual

arrangements

• Assigning a debt rating to a company or bond issue

• Valuing a security for making an investment recommendation to

others

• Forecasting future net income and cash flow

Fin

an

cia

lan

aly

sis

Some Important Economic Decisions…

Qualitative Characteristics of Financial ReportsF

ina

nc

ial R

ep

ort

ing

• Relevance (Information)

• Faithful Representation

• Comparability

• Verifiability

• Timeliness

• Understandability

Required Financial StatementsF

ina

nc

ial R

ep

ort

ing

• Relevance (Information)

• Statement of financial position (Balance sheet)

• Statement of comprehensive income (Single statement or

Income statement + Statement of comprehensive income)

• Statement of changes in equity

• Statement of cash flows

• Notes, Summarizing accounting policies and disclosing other

items

• In certain cases, Statement of financial position from earliest

comparative period

General FeaturesF

ina

nc

ial R

ep

ort

ing

• Fair Presentation

• Going Concern

• Accrual basis

• Materiality and aggregation

• No offsetting

• Frequency of reporting

• Comparative information

• Consistency of presentation

Structure and ContentF

ina

nc

ial R

ep

ort

ing

• Classified balance sheet

• Minimum specified information on face

• Minimum specified note disclosures

• Comparative Information

IFRS vs USGAAP (CashFlow Statement-Income Tax)F

ina

nc

ial R

ep

ort

ing

TOPIC IFRS USGAAP

• Interest Received

• Interest Paid

• Dividends Received

• Dividends Paid

• Bank overdrafts

• Operating or investing

• Operating or financing

• Operating or Investing

• Operating or financing

• Considered part of

cash equivalents

• Operating

• Operating

• Operating

• Financing

• Not considered part of

cash and cash

equivalents and

classified as financing

operating

• Taxes Paid • Generally operating,

but a portion can be

allocated to investing or

financing if it can be

specifically identified

with these categories

Operating

• Format of Statement • Direct or Indirect Direct or Indirect

Risk Factors involved in accounting misrepresentationsQ

uali

ty R

ep

ort

ing

• High degree of competition or market saturation, declining margins

• Operating losses making the threat of bankruptcy

• Need to obtain additional debt or equity financing to stay Competitive

Incentives/

Pressures

• Assets, liabilities, revenues or expenses based on significant estimates that involve subjective judgements

• Significant, unusual, or highly complex transactions

• High turnover of senior management, counsel or board members

Opportunities

• Excessive interest by management in maintaining or increasing the entity’s stock price or earnings trend.

• An interest by management in employing inappropriate means to minimize reported earnings for tax-motivated reasons

Attitudes/

Rationalizations

Red Flags – Accounting Warning Signs

Qu

ali

ty R

ep

ort

ing • Aggressive Revenue Recognition

• Operating cash flow out of line with reported earnings

• Growth in revenues out of sync with economy with growth in receivables

• Growth in inventory out of line with sales growth or days inventory

• Classification of nonoperating or nonrecurring income as a revenue

• Deferral expenses

• Excessive use of operating leases by lessees

• Classification of expenses or losses as extraordinary or nonrecurring

• LIFO liquidations

• Gross margins or operating margins out of line with peer companies

• Use of long useful lives for depreciation and amortization

• Use of aggressive pension plan assumptions

• Common use of fourth quarter surprises

• Equity method of accounting/frequent use of off-balance sheet

• Other off-balance sheet financing or guarantees

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