I have been doing some analysis of the ASX All Ordinaries to value some bank stocks recently (particularly NAB which has released it's results). But to value stocks, generally you want to know what the ROE is so you can discount the future cash flows.
ROE is generally found by using the CAPM (or the Capital Asset Pricing Model). This is of the form R = rf + Beta(rm-rf) where rf = Risk free rate (generally 10 year government bond rate) and Beta (the correlation between the return of the Asset you are looking at and the return on the market). rm-rf is generally known as the market risk premium.
Now a lot of this info is available at Yahoo finance/Google Finance, but I always like to check the stats myself to ensure it is correct.
Using OLS regression with ALLORD returns VS NAB monthly returns annualised (from Yahoo Finance), we find the Beta of NAB is 0.36 (fairly low risk). Risk free rate (Aus Govt 10 year bond) at the moment is 0.038. All that is left is to calculate the Market Risk Premium.
To do this, I wanted to find out the historical average of the Market Risk Premium over the decade. Checking the last 10 years of monthly returns (roughly 140 entries), using data on the ALLOrds from Yahoo Finance and historical 10 year bond rates from rba.gov.au, I have found that the average Market Risk Premium is, in fact, negative (-0.03). This is unusual as finance theory dictates that investing the market requires a positive market risk premium. But with volatility in the ASX being what it is, it appears that investors are happy to hold bonds and are paying a premium (in opportunity cost) to do so.
It also explains why some companies are increasing or maintaining dividends at the moment. AS the CAPM is producing sub par returns, the dividend yield is required to boost the return on equity.
For example, for NAB, using CAPM, the Return is a very small 2.63%. This would normally send investors running for the hills. However add of the very generous fully franked dividend yield of 7.16%, investors would be clearing around 9.8% ROE. Not too shabby in this market.
Friday, February 10, 2012
Tuesday, February 7, 2012
Reserve Bank Decision - Hold at 4.25%!!!!
Looks like my model isn't too bad after all! Still one swallow does not make a summer and all that.
Highlights from the Reserve Bank seem to indicate
1. US and China going ok
2. Europe has improved, but still on death watch
3. Australian GDP growth close to trend.
4. Commodity prices still high (but my model indicates this is negatively correlated to interest rates..might need to investigate this. Might be some multicollinearity in my model)
5. Inflation not a problem
6. Unemployment flat
7. Credit Growth slowly increasing, but retail rates close to long run average
8. Housing prices stable
9. Terms of trade down, but Australian dollar still high.
Highlights from the Reserve Bank seem to indicate
1. US and China going ok
2. Europe has improved, but still on death watch
3. Australian GDP growth close to trend.
4. Commodity prices still high (but my model indicates this is negatively correlated to interest rates..might need to investigate this. Might be some multicollinearity in my model)
5. Inflation not a problem
6. Unemployment flat
7. Credit Growth slowly increasing, but retail rates close to long run average
8. Housing prices stable
9. Terms of trade down, but Australian dollar still high.
Reserve Bank Prediction - Hold Interest rates at 4.25%
I have been doing some modelling to determine if I can accurately predict the Reserve Banks intentions regarding the cash rate.
Based on Historical time series data, I have come up with the following factors that affect interest rates :-
1. 1 month lag in change of difference between 10 year bond and indexed bond (increase puts positive pressure on interest rates)
2. 2 month lag in change of difference between 10 year bond and indexed bond (increase puts positive pressure on interest rates)
3. Previous two Reserve Bank decisions on Interest rates (increase puts positive pressure on interest rates)
4. Commodity prices (increase puts negative pressure on interest rates)
5. Unemployment (increase puts negative pressure on interest rates)
Based on todays data, while there was an decrease in Interest rates last December by the reserve, the fact that the last two months spread change on Government bonds vs index bonds were both "+" and commodity prices have been decreasing and unemployment stationary would indicate that the Reserve Bank will hold interest rates at 4.25%
We shall see.
