valuation of equity share prices
TRANSCRIPT
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VALUATION OF EQUITY SHARE PRICES
A DISSERTATON SUBMITTED IN PARTIAL FULFILMENT OF THE
REQUIREMENTS FOR THE AWARD OF MBA DEGREE OFBANGALORE UNIVERSITY
SUBMITTED BY
DANTULURI S HARSHA VARMA
Reg.No-06XQCM6069
Under the Guidance and Supervision
Of
PROF.PRAVEEN BHAGAWAN
M P BIRLA INSTITUTE OF MANAGEMENTAssociate Bharatiya Vidya Bhavan
#43, Race Course Road, BANGALORE. 560001
2006-2008
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STUDENT DECLARATION
I hereby declare that this dissertation entitled a study on VALUATION
OF EQUITY SHARE PRICES is the result of my own research work carried
out by me, under the guidance and supervision o f PROF. PRAVEEN
BHAGAWAN, M. P Birla Institute of Management, Bangalore. I also
declare that this dissertation has not been submitted earlier to any
Institute/organization for the award of any degree or diploma.
Place: Bangalore DANTULURI S HARSHA VARMA
Date: (06XQCM6069)
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PRINCIPALS CERTIFICATE
This is to certify that this dissertation entitled VALUATION OF
EQUITY SHARE PRICES is the result of research work carried out by
Mr. Dantuluri S Harsha Varma (REG 06XQCM6069) under the guidance
and supervision ofProf.Praveen baghwan, Senior Professor , M.P. Birla
Institute ofManagement, Bangalore.
Plac e: Banga lore Dr. NAGESH S. MALAVALLI
Date: Principal
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GUIDES CERTIFICATE
I here by cetify that the Dissertation entitled VALUATION OF EQUITY
SHARE PRICES is the project work carried out byMr. Dantuluri S Harsha
varma bearing registration number 06XQCM6069 under my guidance and
supervision as per the requirements of the Bangalore University, MBA
syllabus. This report has not formed the basis for the award of any other
degree.
Place: Bangalore Prof. PRAVEEN BHAGAWAN
Date: Faculty (MPBIM)
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ACKNOWLEDGEMENT
This project is made successful by the combining efforts of a no. of officials
whose knowledge and experience have helped me a lot. This project can
not be said completed unless and until, I fulfill my duty of thanking those
persons to whom I deeply indebted. I wish to express my deep gratitude
towards them to their whole hearted support and existence.
First, I would like to thank Dr. N.S. MALAVALLI, Principal, M.P Birla
Institute of Management for his kind support and giving me the opportunity
to present this project.
I am extremely thankful to, Prof. Praveen Bhagawan,M.P. Birla Institute
of Management, Bangalore, who has guided me to do this project by
giving valuable suggestion and advice.
At the end I am also thankful to my parents and my friends to help me in
preparing my report.
Place: Bangalore DANTULURI S HARSHA VARMA
Date: (06XQCM6069)
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Contents
ABSTRACT .................................................................................................7
CHAPTER 1.................................................................................................9INTERDICTION1.1INTRODUCTION...........................................................9
1.1INTRODUCTION...................................................................................10
1.2OVERVIEWOFVALUATION................................................................111.3THEROLEOFVALUATION .................................................................11
1.7RESEARCH PROPOSAL.....................................................................32
1.7.1PROBLEMSTATEMENT:-.................................................................321.7.2OBJECTIVES:-...................................................................................32
1.7.3SCOPEOFSTUDY:-..........................................................................32
CHAPTER 2...............................................................................................33
2.1LITERATURE REVIEW ........................................................................34
CHAPTER 3...............................................................................................43
3.1RESEARCH METHODOLOGY ............................................................44
3.1.1TYPEOFRESEARCH .......................................................................443.1.2SAMPLINGTECHNIQUE...................................................................44
3.1.3DATACOLLECTION..........................................................................443.1.4SOURCESOFDATA .........................................................................44
3.1.5DATA REQUIRED AND PERIOD OF STUDY...................................45
CHAPTER 4...............................................................................................46
4.1ANALYSIS & INTERPRETATION........................................................47
4.2FREECASHFLOWTOEQUITYMODEL .............................................474.4PEMULTIPLIERMODEL......................................................................754.5RELATIVECOMPARISONOFCOMPANIES .......................................76
4.6CONCLUSION:-....................................................................................79BIBLIOGRAPHY........................................................................................82
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LIST OF TABLES
FREE CASH FLOWS TO EQUITY METHOD TABLES
4.2.1INFOSYS TECHNOLOGY LTD 39
4.2.2HCL TECHNOLOGIES LTD 40
4.2.3SATYAM COMPUTERS LTD 42
4.2.4TECH MAHINDRA LTD 43
4.2.5I-FLEX SOLUTIONS 45
4.2.6MPHASIS LTD 48
4.2.7PATNI COMPUTERS 49
4.2.8POLARIS SOFTWARE 50
4.2.9WIPRO LTD 51
4.2.10TCS 53
DIVIDENT DISCOUNT MODEL TABLES
4.3.1INFOSYS TECHNOLOGY 55
4.3.2HCL TECHNOLOGIES 56
4.3.3SATYAM COMPUTERS LTD 57
4.3.4I-FLEX SOLUTIONS 58
4.3.5MPHASIS LTD 59
4.3.6PATNI COMPUTERS 60
4.3.7POLARIS SOFTWARE 61
4.3.8WIPRO TECHNOLOGIES LTD 62
4.3.9TCS 63
4.3.10TECH MAHINDRA 64
4.4PE MULTIPLIER MODEL 65
4.5RELATIVE COMPARISON OF COMPANIES 66
4.6.1CONSOLIDATED RESULTS 69
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ABSTRACT
Valuation is the process of determining the real value (intrinsic value) as opposed to the
observed market price of a security.
Different methods give different intrinsic value of company and also in each method
there are different growth and different forces which drive the security price the problem
lies in which intrinsic value to choose.
In this project four different methods namely free cash flows to equity, dividend discountmodel, PE multiplier model and relative comparison of companies are done and the
drivers of each model are calculated.
One industry namely large capitalization information technology (IT) is considered and
ten companies in IT large cap industry are analysis and the intrinsic value for these
companies is calculated using four methods which considered.
In each method the market value is compared with the intrinsic value for each company
and whether the share price is over valued or under valued is decided.
Finally the market price is compared with the intrinsic values of four methods and a
consolidated, that is whether market share price is is over valued or under valued is
decided.
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CHAPTER 1
INTRODUCTION
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1.1INTRODUCTION
Every asset, financial as well as real, has a value. The key to successfully investing in
and managing these assets lies in understanding not only what the value is but also the
sources of the value. Any asset can be valued, but some assets are easier to value than
others and the details of valuation will vary from case to case. Thus, the valuation of a
share of a real estate property will require different information and follow a different
format than the valuation of a publicly traded stock. What is surprising; however, is not
the difference in valuation techniques across assets, but the degree of similarity in basic
principles. There is undeniably uncertainty associated with valuation. Often that
uncertainty comes from the asset being valued, though the valuation model may add to
that uncertainty.
In the wake of economic liberalization, companies are relying more on the capital
market, acquisitions and restructuring are becoming common place, strategic alliances
are gaining popularity, employee stock option plans are proliferating, and regulatory
bodies are struggling with tariff determination. In these exercises a crucial issue is: how
should the value of a company or a division thereof is appraised.
The goal of such an appraisal is essentially to estimate a fair market value of a
company. The fair market value is the price at which the property would change hands
between a willing buyer and a willing seller when the former is not under any
compulsion to buy and the latter is not under any compulsion to sell, both parties having
reasonable knowledge of relevant facts. When the asset being appraised is a company,
the property the buyer and the seller are trading consists of the claims of all the
investors of the company; this includes outstanding equity shares, preference shares,
debentures and loans.
