The paper “ Inherited Portfolio of the Companies in the Technological and in the Financial Services Sectors" is a forceful example of a statistics project on finance & accounting. Analysis of Two Positions in Inherited Portfolio The two chosen companies within the Fall 2018 SMIP PNY are YY Inc (YY) and Evercore Inc (EVR). These companies are found in different sectors hence the determination of their valuation differs. This assignment is going to determine the value of the firm and hence propose a buy, hold, or sell proposition. Fundamentals YY Inc YY is a company in the technological sector. Currently, the firm has a market capitalization of $ 4.583 billion.
The open price as of the day of analysis was $73.37 while the previous close price was at $72.49. The bid price on the day of analysis was at $72.53 while the asking price was at $72.64. The firm's current beta is at 1.55. Evercore Inc Evercore is a company in the financial services sector. Currently, the company has a market capitalization worth $4.511 billion. The open price as of the day of analysis was $102.30 while the previous close price was at $102.55.
The bid price on the day of analysis stood at $102.85 while the asking price was at $103.00. The firm’ s current beta is at 1.87. Overview Valuation of companies follows a series of logical steps that result in fair value of the firm. Damodaran in his presentation titled, “ The Dark Side of Valuation, ” proposes various steps that can be used to compute the value of firms located in various economic segments. For instance, he opines that companies in the technological sector are considered to be firms with “ intangible” assets.
In our case, the valuation of YY Inc. will follow the steps proposed for the valuation of firms with intangible assets. On the other hand, Damodaran also proposes a method of valuation for firms that offer financial services. In our case, Evercore Inc. will follow the steps proposed in the valuation method. Valuation of firms with “ intangible” assets Before one proceeds with the valuation of firms with intangible assets, there are a few lessons and assumptions that ought to be considered.
For instance, it is assumed that accounting principles are plagued with inconsistencies and as such research and design are treated as the ultimate cap-ex for firms in the technological sector (Damodaran, ). In this case, the valuation of YY shall be computed as below. The first step involves determining an amortizable life for the research and design expenses for a specific period of time, for instance, three years. The next step involves the capitalization of the historical value of the research and design expenses. Year Research and Design Expenses Unamortized Portion Amortization this year Current 781,886 1.00 781,886 2016 675,230 0.90 607,707 67,523.0 2015 548,799 0.80 439,039 54,879.9 2014 431,188 0.70 301,832 43,118.80 2013 267,005 0.60 160,203 26,700.5 2012 176,725 0.50 88,363 17,672.50 2011 106,804 0.40 42,722 10,680.40 2010 49,219 0.30 14,766 4,921.9 2009 12,597 0.20 2,519 1,259.7 2008 10,129 0.10 1,013 1,012.9 2007 8,004 0.00 0 800.4 2,440,050 228,570 The next step involves restating the earnings, the book values and return numbers of the firm.
Unadjusted Adjusted for Research and Design Net Income 1,037,657 2,508,391 + 781,886 - 228,570 = 3,061,707 Book Value of Equity 10,712,859 10,712,589 + 2,440,050 = 13,152,639 Return on Equity 1,037,657 / 10,712,859 = 9.69% 3,518,847 / 13,152,639 = 26.75% Pretax Operating Income 2,699,231 2,699,231 + 781,886 - 228,570 = 3,252,547 Book Value of Invested Capital 5,339,924 5,339,924 + 2,440,050 = 7,779,974 Pretax Return on Capital 2,699,231 / 5,339,924 = 50.55% 3,252,547 / 7,779,974 = 41.8% It is worth noting that the method used in determining the valuation of YY Inc uses a two-stage growth model where the initial stage of growth may see the company exhibiting a higher growth rate while the second phase assumes a perpetual growth rate.
To begin with, analysts estimated that YY Inc’ s levered free cash flows in the next 10 years would be around 9.6%. When considering the other measures important in the calculation of the present value of cash flows, the above levered free cash flow rate yielded a 10-year cash flow of US$ 2.26 billion. The next stage entails discounting the firm’ s terminal value 10 years back and based on the above data, this yielded a present value of US$ 4.45 billion.
The equity value is then determined as the sum of the present values of the cash flows that are computed above, which in this case is US$ 6.71 billion. To determine the intrinsic value of the firm, the equity value computed above is then divided by the number of shares outstanding. YY’ s intrinsic value was found to be $118.82. From the firm’ s fundamental information, it is evident that YY Inc. is undervalued as at the time of writing this since the firm’ s current value was $73.10.
Hence, the recommended position is buying. Valuation of Financial Services Firms There is particular lessons and assumptions that ought to be taken into consideration when conducting the valuation of firms in the financial services sector. For instance, it is assumed that financial services firms are opaque meaning that so little is known about the quality of their assets. Additionally, book value matters a lot when valuing the financial services firms. In this case, the valuation of Evercore Inc. shall be computed as below. First, of all, determine the basic elements that will be significant in monitoring the growth of the value of the firm such as the asset base, the capital ratio, the change in capital, the return on equity, the net income, reinvestments, and the free cash flow to equity.
2013 2014 2015 2016 2017 Asset Base 1,180,783 1,446,556 1,479,171 1,662,346 1,584,886 Capital Ratio 189.28% 177.35% 183.67% 215.54% 199.74% Change in Capital 12.86% -2.15% 9.26% 4.31% 3.06% ROE 11.43% 16.49% 8.12% 20.84% 23.42% Net Income 53,194 86.874 42,863 107,528 125,454 -Reinvestment - - - - -3.06 Free Cash Flow to Equity 53,194 86.874 42,863 107,528 125,454 From the above date, the valuation is computed as follows: First, determine the company’ s preferred discounting rate from the financial data (12%).
Then pick up the growth rate (g1) in the growth stage to date which was found out to be 9.69% as from the above table. Then, determine the number of years of growth stage (y1) which was found to be 10 years. Then record the firm’ s preferred terminal growth rate (g2) which is 4%. Then, it also states the number of years to terminal growth (y2) which is 10.
From the data given above, the discounted cash flow of the firm is found to be $14.3731 Also determine the firm’ s free cash flow per share which was $11.504 as of the end of June 2018. Hence, the value of Evercore is determined as Free Cash Flow per share X Discounted Cash Flow = 11.504 x 14.3731 = 165.35 From the firm’ s fundamental information, it is evident that Evercore Inc. is undervalued as at the time of writing this since the firm’ s current value was $73.10.
hence, the recommended position is to buy.