Based on Historical time series data, I have come up with the following factors that affect interest rates :-
1. 1 month lag in change of difference between 10 year bond and indexed bond (increase puts positive pressure on interest rates)
2. 2 month lag in change of difference between 10 year bond and indexed bond (increase puts positive pressure on interest rates)
3. Previous two Reserve Bank decisions on Interest rates (increase puts positive pressure on interest rates)
4. Commodity prices (increase puts negative pressure on interest rates)
5. Unemployment (increase puts negative pressure on interest rates)
Based on todays data, while there was an decrease in Interest rates last December by the reserve, the fact that the last two months spread change on Government bonds vs index bonds were both "+" and commodity prices have been decreasing and unemployment stationary would indicate that the Reserve Bank will hold interest rates at 4.25%
We shall see.
Monday, February 6, 2012
Facebook Valuation - Around $19 a share
I have been doing a few "back of the envelope" calculations on the Facebook IPO. At the moment, details are a bit sparse vis a vis the price of shares and the number of shares to be issued in the IPO. All we really know is that the total value of the shares in the IPO will be US$5,000,000,000 (5 billion).
So how do we value the company based on this info? By making some assumptions.
Note: In this valuation, we will be making some early assumption about the IPO (which may change). So watch these pages in the future as I will update as more info is released to the SEC.
First Assumption - Book Value will be doubled after IPO.
One thing that stands out about the Facebook SEC filing is that the current book value of the company at 31/12/2011 is roughly the same size as the total value of the IPO. (Book Value of company,or net assets = $4,899,000,000)
So I believe that the investment bank assigned to float the company will be looking to double the size of the business. Thus after the IPO, the book value of the Business will be roughly US $10,000,000,000
Second Assumption - Class A and Class B shares will be the same price.
Facebook has gone the two class share structure so Zukerberg can preserve his control over the company. There is no guarantee that the IPO Class A shares will be the same price as the Class B (as Class B has greater weight in voting rights...1 vote of Class B has the same weight as 10 votes of Class A). However for the purposes of this valuation, we will assume they are the same price.
Third Assumption - WACC of Facebook will be 20%
To perform a reasonable valuation of a business, it is important to calculate a businesses WACC or Weighted Average Cost of capital. With a private company, this is quite difficult as WACC depends on the ROE (or return on equity) With Facebook not paying out dividends and with low liquidity due to the restricted secondary market, this ROE is difficult to establish. However, comparing Facebook to Google (WACC of 18.7%) indicates a ROE of 20% may be appropriate. As Facebook has very little debt, we make the next assumption that Facebook's WACC will be the same as it's ROE, which is Google's WACC with a 1.3% risk premium for an unproven public company.
Fourth Assumption - Average Earnings growth of 60% in years 1 and 2 after IPO, 50% in years 3 and 4, 25% growth in 5 and 6. Terminal growth of 4% onwards
According to a paper from Salim Chahine from the Nates School of Management in France, IPO's earnings usually meet only 80% of expectations in the first year after an IPO (See "Long-run abnormal returns after IPO's and optimistic analysts forecasts", International Review of Financial analysis, 2004). Last year, Facebook's earning grew at 65%. 80% of this is approx 52%. So I have assumed that Facebook will grow at an average of 60% over the next two years (as there will be pressure for facebook to perform, I have added a growth premium). I have then added reduced growth of 50% over the following two years and 25% growth the years after that. Terminal growth is the long term growth in perpetuity and I have assumed the 10 year US bond rate for that (plus another 2% premium for a tech company)
With these assumptions in place, we can then use the Residual Income method to calculate the share price. The RI method assumes that value is created when a companies earning
s exceed it's WACC assumed earnings (i.e If a company has a WACC of 20%, earnings of 300 and a Bookvalue of 1000, the RI = 300 - (0.2*1000) = 100. This increase in earnings then gets added to the Book Value of the company which is then used to calculate the next year's RI.
Using this methodology over 6 years (and the terminal year), and discounting the values to the present day using the WACC we get full value for the company (and it's future cash flows) of 38 billion. Divided by the current number of shares indicates a value of $20.40. By dividing the 5,000,000,000 IPO by 20.40, we get an extra 245,125,911 shares added in the IPO.
But this increase in shares will also reduce the value of the shares in our RI valuation. If we divide the 38 billion valuation by the post IPO shareholding (which is 2,121,125,444), we get a valuation of $18.04 a share.
So I would say that the Facebook IPO values would be a issue share price of around $19.00 (average of the two share prices) and around 263,000,000 shares will be issued.