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1.2OVERVIEW OF VALUATION
Analysts use a wide spectrum of models, ranging from the simple to the sophisticated.
These models often make very different assumptions about the fundamentals that
determine value, but they do share some common characteristics and can be classified
in broader terms. There are several advantages to such a classification --it makes it is
easier to understand where individual models fit in to the big picture, why they provide
different results and when they have fundamental errors in logic.
In general terms, there are four approaches to valuation. The first, discounted cashflowvaluation, relates the value of an asset to the present value of expected future
cashflows on that asset. The second, liquidation and accounting valuation is built
around valuing the existing assets of a firm, with accounting estimates of value or book
value often used as a starting point. The third, relative valuation, estimates the value of
an asset by looking at the pricing of 'comparable' assets relative to a common variable
like earnings, cashflows, book value or sales. The final approach, contingent claim
valuation, uses option pricing models to measure the value of assets that share option
characteristics. This is what generally falls under the rubric of real options.
1.3THE ROLE OF VALUATION
Valuation is useful in a wide range of tasks. The role it plays however is different in
different arenas. The following section lays out the relevance of valuation in portfolio
management, in acquisition analysis, and in corporate finance.
1.3.1VALUATION AND PORTFOLIO MANAGEMENT
The role that valuation plays in portfolio management is determined in large part by the
investment philosophy of the investor. Valuation plays a minimal role in portfolio
management for a passive investor, whereas it plays a larger role for an active investor.
Even among active investors, the nature and the role of valuation is different for
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different types of active investment. Market timers use valuation much less than
investors who pick stocks and the focus is on market valuation rather than on firm-
specific valuation. Among security selectors, valuation plays a central role in portfoliomanagement for fundamental analysts and a peripheral role for technical analysts.
1.3.2VALUATION IN ACQUISITION ANALYSIS
Valuation should play a central part in acquisition analysis. The bidding firm or individual
has to decide on a fair value for the target firm before making a bid, and the target firm
has to determine a reasonable value for itself before deciding to accept or reject the
offer. There are also special factors to consider in takeover valuation. First the effects of
synergy on the combined value of the two firms (target plus bidding firm) have to be
considered before a decision is made on the bid. Those who suggest that synergy is
impossible to value and, therefore should not be considered in quantitative terms are
wrong. Second the effects on value of changing management and restructuring the
target firm will have to be taken into account in deciding on a fair price. This is of
particular concern in hostile takeovers. Finally there is a significant problem with bias in
the takeover valuations. Target firms may be overoptimistic in estimating value,
especially when the takeover is hostile and they are trying to convince their
shareholders that the offer price is too low. Similarly if the bidding firm has decided, for
strategic reasons, to do an acquisition, there may be strong pressure on the analyst to
come up with an estimate of value that backs up the acquisition.
1.3.3VALUATION IN CORPORATE FINANCE
In recent years, management consulting firms have started offering companies advice
on how to increase value. This has been possible because of the fear of hostile
takeovers. Companies have increasingly turned to .value consultants. To tell them how
to restructure, increase value, and avoid being taken over. The consultants.
Suggestions have often provided the basis for the restructuring of these firms. The
value of a firm can be directly related to decisions that it makes: on which projects it
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takes, on how it finances them, and on its dividend policy. Understanding this
relationship is key to making value increasing decisions and to sensible financial
restructuring.
1.4APPROACHES TO VALUATION
There are four broad approaches to appraising the value of a company namely
1. Adjusted book value approach
2. Stock and debt approach
3. Relative Valuation and
4. Discounted cash flow approach.
1.4.1ADJUSTED BOOK VALUE APPROACH
The simplest approach to valuing a firm is to rely on the information found on its balance
sheet. There are two equivalent ways of using the balance sheet information to appraise
the value of a firm. First, the book values of investor claims may be summed directly.
Second, the assets of a firm may be totaled and from this total non-investor claims (like
accounts payable and provisions) may be deducted. The accuracy of the book value
approach depends on how well the net book values of the assets reflect their fair market
values.
1.4.2STOCK AND DEBT APPROACH
When the securities of a firm are publicly traded, its value can be obtained by merely
adding the market value of all its outstanding securities. This simple approach is called
the stock and the debt approach by property tax appraisers. It is also referred to as the
market approach.
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1.4.3Relative Valuation
While we tend to focus most on discounted cash flow valuation, when discussing
valuation, the reality is that most valuations are relative valuations. The value of most
assets, from the house you buy to the stocks that you invest in, are based upon how
similar assets are priced in the market place. We begin this section with a basis for
relative valuation, move on to consider the underpinnings of the model and then
consider common variants within relative valuation.
In relative valuation, the value of an asset is derived from the pricing of 'comparable'
assets, standardized using a common variable such as earnings, cash flows, book
value or revenues. One illustration of this approach is the use of an industry-average
price-earnings ratio to value a firm. This assumes that the other firms in the industry are
comparable to the firm being valued and that the market, on average, prices these firms
correctly. Another multiple in wide use is the price to book value ratio, with firms selling
at a discount on book value, relative to comparable firms, being considered
undervalued. The multiple of price to sales is also used to value firms, with the average
price-sales ratios of firms with similar characteristics being used for comparison. While
these three multiples are among the most widely used, there are others that also play a
role in analysis - price to cash flows, price to dividends and market value to replacement
value (Tobin's Q), to name a few.
Categorizing Relative Valuation Models
Analysts and investors are endlessly inventive when it comes to using relative valuation.
Some compare multiples across companies, while others compare the multiple of a
company to the multiples it used to trade in the past. While most relative valuations are
based upon comparables, there are some relative valuations that are based upon
fundamentals.
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1. Using Fundamentals
The first approach relates multiples to fundamentals about the firm being valued growth rates in earnings and cashflows, payout ratios and risk. This approach to
estimating multiples is equivalent to using discounted cashflow models, requiring the
same information and yielding the same results. Its primary advantage is to show the
relationship between multiples and firm characteristics, and allows us to explore how
multiples change as these characteristics change. For instance, what will be the effect
of changing profit margins on the price/sales ratio? What will happen to price-earnings
ratios as growth rates decrease? What is the relationship between price-book value
ratios and return on equity?
2. Using Comparables
The more common approach to using multiples is to compare how a firm is valued with
how similar firms are priced by the market, or in some cases, with how the firm was
valued in prior periods. As we will see in the later chapters, finding similar and
comparable firms is often a challenge and we have to often accept firms that are
different from the firm being valued on one dimension or the other. When this is the
case, we have to either explicitly or implicitly control for differences across firms on
growth, risk and cash flow measures. In practice, controlling for these variables can
range from the naive(using industry averages) to the sophisticated (multivariate
regression models where the relevant variables are identified and we control for
differences.).
3. Cross Sectional versus Time Series Comparisons
In most cases, analysts price stocks on a relative basis by comparing the multiple it is
trading to the multiple at which other firms in the same business are trading. In some
cases, however, especially for mature firms with long histories, the comparison is done
across time.
a. Cross Sectional Comparisons
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When we compare the price earnings ratio of a software firm to the average price
earnings ratio of other software firms, we are doing relative valuation and we are
making cross sectional comparisons. The conclusions can vary depending upon ourassumptions about the firm being valued and the comparable firms. For instance, if we
assume that the firm we are valuing is similar to the average firm in the industry, we
would conclude that it is cheap if it trades at a multiple that is lower than the average
multiple. If, on the other hand, we assume that the firm being valued is riskier than the
average firm in the industry, we might conclude that the firm should trade at a lower
multiple than other firms in the business. In short, you cannot compare firms without
making assumptions about their fundamentals.
b. Comparisons across time
If you have a mature firm with a long history, you can compare the multiple it trades
today to the multiple it used to trade in the past. Thus, Ford Motor company may be
viewed as cheap because it trades at six times earnings, if it has historically traded at
ten times earnings. To make this comparison, however, you have to assume that your
firm has not changed its fundamentals over time. For instance, you would expect a high
growth firms price earnings ratio to drop and its expected growth rate to decrease over
time as it becomes larger. Comparing multiples across time can also be complicated by
changes in the interest rates over time and the behavior of the overall market. For
instance, as interest rates fall below historical norms and the overall market increases,
you would expect most companies to trade at much higher multiples of earnings and
book value than they have historically.
