FIN 345 Research Paper

profileWaqas Ahmed
finc435_term_paper_outline-1.ppt
Home>Business & Finance homework help>FIN 345 Research Paper

*

Research term paper

Five major sections:

  • Company background / introduction
  • Competitive strengths
  • Financial analysis (focus section)
  • Stock valuation analysis
  • Investment summary & recommendations

*

Company Competitive strengths

  • Cost / price leadership
  • Differentiated products
  • Industry positioning:
  • market share, brand & reputation, corporate culture, management track record, etc.

*

An Economic moat

An economic moat is a barrier that protects a firm's margin and profits from competing firms, thus better able to sustain its high margin and profitability.

  • An economic moat comes from a firm’s sustainable competitive advantages over similar companies.

Example:

  • Wal-Mart's buying power, economy scale and distribution infrastructure create a wide and sustainable economic moat.

Economic moats

  • A cost advantage
  • A size advantage: economic scale
  • Intangible assets: patents, brand recognition, government licenses, etc.
  • High switching cost
  • Network effect: a firm's value increases as number of users increase
  • Soft moats: exceptional management, unique corporate culture.

Example: Intel Corporation

Competitive strengths:

Low cost producer / economy of scale

Generally superior products

Dominant market share

Well capitalized balance sheet

Manufacturing expertise / vertical integration

Brand recognition: Intel Inside

*

Intel: economic moats

Sustainable advantages:

Dominant market share position

well capitalized balance sheet

Strong technology and R&D expertise

Deep manufacturing knowhow

*

Financial analysis

  • Sales / growth analysis
  • Profitability and margin analysis
  • Asset turn over analysis
  • Liquidity analysis
  • Financial leverage
  • ROE analysis (DuPont formula)
  • WACC analysis and Enterprise value
  • Free cash flow projections


Sales / growth analysis

  • Sales by business segments and by regions
  • Historic sales growth rate (last 5 years)
  • Estimating growth rate next 5 years based on the historic sales growth

Ratio analysis

  • Profitability and margin analysis:
  • EBIT margin and net margin
  • Asset turn over analysis:
  • Total asset turnover
  • Inventory turnover
  • Liquidity analysis
  • Quick ratio
  • Financial leverage
  • Debt/equity ratio
  • EBIT/interest coverage


ROE analysis

The DuPont Identity:

  • ROE

= Net margin * total asset turnover * equity multiplier

Free cash flow projections

Using the % of sales approach:

  • Look up 2015 year sales, EBITDA, taxes, capex and working capital change
  • Estimate sales growth rate for next 3 years;
  • estimate growth rates for other income statement items: EBIT, Taxes, capex and working capital change
  • Estimate free cash flows for next 3 years

(see FCF forecast template)


WACC analysis

  • Market value of debt
  • Market value of equity
  • Total enterprise value
  • Cost of debt estimate
  • Cost of equity estimate using CAPM
  • WACC calculation

Financial analysis example:
Apple Inc.

Company Competitive strengths:

Integrated products and services (one eco-system): hardware, software, apps store, iclouds, Pay, etc

Brand

Customer loyalty

Financial strength and profitability

Ability to leverage current platform: Apple Pay, Watch

Management

Apple Inc.

Competitive strategies:

Differentiated products

Product quality and innovations

Integrated offerings: hardware, software and services

Third party developer contents and apps

Company-own distribution network: retail stores

New products/ services: Pay

Apple: Free cash flow projections

From Yahoo/finance:

For FY2015:

  • EBIT: $71.2 b
  • D&A: $11.2 b
  • Taxes: 19.1 b
  • Capex: 11.2 b
  • w/capital increase: $4 b

Apple FCF forecast
(see template)

*


Apple: WACC analysis

  • Market value of debt:
  • use book value of debt at $64.5 b
  • Cost of debt: average about 1.5%
  • Market value of equity
  • Market capitalization at $528 b
  • Total enterprise value
  • Debt + equity = 64.5 + 528 = $592.5 b
  • Debt % = 64.5 / 592.5 = 11%
  • Equity % = 528 / 592.5 = 89%


Apple: stock data
(from yahoo/finance)

Stock Price: $95 (as of 2/24/2016)

  • Current dividend: $2.08 per share
  • Beta: 1.35 (will use 1.1)
  • Growth rate (next 5-year): 12.7%
  • Total shares outstanding: 5.5 billion

Stock Market assumptions:

  • Market beta: 1.0
  • Long term risk free rate: 4.5%
  • Long term risk premium: 6%

Apple: WACC analysis

Cost of equity estimate using CAPM:

  • Re = 4.5% risk free rate + 1.1 beta* 6% risk premium = 11.1%

WACC calculation:

  • WACC = Re * (E%) + Rd *D% (1 – t)
  • = 11.1% * 89% + 1.5%*11% (1 -35%)
  • = 10%

*


Stock valuation analysis

  • Estimate the stock beta
  • Estimate stock discount rate using CAPM
  • Estimate dividend growth rate
  • stock valuations model:
  • Dividend Growth Model
  • Discount Free Cash Flow model
  • Set weighted price target
  • Use the investment criteria to make buy /sell decision