This will put the market capitalisation of Facebook at $40 billion, which is roughly half of the media speculation of $100 billion valuations being bandied about. But this company, with all the hype stripped away, still has an EPS of only 53 cents a share.
Will be interesting to see how close I am once the IPO is released.
Disclaimer: This is a personal opinion based on certain assumptions that may or may not be true. It is not financial advice and should not be taken as a recommendation to invest/not invest in the Facebook IPO.
So how do we value the company based on this info? By making some assumptions.
Note: In this valuation, we will be making some early assumption about the IPO (which may change). So watch these pages in the future as I will update as more info is released to the SEC.
First Assumption - Book Value will be doubled after IPO.
One thing that stands out about the Facebook SEC filing is that the current book value of the company at 31/12/2011 is roughly the same size as the total value of the IPO. (Book Value of company,or net assets = $4,899,000,000)
So I believe that the investment bank assigned to float the company will be looking to double the size of the business. Thus after the IPO, the book value of the Business will be roughly US $10,000,000,000
Second Assumption - Class A and Class B shares will be the same price.
Facebook has gone the two class share structure so Zukerberg can preserve his control over the company. There is no guarantee that the IPO Class A shares will be the same price as the Class B (as Class B has greater weight in voting rights...1 vote of Class B has the same weight as 10 votes of Class A). However for the purposes of this valuation, we will assume they are the same price.
Third Assumption - WACC of Facebook will be 20%
To perform a reasonable valuation of a business, it is important to calculate a businesses WACC or Weighted Average Cost of capital. With a private company, this is quite difficult as WACC depends on the ROE (or return on equity) With Facebook not paying out dividends and with low liquidity due to the restricted secondary market, this ROE is difficult to establish. However, comparing Facebook to Google (WACC of 18.7%) indicates a ROE of 20% may be appropriate. As Facebook has very little debt, we make the next assumption that Facebook's WACC will be the same as it's ROE, which is Google's WACC with a 1.3% risk premium for an unproven public company.
Fourth Assumption - Average Earnings growth of 60% in years 1 and 2 after IPO, 50% in years 3 and 4, 25% growth in 5 and 6. Terminal growth of 4% onwards
According to a paper from Salim Chahine from the Nates School of Management in France, IPO's earnings usually meet only 80% of expectations in the first year after an IPO (See "Long-run abnormal returns after IPO's and optimistic analysts forecasts", International Review of Financial analysis, 2004). Last year, Facebook's earning grew at 65%. 80% of this is approx 52%. So I have assumed that Facebook will grow at an average of 60% over the next two years (as there will be pressure for facebook to perform, I have added a growth premium). I have then added reduced growth of 50% over the following two years and 25% growth the years after that. Terminal growth is the long term growth in perpetuity and I have assumed the 10 year US bond rate for that (plus another 2% premium for a tech company)
With these assumptions in place, we can then use the Residual Income method to calculate the share price. The RI method assumes that value is created when a companies earning
s exceed it's WACC assumed earnings (i.e If a company has a WACC of 20%, earnings of 300 and a Bookvalue of 1000, the RI = 300 - (0.2*1000) = 100. This increase in earnings then gets added to the Book Value of the company which is then used to calculate the next year's RI.
Using this methodology over 6 years (and the terminal year), and discounting the values to the present day using the WACC we get full value for the company (and it's future cash flows) of 38 billion. Divided by the current number of shares indicates a value of $20.40. By dividing the 5,000,000,000 IPO by 20.40, we get an extra 245,125,911 shares added in the IPO.
But this increase in shares will also reduce the value of the shares in our RI valuation. If we divide the 38 billion valuation by the post IPO shareholding (which is 2,121,125,444), we get a valuation of $18.04 a share.
So I would say that the Facebook IPO values would be a issue share price of around $19.00 (average of the two share prices) and around 263,000,000 shares will be issued.
This will put the market capitalisation of Facebook at $40 billion, which is roughly half of the media speculation of $100 billion valuations being bandied about. But this company, with all the hype stripped away, still has an EPS of only 53 cents a share.
Will be interesting to see how close I am once the IPO is released.
Disclaimer: This is a personal opinion based on certain assumptions that may or may not be true. It is not financial advice and should not be taken as a recommendation to invest/not invest in the Facebook IPO.
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