1.4.4Standardized Values and Multiples
The price of a stock is a function both of the value of the equity in a company and the
number of shares outstanding in the firm. Thus, a stock split that doubles the number of
units will approximately halve the stock price. Since stock prices are determined by the
number of units of equity in a firm, stock prices cannot be compared across different
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firms. To compare the values of similar firms in the market, you need to standardize
the values in some way. Values can be standardized relative to the earnings firms
generate, to the book value or replacement value of the firms themselves, to therevenues that firms generate or to measures that are specific to firms in a sector.
1. Earnings Multiples
One of the more intuitive ways to think of the value of any asset is the multiple of the
earnings that asset generates. When buying a stock, it is common to look at the price
paid as a multiple of the earnings per share generated by the company. This
price/earnings ratio can be estimated using current earnings per share, yielding a
current PE, earnings over the last 4 quarters, resulting in a trailing PE, or an expected
earnings per share in the next year, providing a forward PE.
When buying a business, as opposed to just the equity in the business, it is common to
examine the value of the firm as a multiple of the operating income or the earnings
before interest, taxes, depreciation and amortization (EBITDA). While, as a buyer of the
equity or the firm, a lower multiple is better than a higher one. These multiples will be
affected by the growth potential and risk of the business being acquired.
2. Book Value or Replacement Value Multiples
While markets provide one estimate of the value of a business, accountants often
provide a very different estimate of the same business. The accounting estimate of book
value is determined by accounting rules and is heavily influenced by the original price
paid for assets and any accounting adjustments (such as depreciation) made since.
Investors often look at the relationship between the price they pay for a stock and the
book value of equity (or net worth) as a measure of how over- or undervalued a stock is;
the price/book value ratio that emerges can vary widely across industries, depending
again upon the growth potential and the quality of the investments in each. When
valuing businesses, you estimate this ratio using the value of the firm and the book
value of all assets (rather than just the equity). For those who believe that book value is
not a good measure of the true value of the assets, an alternative is to use the
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replacement cost of the assets; the ratio of the value of the firm to replacement cost is
called Tobins Q.
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3. Revenue Multiples
Both earnings and book value are accounting measures and are determined by
accounting rules and principles. An alternative approach, which is far less affected byaccounting choices, is to use the ratio of the value of an asset to the revenues it
generates. For equity investors, this ratio is the price/sales ratio (PS), where the market
value per share is divided by the revenues generated per share. For firm value, this
ratio can be modified as the value/sales ratio (VS), where the numerator becomes the
total value of the firm. This ratio, again, varies widely across sectors, largely as a
function of the profit margins in each. The advantage of using revenue multiples,
however, is that it becomes far easier to compare firms in different markets, with
different accounting systems at work, than it is to compare earnings or book value
multiples.
4. Sector-Specific Multiples
While earnings, book value and revenue multiples are multiples that can be computed
for firms in any sector and across the entire market, there are some multiples that are
specific to a sector. For instance, when Internet firms first appeared on the market in the
later 1990s, they had negative earnings and negligible revenues and book value.
Analysts looking for a multiple to value these firms divided the market value of each of
these firms by the number of hits generated by that firms web site. Firms with a low
market value per customer hit were viewed as more under valued. More recently,
retailers have been judged by the market value of equity per customer in the firm,
regardless of the longevity and the profitably of the customers.
While there are conditions under which sector-specific multiples can be justified, they
are dangerous for two reasons. First, since they cannot be computed for other sectors
or for the entire market, sector-specific multiples can result in persistent over or under
valuations of sectors relative to the rest of the market. Thus, investors who would never
consider paying 80 times revenues for a firm might not have the same qualms about
paying Rs 2000 for every page hit (on the web site), largely because they have no
sense of what high, low or average is on this measure. Second, it is far more difficult to
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relate sector specific multiples to fundamentals, which is an essential ingredient to using
multiples well. For instance, does a visitor to a companys web site translate into higher
revenues and profits? The answer will not only vary from company to company, but willalso be difficult to estimate looking forward.
1.5Discounted Cash flow Valuation
1.5.1Basis for Discounted Cash flow Valuation
This approach has its foundation in the present value rule, where the value of any asset
is the present value of expected future cash flows that the asset generates.
Value =
Where,
n = Life of the asset
CFt = Cashflow in period t
r = Discount rate reflecting the riskiness of the estimated cashflows.
The cashflows will vary from asset to asset -- dividends for stocks, coupons (interest)
and the face value for bonds and after-tax cashflows for a real project. The discount rate
will be a function of the riskiness of the estimated cashflows, with higher rates for riskier
assets and lower rates for safer projects. You can in fact think of discounted cash flow
valuation on a continuum. At one end of the spectrum, you have the default-free zero
coupon bond, with a guaranteed cash flow in the future. Discounting this cash flow atthe riskless rate should yield the value of the bond. A little further up the spectrum are
corporate bonds where the cash flows take the form of coupons and there is default
risk. These bonds can be valued by discounting the expected cash flows at an interest
rate that reflects the default risk. Moving up the risk ladder, we get to equities, where
there are expected cash flows with substantial uncertainty around the expectation. The
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value here should be the present value of the expected cash flows at a discount rate
that reflects the uncertainty.
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1.5.2Categorizing Discounted Cash Flow Models
There are literally thousands of discounted cash flow models in existence. Oftentimes,we hear claims made by investment banks or consulting firms that their valuation
models are better or more sophisticated than those used by their contemporaries.
Ultimately, however, discounted cash flow models can vary only a couple of dimensions
and we will examine these variations in this section.
1.5.3Total Cash Flow versus Excess Cash Flow Models
The conventional discounted cash flow model values an asset by estimating the present
value of all cash flows generated by that asset at the appropriate discount rate. In
excess return (and excess cash flow) models, only cash flows earned in excess of the
required return are viewed as value creating, and the present value of these excess
cash flows can be added on to the amount invested in the asset to estimate its value.
Excess return = Cash flow earned Cost of capital * Capital Invested in asset
1.5.4free cash flow to equity discount models
The dividend discount model is based upon the premise that the only cashflows
received by stockholders is dividends. Even if we use the modified version of the model
and treat stock buybacks as dividends, we may misvalue firms that consistently return
less or more than they can afford to their stockholders.
1.5.5Free Cash Flows to Equity
To estimate how much cash a firm can afford to return to its stockholders, we begin with
the net income the accounting measure of the stockholders earnings during the
period and convert it to a cash flow by subtracting out a firms reinvestment needs.
First, any capital expenditures, defined broadly to include acquisitions, are subtracted
from the net income, since they represent cash outflows. Depreciation and amortization,
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on the other hand, are added back in because they are non-cash charges. The
difference between capital expenditures and depreciation is referred to as net capital
expenditures and is usually a function of the growth characteristics of the firm. High-growth firms tend to have high net capital expenditures relative to earnings, whereas
low-growth firms may have low, and sometimes even negative, net capital expenditures.
Second, increases in working capital drain a firms cash flows, while decreases in
working capital increase the cash flows available to equity investors. Firms that are
growing fast, in industries with high working capital requirements (retailing, for instance),
typically have large increases in working capital. Since we are interested in the cash
flow effects, we consider only changes in non-cash working capitalin this analysis.