Investment buy criteria

To buy a stock:

  • Strong competitive strengths
  • Strong financial conditions
  • Free cash flow generation
  • Stock price target from DGM and DCF models:
  • upside potential from current price at least 20%


Apple: stock data
(from yahoo/finance)

Stock Price: $95 (as of 2/24/2016)

  • Current dividend: $2.08 per share
  • Beta: 1.35 (will use 1.1)
  • Growth rate (next 5-year): 12.7%
  • Long term growth rate:
  • Total shares outstanding: 5.5 billion

Market assumptions:

  • Market beta: 1.0
  • Long term risk free rate: 4.5%
  • Long term risk premium: 6%

Apple: discount rate & growth rate

Apple Beta = 1.1

  • Discount rate using CAPM:

k = 4.5% + 1.1 *6% = 11.1%

  • 5-year growth rate estimate: 11.9% (yahoo/finance)
  • For my models, I will use 9% 5-year growth rate.

Apple Inc:
Perpetual DDM model

  • Current dividend: $2.08 per share
  • dividend growth rate: 9% (assumption)
  • Equity discount rate: 11.1%

  • Fair value = $2.08 (1+9%) / (11.1% - 9%)
  • = $108

Apple: DCF Model

From the DCF spread sheet:

  • 3-year growth rate: 9.55%
  • Discount rate: WACC = 10%

  • Equity fair value = $133

*

*

Apple: Setting price target

  • DDM fair value : $108
  • DCF fair value: $133

Weighted average price target: $120.5

  • Current price: $95
  • Stock upside potential: 26.8%

  • Investment recommendation: buy


Apple:
Investment summary & recommendation

Investment summary:

  • Strong competitive positions with leading market share, integrated products and services (one eco-system), strong brand and customer loyalty
  • Strong financial strength and profitability
  • Stock fair value: over 20% upside from current price

Recommendation: buy

Team discussions items:

  • What are the company’s competitive strengths?
  • How are the company’s financial conditions?
  • What are reasonable estimates for company beta and growth rate and discount rate?
  • What is the fair value from the DDM and DCF models?
  • Does the price target from the stock valuation models provide 20% upside?
  • What’s the investment recommendation based on the buy criteria?

Free Cash Flow Forecast Template

Appl Inc. (billions of dollars)

2015 2016 2017 2018 Sales $233.7 $252.4 $272.6 $294.4 % increase 8.0%

EBIT 71.2 Depreciation 11.2 EBITDA 82.4 89.8 97.9 106.7

% increase 9.0%

Tax Expenses 19.1 20.8 22.7 24.7 % increase 9.0%

Operating Cash flow 63.3 69.0 75.2 82.0

Capex 11.2 12.0 12.8 13.7 % increase 7.0%

YoY increse in w/capital 4 4.3 4.7 5.0 % increase 8.0%

Levered Free cash flow $48.10 $52.69 $57.72 $63.22 growth rate 9.55% 9.54% 9.53%

Free Cash Flow Forecast Template

Appl Inc.

(billions of dollars)

2015201620172018

Sales $233.7$252.4$272.6$294.4

% increase 8.0%

EBIT 71.2

Depreciation 11.2

EBITDA 82.489.897.9106.7

% increase 9.0%

Tax Expenses 19.120.822.724.7

% increase 9.0%

Operating Cash flow 63.369.075.282.0

Capex 11.212.012.813.7

% increase 7.0%

YoY increse in w/capital 44.34.75.0

% increase 8.0%

Levered Free cash flow$48.10$52.69$57.72$63.22

growth rate 9.55%9.54%9.53%

(

)

k)

g

:

(Important

g

k

D

g

k

g

1

D

P

1

0

0

<

-

=

-

+

´

=

Discount free cash flow model

Apple Inc. Date: 2/24/16

assumptions: 3-year growth rate 9.55% discount rate (wacc) 10.0% discount factor 1.10 1.21 1.33

2015 2016 2017 2018 terminal value free cash flow 48.1$ 52.70$ 57.70$ 63.20$ 632.0$ growth rate 9.55% 9.55% 9.55% discount factor 1.10 1.21 1.33 1.33

Present value 47.9$ 47.7$ 47.5$ 474.8$

total firm value per share 617.9$ billions debt 64.5$ cash 180.0$

total equity value 733.4$ shares outstanding 5.5$

equity value per share $133.3

terminal value calculation: using the 10 factor 632.0$

Note: Red numbers indicate required inputs

Discount free cash flow model

Apple Inc.

Date: 2/24/16

assumptions:

3-year growth rate9.55%

discount rate (wacc)10.0%

discount factor 1.101.211.33

2015201620172018 terminal value

free cash flow 48.1$ 52.70$ 57.70$ 63.20$ 632.0$

growth rate 9.55%9.55%9.55%

discount factor 1.101.211.331.33

Present value 47.9$ 47.7$ 47.5$ 474.8$

total firm value per share 617.9$ billions

debt 64.5$

cash 180.0$

total equity value 733.4$

shares outstanding 5.5$

equity value per share $133.3

terminal value calculation:

using the 10 factor632.0$

Note: Red numbers indicate required inputs