Presentation on theme: "Competitive Advantage Period & Growth Rate Analysis"— Presentation transcript:
1 Competitive Advantage Period & Growth Rate Analysis Chris Argyrople, CFAConcentric
2 Competitive Advantage Period (CAP) Economic Theory suggests that companies can’t earn “Economic Rents”Firms earnining ROIC > WACC attract competition, driving down returns to WACCROICWACCCAP
3 What CAP MeansManagers try to maximize area under curve by moving out on both axes !ROIC Higher LongerReturns CAPWACCSuper Companies: CAP > 20 YearsGreat Companies: CAP > 15 YearsMost S&P 500 Cos: 5 Years < CAP < 10 Years
4 Reality: CAP can be Very Long Economic Thoery does not reflect the reality of the stock market: CAP can be very large (Economic Theory states that it will be low).
5 Buffett Secret To Generate Excess Returns, Buy: Value Creating Firms (Creates EVA)Where CAP growing or stable
6 Calculating CAP Value = Value of Current Ops + Forward Plan NOPAT + Inv (ROIC - WACC) CAPWACC WACC (1 + WACC)Intrinsic Val / Share = (Value + Cash - Debt)SharesInv = Incremental Annualized InvestmentNote: formula assumes “next year”
7 Using CAPDetermine how much of value is growth (mgt must act if no value to forward plan)Analyst can plug for: ROIC, WACC, or CAP
8 Value Based Framework Value Creation Value Drivers Cash Flow EBITDA MarginsRisk Cost of CapitalSustainab. of Returns Comp. Adv. PeriodEVA Measures:Magnitude & Sustainability of Returns
9 EVATM vs. FCF Model FCF Model Value = PV(FCF) + PV(terminal FCF) EVA ModelValue = Capital + Cumul. PV of Future EVA** 2 Models should produce same result** Can project and discount EVA
10 Incremental Analysis Examine Incremental EVA (year-over-year) ROI on Incremental Capital =Delta EVA / Delta Invested CapitalNote:1) Like first derivative in Calculus.2) Some value derived from changing returns on existing investments.3) ROIC can fall while ROI Increm is Rising
11 Using EVA to Make Money Value Investing: Mean Reversion Momentum Investing: Improving ROICGrowth Investing: High ROIC, SustainableTime / Accuracy TradeOff: Stern Stewart uses 164 potential adjustments, about 7 matterCSFB: LOOKING FOR CHANGE IN EVA, NOT ABSOLUTE (I DISAGREE)
12 RiskBest Risk MeasureDebt / Total Capital (Market Values, not Book Values)Examine PVGO as % of Stock Price
13 CSFB Methodology Screen for Increasing ROIC or CAP Look at Volatility Look for companies where PVGO as a % of Stock price is zero: this is a free option on Value Creation
14 Thoughts on P/E Multiples Market Average is 20X right nowIt is quite easy to go from 15X to 20XA company trading at 10X likely has problems -- be carefulIt is also easy to go from 30X to 20XThus, mean reversion is likely near the mean, ask tough questions away from the meanAs always, analyze each case separately
17 What is the Price of a Stock? Price = Dollars paid for the stockEarnings = what you relate the price toThus,P/E ratio relates the price to the earnings stream purchased.Lower P/E is better, all else equalbut, how do you compare P/Es with firms that have different growth rates?
18 PEG Ratio PEG Ratio = P/E / growth dimensionless Relates P/E to growth Financial Press talks about never paying a P/E higher than the underlying growth rate of a stock -- i.e. they recommend never paying more than 1 times the growth rate.I disagree with this strict interpretation, although I strongly agree with the intent.
19 PEG Ratio: Implementation What do you pay for a non-growth firm? Easy. Pay the current earnings divided by the cap rate (WACC). Thus, for a non-growth firm, pay no more than the inverse of the WACC.Conversely, what do you pay for a firm growing 100% per year? Do you pay a P/E of 100? No because the growth rate is likely to trend towards a lower mean.
20 What PEG do you pay?? Ke = 12% Growth Rate Press Realistically 0% zero 1 / Ke = 8 X5% / K OR5 + 8 = 1310% = 18 X15% = 23 X20% = 28 X25% X (my limit)
21 How P/E relates to Growth Constant Growth DDMP = Theoretical Stock Price based on DDMD1 = next years DividendP = D1 / ( k - g ) k = CAPM cost of capital = rf + B* ( E(rm) - rf )E(r) = D1 / P0 + g g = growth rate= ROE x plowback ratio
22 How P/E relates to Growth E(r) = Divid. Yield + Divid. growthPrice = PV(EPS) PV(growth)= E1 / k PV(growth)P / E = 1 / k PV(growth) / EP = E *(1 - b) / (k - g)P/E = ( 1 - b ) / ( k - g ) p/e positively related to growth
23 Why Does DDM Break Down? Growth > WACC No Dividends (ok, replace with Earnings)Sustainable Growth g = ROE x PlowbackROE < 0Can’t forecast stages in multistage model
24 Seven Sources of Growth PriceVolumeMixAcquisitionsCost CuttingReinvestment of Internally Gener. CashExternal Cash Raised for projects where: ROIC > WACC
26 Coke Example -- one cent miss The Coke example clarifies why a stock crashes when the company misses EPS by a pennyA one percent downward revision in the future growth estimate for the company drives the DDM stock valuation down from $84 to $56Thus, THE PENNY MATTERS DUE TO THE REVISION IN THE GROWTH RATE
27 Coke, Oct 1998 New 1998E $1.46 (it was above $1.80 at one time). Stock now at $67Where does it go from here?