Finally, equity investors also have to consider the effect of changes in the levels of debt
on their cash flows. Repaying the principal on existing debt represents cash outflow; but
the debt repayment may be fully or partially financed by the issue of new debt, which is
a cash inflow. Again, netting the repayment of old debt against the new debt issues
provides a measure of the cash flow effects of changes in debt.
Allowing for the cash flow effects of net capital expenditures, changes in working capital
and net changes in debt on equity investors, we can define the cash flows left over after
these changes as the free cash flow to equity (FCFE).
Free Cash Flow to Equity (FCFE) = Net Income
- (Capital Expenditures - Depreciation)
- (Change in Non-cash Working Capital)
+ (New Debt Issued - Debt Repayments)
This is the cash flow available to be paid out as dividends or stock buybacks.
This calculation can be simplified if we assume that the net capital expenditures and
working capital changes are financed using a fixed mix1 of debt and equity.
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1.5.6The Free Cashflow to the Firm
The free cashflow to the firm is the sum of the cashflows to all claim holders in the firm,
including stockholders, bondholders and preferred stockholders. There are two ways of
measuring the free cashflow to the firm (FCFF). One is to add up the cashflows to the
claim holders, which would include cash flows to equity (defined either as free cash flow
to equity or dividends), cashflows to lenders (which would include principal payments,
interest expenses and new debt issues) and cash flows to preferred stockholders
(usually preferred dividends).
FCFF = Free Cashflow to Equity + Interest Expense (1 - tax rate) + PrincipalRepayments - New Debt Issues+ Preferred Dividends
Note, however, that we are reversing the process that we used to get to free cash flow
to equity, where we subtracted out payments to lenders and preferred stockholders to
estimate the cash flow left for stockholders. A simpler way of getting to free cash flow to
the firm is to estimate the cash flows prior to any of these claims. Thus, we could begin
with the earnings before interest and taxes, net out taxes and reinvestment needs and
arrive at an estimate of the free cash flow to the firm.
FCFF = EBIT (1 - tax rate) + Depreciation - Capital Expenditure - Working Capital
Since this cash flow is prior to debt payments, it is often referred to as an unlevered
cash flow. Note that this free cash flow to the firm does not incorporate any of the tax
benefits due to interest payments. This is by design, because the use of the after-tax
cost of debt in the cost of capital already considers this benefit and including it in the
cash flows would double count it.
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The Model
The value of the firm, in the most general case, can be written as the present value ofexpected free cashflows to the firm.
Value of Firm =
Where,
FCFFt = Free Cashflow to firm in year t.
WACC = Weighted average cost of capital.
DIVIDEND DISCOUNT MODELS
In the strictest sense, the only cash flow you receive from a firm when you buy publicly
traded stock is the dividend. The simplest model for valuing equity is the dividend
discount model -- the value of a stock is the present value of expected dividends on it.
While many analysts have turned away from the dividend discount model and viewed itas outmoded, much of the intuition that drives discounted cash flow valuation is
embedded in the model. In fact, there are specific companies where the dividend
discount model remains a useful took for estimating value.
The General Model
When an investor buys stock, she generally expects to get two types of cashflows -
dividends during the period she holds the stock and an expected price at the end of the
holding period. Since this expected price is itself determined by future dividends, the
value of a stock is the present value of dividends through infinity.
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Value per share of stock =
Where,
DPSt = Expected dividends per share
Ke = Cost of equity
There are two basic inputs to the model - expected dividends and the cost on equity. To
obtain the expected dividends, we make assumptions about expected future growth
rates in earnings and payout ratios. The required rate of return on a stock is determined
by its riskiness, measured differently in different models - the market beta in the CAPM,
and the factor betas in the arbitrage and multi-factor models. The model is flexible
enough to allow for time-varying discount rates, where the time variation is caused by
expected changes in interest rates or risk across time.
The Gordon Growth Model
The Gordon growth model can be used to value a firm that is in 'steady state' with
dividends growing at a rate that can be sustained forever.
The Model
The Gordon growth model relates the value of a stock to its expected dividends in the
next time period, the cost of equity and the expected growth rate in dividends.
Value of Stock =
Where,
DPS1 = Expected Dividends one year from now (next period)
Ke = Required rate of return for equity investors
G = Growth rate in dividends forever
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1.6METHODS USED FOR VALUATIONS:-
VALUATION PARAMETERS:-
The following parameters are used for valuing the companies:-
1. Net operating profit less adjusted taxes (NOPLAT)
2. Return on capital employed (ROCE)
3. Growth rate
4. Weighted average cost of capital
5. Free cash flow (FCFF)
As per the sample size ten companies representing information technology industry areanalyzed by four different techniques those are
1. Free cash flows to equity.
2. Dividend discount model.
3. PE ratio method.
4. Direct comparison approach.
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1.6.1Free cash flows to equity:-
Value of high - growth business =
Free cash flows to firm
PARTICULARS AMOUN
SALES XXX
LESS:-COGS XXX
EBIT XXX
LESS:-TAX XXX
EBIT (1-T) XXX
LESS: - CHANGE IN WORKING CAPITAL XXX
FCFF XXX
Assumption: - In the long run both capital expenditure and depreciation with equal and
cancel off each other.
Now free cash flow to firm (FCFF) is estimated for next 5 years and then terminal value
of the firm is calculated. These FCFF are discounted to present value by using weighted
average cost of capital (WACC).
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1.6.2TERMINAL VALUE
The terminal value of a security is the present value at a future point of all future cash
flows. It allows for the inclusion of the value of future cash flows occurring beyond a
several year projection period while satisfactorily mitigating many of the problems of
valuing such cash flows. The terminal value is calculated in accordance with a stream of
projected future free cash flows in discounted cash flow analysis.
Terminal value=final projected year cash flow/ (WACC-growth rate)
Once the terminal values and operating cash flows have been estimated, they are
discounted back to the present to yield the value of the operating assets of the firm.
Fair value of equity = FCFF - Total Debt.
Value of each equity share = fair value of equity/total number of equity shares.
ESTIMATING SALES:-
The sale of last 4 years is considered and the growth rate of sales for 3 years iscalculated and weights of 0.4, 0.3 & 0.3 are given 0.4 is given to most resent year.
Average growth rate is calculated and taking this rate next 6 years sales is projected.
ESTIMATING EBIT:-Earning before interest and tax (EBIT) is calculated for first 3 years using financialstatements for the next 6 years the EBIT is projected using the growth rate of EBIT.
Growth rate in EBIT = Reinvestment Rate*Return on capital employed
Reinvestment rate = Capital expenditure-depreciation+change in non cash working capitalEBIT (1-Tax)
Return on capital employed = net earningsCapital employed
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ESTIMATING TAX & CHANGE IS WORKING CAPITAL:-
For tax purpose standard value of 33.66% is taken which is tax right now and for
change is working capital the working capital is estimated for next 6 years using sales
that is the working capital will change in proportion of sales.
1.6.3Dividend discount model:-
The Gordon Growth Model
The Gordon growth model can be used to value a firm that is in 'steady state' with
dividends growing at a rate that can be sustained forever. The Gordon growth model
relates the value of a stock to its expected dividends in the next time period, the cost of
equity and the expected growth rate in dividends.
Value of Stock = DPS1Ke g
Where,DPS1 = Expected Dividends one year from now (next period)Ke= required rate of return for equity investorsg = Growth rate in dividends forever
g =Growth rate = ROC* b
Where,
Roc = return on equity & b = retention ratio.
DPS1 = DPS0 (1+g).
Here ke is calculated using share price of stock for last 5 years. Roc & b are calculatedfor last 5 years using financial statements of those companies.
