If one equity is valued at 15x P/E, and another at 10x P/E, is the latter a bargain? To answer this question we should adjust for growth.
Adjusting a valuation multiple (such as P/E or EV/EBITDA) is frequently done by dividing by growth — such as with the common P/E/G multiple.
We can do better… [Read more…]
In an earlier post we showed that, for a tax-paying firm, WACC is always a declining function of leverage. If firm value is an inverse function of WACC, this suggests funding operations with 100% debt.
In fact we observe that firm value is concave in leverage and appears to peak when there is some equity in the capital structure. We’re forced to conclude that firm value isn’t solely a function of WACC, but instead varies in a more complicated fashion with leverage. In this post we’ll review one theory that explains this, and which can guide us in divining an “optimal” capital structure. [Read more…]
In an earlier post we saw how peer analysis can mislead. In this post we suggest a better method: distance-based peer analysis. [Read more…]
There are lies, damn lies, statistics, and regression analyses. In this post we’ll examine some of the abuses of the last style.
Our search for understanding corporate finance leads us to drink from many questionable springs. Statistical analysis can help or hinder during the journey. A good rule of thumb is All regression analyses are wrong, but some are useful.
Our example analysis seeks to discover whether paying a dividend increases firm value. [Read more…]
Calculating WACC correctly should preclude its use to optimize capital structure. In this post we’ll see why.
There was a time when WACC was used to find an “optimal capital structure”, which meant a debt/equity ratio that minimized the cost of capital. Charts like this were part of the argument:
There are a variety of online sources of company fundamental data (historical financial filings). The easiest and most reliable are the paid services, such as Compustat, Capital IQ, or Bloomberg.
In this recipe we show how to use Yahoo Finance’s “Stock Market Functions” Excel add-in, which consolidates references to a variety of company and market data from several online sources. [Read more…]
Separately from overall debt capacity, debt structure reflects specific choice of capital structure instruments. We address the goal of maximizing shareholder value in two ways:
In this post we consider duration matching, which clients occasionally propose. [Read more…]
Better analysis requires more information. In this recipe you will learn
Information is difficult and costly to acquire. This issue is at the forefront of quantitative analysis, which elevates the reliance on data in decision making. The following diagram lays out, left to right, the use of increasing amounts of information: [Read more…]