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1.6.4Price Earnings Ratio (PE)
The price-earnings multiple (PE) is the most widely used and misused of all multiples.
Its simplicity makes it an attractive choice in applications ranging from pricing initial
public offerings to making judgments on relative value, but its relationship to a firm's
financial fundamentals is often ignored, leading to significant errors in applications.
Definitions of PE ratio
The price earnings ratio is the ratio of the market price per share to the earnings per
share.
PE ratio Market price per share
Earnings per share
The PE ratio is consistently defined, with the numerator being the value of equity per
share and the denominator measuring earnings per share, both of which is a measure
of equity earnings.
Actual process is that the PE ratio of first ten companies are calculated individually and
then depending on the market share of each company further the weight of each
company is calculated on the basis of percentage of these companies market share.
And then the industry average PE ratio is decided. When this industry PE ratio is
compared with the actual PE ratio of each company in order to decide whether the stock
is over prices or under prices.
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1.7RESEARCH PROPOSAL
1.7.1PROBLEM STATEMENT:-There are different methods for analyze an
equity share price and the inputs needed for each method is different. So each method
generates different intrinsic value of the equity share price and the problem is which
value to choose. In some cases the difference between price generated by different
method is slightly varied in other cases price variation is wide so the problem is whether
to take an average value or to ignore the value which widely different form other
methods and to arrive at the right value.
1.7.2OBJECTIVES:-
1. To analyze the parameters to evaluate or value an equity share price.
2. To compare the value of the firm with that of market value of share.
3. To find a fair intrinsic value of the company using different methods.
1.7.3SCOPE OF STUDY:-
It is essential that strategic decisions for companies are based on accurate information.
Whether while buying, selling, merging, restructuring or raising additional capital, it is
imperative to know the value of a company. Accurate valuation helps in making prudent
investments and strategic decisions. Valuations are critical components of nearly allfinancial transactions. The demand of corporations and industrial practitioners to
optimize value for commercial purposes has driven the need to utilize valuation as a
strategic corporate tool. Valuation or the estimate of the current market value of an
asset is found in all business and in all dimensions.
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CHAPTER 2
REVIEW OF LITERATURE
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2.1Literature review
Review of literature means examining and analyzing the various literatures available in
any field either for references purposes or for further research. Further research can be
done by identifying the areas which have not been studied and in turn undertaking
research to add value to the existing literature. For the purpose of literature review
various sources of information have been used. Sources include books, journals as well
as some literature papers.
2.1.1The valuation of cash flows forecasts: an empirical analysis
By: Steven n. Kaplan and Richard s.ruback
The study provides evidence that discount cash flow valuation methods provide reliable
estimates of market value. their median estimates of discounted cash flows for 51 highly
leveraged transactions (HLTS) are within 10 percent of the market values of the
completed transactions and perform at least as well as valuation approaches using
companies in similar industries and companies involved in similar transactions .the
stress on estimates rely on a number of ad hoc assumptions that should be able to
improve on. the research expect such improvements to bring the DCF valuations even
closer to the transaction values.
Three CAPM-based approaches are use to estimate discount rate corresponding to
firm-level, industry-level, and market-level measures of risk. All three methods perform
well compared to those using comparable transactions and companies. They
considered the most realistic assumptions; the industry- and market-based approaches
perform best.
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In the second part, the forecasted cash flows and transaction values are calculated
using discount rates and risk premia.the median implied market equity risk premium, theamount by which the return on the equity market exceeds the long-term Treasury bond
yield, equals 7.78 percent. This accords well with the historical risk premium by which
returns on the S&P 500 have exceeded Treasury bond returns. The relations between
the implied risk premia and both firm and industry betas are positive and marginally
significant. In contrast, there are no apparent relations between the implied risk premia
and either transaction value.
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restructuring (where the financing mix is set by the acquirer) and the possibility that
financial leverage can change quickly over time. Second, the connections between
corporate finance and valuation have become clearer as value is linked to a firmsactions. In particular, the excess return models link value directly to the quality of
investment decisions, whereas adjusted present value models make value a function of
financing choices. Third, the comforting conclusion is that all models lead to equivalent
values, with consistent assumptions, which should lead us to be suspicious of new
models that claim to be more sophisticated and yield more precise values than prior
iterations.
The challenges for valuation research in the future lie in the types of companies that we
are called upon to value. First, the shift of investments from developed markets to
emerging markets in Asia and Latin America has forced us to re-examine the
assumptions we make about value. In particular, the interrelationship between corporate
governance and value, and the question of how best to deal with the political and
economic risk endemic to emerging markets have emerged as key topics. Second, the
entry of young companies into public markets, often well before they have established
revenue and profit streams, requires us to turn our attention to estimation questions:
How best do we estimate the revenues and margins for a firm that has an interesting
product idea but no commercial products? How do we forecast the reinvestment needs
and estimate discount rates for such a firm? Third, with both emerging market and
young companies, we need to reassess our dependence on current financial statement
values as the basis for valuation. For firms in transition, in markets that are themselves
changing, we need to be able to allow for significant changes in fundamentals, be they
risk parameters, debt ratios and growth rats, over time. In short, we need dynamic
valuation models rather than the static ones that we offer as the default currently.
Fourth, as the emphasis has shifted from growth to excess returns as the driver of
value, the importance of tying corporate strategy to value has also increased. After all,
corporate strategy is all about creating new barriers to entry and augmenting or
preserving existing ones, and much work needs to be done at the intersection of
strategy and valuation. Understanding why a company earns excess returns in the first
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place and why those excess returns may come under assault is a pre-requisit for good
valuation. Finally, while the increase in computing power and easy access to statistical
tools has opened the door to more sophisticated variations in valuation, it has alsoincreased the potential for misuse of these tools. Research on how best to incorporate
statistical tools into the conventional task of valuing a business is needed. In particular,
is there a place for simulations in valuation and if so, what is it? How about scenario
analysis or neural networks? The good news is that there is a great deal of interesting
work left to be done in valuation. The bad news is that it will require a mix of
interdisciplinary skills including accounting, corporate strategy, statistics and corporate
finance for this research to have a significant impact.
2.1.3The Cost of Distress Survival, Truncation Risk and Valuation
Aswath Damodaran:Stern School of Business:-
Traditional valuation techniques- both DCF and relative - short change the effects of
financial distress on value. In most valuations, we ignore distress entirely and make
implicit assumptions that are often unrealistic about the consequences of a firm being
unable to meet its financial obligations. Even those valuations that purport to consider
the effect of distress do so incompletely. In this paper, they begin by considering how
distress is dealt with in traditional discounted cash flow models, and when these models
value distress correctly. Then they look at ways in which they can incorporate the
effects of distress into value in discounted cash flow models. At last they conclude by
looking at the effect of distress on relative valuations, and ways of incorporating its
effect into relative value.
In both discounted cash flow and relative valuation, they implicitly assume that the firms
that they are valuing are going concerns and that any financial distress that they are
exposed to is temporary. After all, a significant chunk of value in every discounted cash
flow valuation comes from the terminal value, usually well in the future. In this paper,
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they will argue that they tend to over value firms such as these in traditional valuation
models, largely because is difficult to capture fully the effect of such distress in the
expected cash flows and the discount rate. The degree to which traditional valuationmodels miss value distressed firms will vary, depending upon the care with which
expected cash flows are estimated, the ease with which these firms can access external
capital market and the consequences of distress. In this paper, they will begin by
looking at the underlying assumptions of discounted cash flow valuation.
Distressed firms, i.e., firms with negative earnings that are exposed to substantial
likelihood of failure, present a challenge to analysts valuing them because so much of
conventional valuation is built on the presumption that firms are going concerns. In this
paper, they have examined how both discounted cash flow and relative valuation deal
(sometimes partially and sometimes not at all) with distress. With discounted cash flow
valuation, they suggested four ways in which they can incorporate distress into value
simulations that allow for the possibility that a firm will have to be liquidated, modified
discounted cash flow models, where the expected cash flows and discount rates are
adjusted to reflect the likelihood of default, separate valuations of the firm as a going
concern and in distress and adjusted present value models. With relative valuation, they
can adjust the multiples for distress or use other distressed firms as the comparable
firms. at last this paper examine two issues that may come up when going from firm
value to equity value. The first relates to the shifting debt load at these firms, as the
terms of debt get renegotiated and debt sometimes becomes equity. The second comes
from the option characteristics exhibited by equity, especially in firms with significant
financial leverage and potential for bankruptcy.
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Second, corporations do not experience an enduring increase in q after they
internationalize. This paper finds that (a) valuations are not higher afterinternationalization and (b) valuations of firms that internationalize do not increase
relative to those of domestic firms (i.e., the relative q does not increase after
internationalization). Thus, although there are large cross firm differences in q, their
results are consistent with the view that these differences are not affected by
internationalization.
Third, in terms of the year-by-year dynamics, qrises before internationalization, but then
falls rapidly in the year after internationalization. They find that one year after
internationalization the qof international firms is not significantly higher than it was two
years (or even three years) before they internationalized. Furthermore, the relative
Tobin.s qof international firms (qdivided by the average qof domestic firms from the
same home country) follows the same pattern: rising in the year before
internationalization and during the internationalization year, but relinquishing these
increases by the year after internationalization.
Finally, in terms of the components ofq, a firm.s market capitalization tends to rise prior
to internationalization and remains high thereafter, while the firm.s assets increase
during internationalization as the firm expands. Thus, firms that internationalize expand
relative to domestic firms.
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CHAPTER 3
RESEARCH METHODOLOGY
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3.1RESEARCH METHODOLOGY
3.1.1TYPE OF RESEARCH
Type of research is Descriptive research, which is Quantitative in nature.
3.1.2SAMPLING TECHNIQUE
Technique use for selection of samples is simple random sampling technique.
3.1.3DATA COLLECTION
Secondary Data
Income statements of companies under studyBalance sheetsHistorical stock prices
3.1.4SOURCES OF DATA
The data relating to the study is taken from two databases namely prowess and capital
line plus.
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3.1.5DATA REQUIRED AND PERIOD OF STUDY
Financial statements of the ten information technology large cap stocks are considered
for a period of years from financial year 2001-2002 to 2006-07.And also the stock
monthly average price and nifty monthly average price for the same period is
considered.
3.1.6SAMPLE SIZE AND METHOD OF SELECTION:-
The Sample size considered for the research undertaken has a scope of one industry &
ten companies in the industry and the industry selected is randomly choose and the
companies in the
Industries are selected on the bases of market leader and market capitalization.
Industry Information technology( large cap)
S.NO Company
1.HCL Technologies
2.
I-Flex Solutions3.Infosys tech
4.mphasis ltd
5.patni computer
6.Polaris Software
7.Satyam Computer
8.TCS
9.Tech Mahindra
10.Wipro
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CHAPTER 4
ANALYSIS OF DATA AND
INTERPRETATION
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4.1ANALYSIS & INTERPRETATION
4.2FREE CASH FLOW TO EQUITY MODEL
4.2.1Infosys technology LTD.
Year 2005 2006 2007 2008 2009 2010 2011 2012 2013
Sa les 6,859.6 9,028.00 13,149.00 18535.7
3
26129.2
3
36833.
5
51923.
0
73194.3 103179.
7
EBIT 2,229.7 2,737.00 4,153.00 5519.69
9
7336.16 9750.3
9
12959.
1
17223.8 22891.9
4Tax -327 -337 -392 -
1857.93
-
2469.35
-3281.9 -4362.0 -
5797.53
-
7705.43
change
in WC
-
1163.88
-1448 -1749.19 -2286.44 -3223.12 -
4543.52
-
6404.86
-9028.73 -12727.5
cash
flow
738.90 952.00 2,011.81 1375.33
2
1643.69
3
1924.8
8
2192.2
2
2397.54
3
15186.5
1
Disc oun
t
Rate
0.86046
4
0.74039
8
0.6370
8
0.5481
8
0.47169
7
present
value
1183.42
4
1216.98
7
1226.3
1
1201.7
5
1130.91
3Tota l 5959.39
5
Terminal value:-
At 5% At 8% At 10%
Present value FCFF 5959.395 5959.395 5959.395
Terminal value 63865.67 87184.52
115234.4
Long term debt -0 -0 -0
value of eq uity 69,825.07 93,143.92 121,193.76
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tota l sha res 571,209,862.00 571,209,862.00 571,209,862.00
equity p er sha re(RS) 1222.40655 1630.643 2121.70292
Interpretation:-
The market price as on 19/3/2008, the stock price of Infosys technology is Rs.1342 and
the intrinsic value according to free cash flows in equity falls between 5% to 8%. So the
investor, who has an estimation of above 5% terminal growth rate, Can buy the stock
because the stock is under valued.
4.2.2HCL TECHNOLOGIES LTD
Year 2005 2006 2007 2008 2009 2010 2011 2012
Sa les 1,127.98 1,447.01 3,032.92 4887.3475 7875.633 12691.055 20450.79 32955.07 53
EBIT 666.57 344.53 344.98 409.23469 485.4572 575.87667 683.1373 810.3759 96
Tax -13.64 -9.86 -21.5 -137.7484 -163.405 -193.8401 -229.944 -272.773 -3
change
in WC 405.89 -54.92-
111.57 15.683257 25.27252 40.724972 65.62557 105.7512
cash
flow 1,058.82 279.75 211.91 287.16955 347.3248 422.76156 518.8189 643.3546 63
Disc ount
Ra te 0.8620548 0.743139 0.6406262 0.552255 0.476074
present
va lue 247.5559 258.1105 270.83213 286.5203 306.2844
Tota l 1369.3032
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Terminal value:-
At 5% At 8% At 10%
Present value FCFF
1369.3032 1369.3032 1369.3032
Terminal value
2759.6075 3794.2146
5058.5524
Long term debt -13.83 -13.83 -13.83
Value of equity4,115.08 5,149.69 6,414.03
Total shares171047856 171047856 171047856
Equity per share(RS)240.58 301.07 374.98427
Interpretation:-
The market price as on 19/3/2008, the stock price of HCL is Rs.255 and the intrinsic
value according to free cash flows in equity falls between 5% to 8%. So the investor,
who has an estimation of above 5% terminal growth rate, Can buy the stock because
the stock is under valued.
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4.2.3SATYAM COMPUTERS LTD
Year 2005 2006 2007 2008 2009 2010 2011 2012
Sa les 3,464.22 4,634.31 6,228.47 8394.966 11315.05 15250.849 20555.67 27705.7 37
EBIT 867.76 1,448.61 1,580.84 2001.968 2535.283 3210.6705 4065.978 5149.135 6
Tax -180.21 -199.72 -122.16 -673.863 -853.376 -1080.712 -1368.61 -1733.2 -2
change
in WC-
584.28 -719.77 -360.59 -1356.95 -1828.94 -2465.1169 -3322.58 -4478.29 -
cash
flow 103.27 529.12 1,098.09 -28.8398 -147.035 -335.1581 -625.207 -1062.36 43
Disc ountRate 0.860492 0.740446 0.637148 0.548261 0.471774
present
va lue -24.8164 -108.872 -213.5453 -342.777 -501.193
Tota l -1191.2
Terminal value:-
At 5% At 8% At 10%
Present value FCFF -1191.2 -1191.2 -1191.2
Terminal value
18201.4758 24850.34
32850.32
Long term debt -13.79 -13.79 -13.79
value of eq uity16,996.48 23,645.34 31,645.32
tota l sha res657,091,673.00 657,091,673.00 657,091,673.00
equity p er sha re(RS)258.662275 359.8485 481.5968
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Interpretation:-
The market price as on 19/3/2008, the stock price of SATYAM TECH. LTD. is Rs.390
and the intrinsic value according to free cash flows in equity falls between 8% to 10%.
So the investor, who has an estimation of above 8% terminal growth rate, Can buy the
stock because the stock is under valued.
4.2.4TECH MAHINDRA LTD
Year 2005 2006 2007 2008 2009 2010 2011 2012 20
Sa les 945.64 1,242.67 2,929.04 5376.485 9868.964 18115.27 33252.01 61036.69 112037
EBIT 111.46 262.11 167.83 301.7458 542.5163 975.4036 1753.703 3153.026 5668.90
Tax -14.22 -24.29 -70.47 -101.568 -182.611 -328.321 -590.296 -1061.31 -1908.1
change
in WC 10 19.43-
235.53 -333.839 -612.788 -1124.82 -2064.7 -3789.92 -6956.
cashflow 97.24 257.25
-138.17 -133.661 -252.883 -477.738 -901.291 -1698.2 3760.75
0.773601 0.598459 0.462968 0.358153 0.277067
present
va lue -103.4 -151.34 -221.177 -322.8 -470.515
Tota l -1269.23
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Terminal value:-
At 5% At 8% At 10%
Present value FCFF-1269.23 -1269.23 -1269.23
Terminal value
3,007.81 3,613.59 4,122.25
Long term debt -17.02 -17.02 -17.02
value of eq uity 69,825.07 93,143.92 121,193.76
tota l sha res116,155,423.00 116,155,423.00 116,155,423.00
equity p er sha re(RS)258.9473 311.0996 354.8911
Interpretation:-
The market price as on 19/3/2008, the stock price of TECH MAHINDRA LTD. is Rs.651
and the intrinsic value according to free cash flows in equity, is far below than the
prevailing market price. So the stock is highly over valued and the investor who owns
the stock is recommended to sell.
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4.2.5I-FLEX SOLUTIONS
Year 2005 2006 2007 2008 2009 2010 2011 2012 201
Sa les 902.86 1,153.82 1,552.34 2044.851 2693.621 3548.227 4673.974 6156.886 8110.28
EBIT 247.11 285.55 381.04 489.3082 628.3396 806.8751 1036.14 1330.547 1708.60
Tax -49.4 -46.21 -25.1 -164.701 -211.499 -271.594 -348.765 -447.862 -575.11
change
in WC -285.4-
150.95
-
366.79 -463.075 -609.995 -803.528 -1058.46 -1394.28 -1836.6
cash
flow
-
87.69 88.39 -10.85 -138.468 -193.154 -268.247 -371.088 -511.597 1133.4
Disc ountRa te 0.830035 0.688957 0.571859 0.474662 0.393986
present
va lue -114.933 -133.075 -153.399 -176.142 -201.562
Tota l -779.111
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Terminal value:-
At 5% At 8% At 10%
Present value FCFF -779.111 -779.111 -779.111
Terminal value2885.457 3579.249
4262.514
Long term debt -0 -0 -0
Value of equity2,106.35 2,800.14 3,483.40
Total shares81,377,678.00 81,377,678.00 81,377,678.00
Equity per share(RS)258.8358 344.0916 428.0538
Interpretation:-
The market price as on 19/3/2008, the stock price of I-FLEX SOLUTIONS. is Rs.925 and
the intrinsic value according to free cash flows in equity, is far below than the prevailing
market price. So the stock is highly over valued and the investor who owns the stock is
recommended to sell.
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4.2.6MPHASIS LTD
Year 2005 2006 2007 2008 2009 2010 2011 2012 2013
Sa les 247.77 380.67 602.14 858.1876 1223.114 1743.218 2484.486 3540.962 5046.683
EBIT 49.28 83.99 142.03 188.5202 250.2277 332.1339 440.85 585.1518 776.6874
Tax -0.89 -3.4 -12.53 -63.4559 -84.2267 -111.796 -148.39 -196.962 -261.433
change
in WC -21-
48.65 -97.56 -61.3138 -87.3863 -124.545 -177.506 -252.987 -360.564
cash
flow 27.39 31.94 31.94 63.75045 78.61484 95.79216 114.9541 135.2032 515.2544
Disc ountRate 0.852425 0.726628 0.619396 0.527988 0.45007
present
value 54.34247 57.12375 59.33326 60.69441 60.85095
Tota l 292.3448
Terminal value:-
At 5% At 8% At 10%
Present value FCFF 292.3448 292.3448 292.3448
Terminal value
1883.473 2490.236
3171.335
Long term debt -1.31 -1.31 -1.31
Value of equity2,174.51 2,781.27 3,462.37
Total shares162,406,981.00 162,406,981.00 162,406,981.00
Equity per share(RS)133.8925 171.2531 213.191
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Interpretation:-
The market price as on 19/3/2008, the stock price of MPHASIS LTD is Rs.165 and the
intrinsic value according to free cash flows in equity falls between 5% to 8%. So the
investor, who has an estimation of above 5% terminal growth rate, Can buy the stock
because the stock is under valued.
4.2.7PATNI COMPUTERS
Year 2005 2006 2007 2008 2009 2010 2011 2012 20
Sa les 702.07 875.6 997.83 1219.547 1490.53 1821.726 2226.512 2721.242 3325.9
EBIT 256.40 248.33 314.77 355.5739 401.6673 453.7357 512.5539 578.9967 654.052
Tax -23.81 -53.29 -102.9 -119.686 -135.201 -152.727 -172.526 -194.89 -220.1
change
in WC -190.5 -413.8 575.56 -62.587 -76.4938 -93.4906 -114.264 -139.654 -170.6
cash
flow 42.08
-
218.7 787.39 173.3008 189.9723 207.5176 225.764 244.4527 433.89
Disc ount
Ra te 0.830051 0.688985 0.571893 0.4747 0.394026present
va lue 143.8485 130.8881 118.6778 107.1702 96.32061
Tota l 596.9053
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Terminal value:-
At 5% At 8% At 10%
Present value FCFF 596.9053 596.9053 596.9053
Terminal value
1104.831 1370.532
1632.222
Long term debt -3.06 -3.06 -3.06
value of equity
1,698.68 1,964.38 2,226.07
total shares138,791,309.00 138,791,309.00 138,791,309.00
equity per share(RS)122.3907 141.5346 160.3895
Interpretation:-
The market price as on 19/3/2008, the stock price ofPATNI COMPUTERS. is Rs.207 and
the intrinsic value according to free cash flows in equity, is far below than the prevailing
market price. So the stock is highly over valued and the investor who owns the stock is
recommended to sell.
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Interpretation:-
The market price as on 19/3/2008, the stock price ofPOLARIS SOFTWARE. is Rs.73 and
the intrinsic value according to free cash flows in equity, is far below than the prevailing
market price. So the stock is highly over valued and the investor who owns the stock is
recommended to sell.
4.2.9WIPRO LTD
Year 2005 2006 2007 2008 2009 2010 2011 2012
Sa les 7,276.18 10,264.09 11,745.26 15288.22 19899.92 25902.74 33716.31 43886.85 57
EBIT 1,761.75 2,342.81 3,183.40 4102.953 5288.127 6815.648 8784.407 11321.86 14
Tax -261.06 -312.92 -334.1 -1381.05 -1779.98 -2294.15 -2956.83 -3810.94 -4
change
in WC -595.13 -323.74 -504.2 -566.047 -736.795 -959.05 -1248.35 -1624.91 -
cash
flow 905.56 1,706.15 2,345.10 2155.852 2771.348 3562.451 4579.228 5886.01 96
0.78513 0.616429 0.483976 0.379984 0.298337present
value 1692.623 1708.338 1724.142 1740.034 1756.014
Tota l 8621.151
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Terminal value:-
At 5% At 8% At 10%
Present value FCFF
8621.151 8621.151 8621.151
Terminal value 12911.84 14911.86
16629.08
Long term debt -382.7 -382.7 -382.7
value of equity
21,150.29 23,150.31121,193.76
total shares1,439,802,322 1,439,802,322 1,439,802,322
equity per share(RS)146.897155 158.3799 170.3066
Interpretation:-
The market price as on 19/3/2008, the stock price of WRIPO LTD. is Rs.377 and the
intrinsic value according to free cash flows in equity, is far below than the prevailing
market price. So the stock is highly over valued and the investor who owns the stock is
recommended to sell.
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4.2.10TCS
Year 2005 2006 2007 2008 2009 2010 2011 2012
Sa les 8,051.11 11,236.01 14,942.09 20361.77 27747.24 37811.5 51526.2 70215.39 9
EBIT 2,122.58 3,078.84 4,174.11 6448.808 9963.112 15392.55 23780.78 36740.22 5
Tax -241 -342.66 -424.59 -2170.67 -3353.58 -5181.13 -8004.61 -12366.8 -
change
in WC -1830.4 -1070.09 -1463.93 -1570.95 -2140.75 -2917.23 -3975.34 -5417.24
cash
flow 51.18 1,666.09 2,285.59 2707.192 4468.78 7294.193 11800.83 18956.22 3
Disc ountRa te 0.869344 0.75576 0.657016 0.571173 0.496546
present
va lue 2353.483 3377.324 4792.399 6740.316 9412.634
Tota l 26676.16
Terminal value:-
At 5% At 8% At 10%
Present value FCFF
8621.151 8621.151 8621.151
Terminal value186434.4 266002.9
371786.3
Long term debt -506.75 -506.75 -506.75
value of equity212,603.78 292,172.31 397,955.69
total shares 978,610,498.00 978,610,498.00 978,610,498.00
equity per share(RS)2172.5066 2985.58321 4066.538164
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Interpretation:-
The market price as on 19/3/2008, the stock price of TCS. Is Rs.810 and the intrinsic
value according to free cash flows in equity, is far below than the prevailing market
price. So the stock is highly over valued and the investor who owns the stock is
recommended to sell. There is huge difference between the stock price and the intrinsic
value so the possibility of information gap can be observed.
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4.3Dividend discount model:-
4.3.1INFOSYS TECHNOLOGY
INFOSYS 2003 2004 2005 2006 2007
RETENTION RATIO 0.8109 0.2388 0.8335 0.449 0.8226 0.63096
ROE 38.78 40.68 44.82 39.89 41.9 0.41214
GROWTH
0.260043
8
KS 0.138993
DO 649
STOCK
PRICE ----
Interpretation
One of the basic assumptions for Gordons dividend discount model is that the required
rate of return of equity must be greater than the sustainable growth rate of dividend. As
this condition is not satisfactory, for the Infosys technology Ltd. So the dividend
discount model can not be applicable in this case.
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4.3.2HCL TECHNOLOGIES
HCL
TECHNOLOGIES 2003 2004 2005 2006 2007
RETENTION
RATIO 0.6072 -0.28 -0.96 0.0866 0.1051 -0.08822
ROE 11.75 11.47 12.78 20.72 36.72 0.18688
GROWTH -0.01648655
KS 0.160111
DO 116.5
STOCK PRICE 648.259066
Interpretation
The stock price of HCL technologies as on 19/3/2008 is Rs.255 but the intrinsic value
according to dividend discount model is Rs 648 so, the HCL technologies share price is
under valued. So, more than 120% growth is expected in this stock.
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4.3.3SATYAM COMPUTERS LTD
SATYAM 2003 2004 2005 2006 2007
RETENTION
RATIO 0.8323 0.8109 0.7811 0.7651 0.6839 0.77466
ROE 28.14 26.85 25.88 23.57 20.55 0.24998
GROWTH 0.193649507
KS 0.16223
DO 232.41
STOCK
PRICE----------
Interpretation
One of the basic assumptions for Gordons dividend discount model is that the required
rate of return of equity must be greater than the sustainable growth rate of dividend. As
this condition is not satisfactory, for the SATYAM COMPUTERS Ltd. So the dividend
discount model can not be applicable in this case.
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4.3.4I-FLEX SOLUTIONS
I-FLEX
2003 2004 2005 2006 2007
RETENTION
RATIO 0.97 0.8375 0.8054 0.8483 0.9461 0.88146
ROE 19.06 19.36 18.9 19.72 26.77 0.20762
GROWTH 0.183008725
KS 0.204769
DO 10.4
STOCK
PRICE 565.401
Interpretation
The stock price of I-FLEX SOLUTIONS as on 19/3/2008 is Rs.925 but the intrinsic
value according to dividend discount model is Rs 565.401 so, the I-FLEX SOLUTIONS
share price is over valued.
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4.3.5MPHASIS LTD
MPHASIS
2003 2004 2005 2006 2007RETENTIONRATIO 0.4811 0.2983 0.2026 0.8816 0.9227 0.55726
ROE 20.07 13.99 10.93 13.58 7.25 0.13164
GROWTH 0.073357706
KS 0.173206
DO 9.82
STOCK
PRICE 105.5638739
Interpretation:-
The stock price of MPHASIS LTD as on 19/3/2008 is Rs.165 but the intrinsic value
according to dividend discount model is Rs 105 so, the MPHASIS LTD share price is
over valued.
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4.3.6PATNI COMPUTERS
PATNI 2003 2004 2005 2006 2007
RETENTION
RATIO 0.7925 0.818 0.89 0.9241 0.976 0.88012
ROE 9.69 11.49 21.08 21.54 23.47 0.17454
GROWTH 0.153616145
KS 0.217485
DO 41.48
STOCKPRICE 749.2227242
Interpretation:-
The stock price of PATNI COMPUTERS as on 19/3/2008 is Rs.207 but the intrinsic
value according to dividend discount model is Rs 750 so, the PATNI COMPUTERS
share price is highly under valued.
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4.3.7POLARIS SOFTWARE
POLARIS 2003 2004 2005 2006 2007
RETENTION
RATIO 0.71 -0.0604 0.6635 0.739 0.6726 0.54494
ROE 14.46 2.51 10.44 14.89 16.44 0.11748
GROWTH 0.064019551
KS 0.217477
DO 22.18
STOCKPRICE 153.7882575
Interpretation:-
The stock price of POLARIS SOFTWARE as on 19/3/2008 is Rs.73 but the intrinsic
value according to dividend discount model is Rs 154 so, the PATNI COMPUTERS
share price is highly under valued
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4.3.8WIPRO TECHNOLOGIES LTD
Wipro 2003 2004 2005 2006 2007
RETENTION
RATIO 0.6782 0.6288 0.7566 0.1852 0.9713 0.64402
ROE 36.12 35.72 35.59 26.76 27.74 0.32386
GROWTH 0.208572317
KS 0.276744
DO 873.7
STOCKPRICE 15489.27047
Interpretation:-
The stock price of WIPRO TECHNOLOGIES as on 19/3/2008 is Rs.377 but the intrinsic
value according to dividend discount model is Rs 15,490 so, the WIPRO
TECHNOLOGIES share price is highly under valued. But there is a vary large difference
between the market share price and intrinsic value. So this difference may because of
growth rate in dividends about 400 to 500% .as we know that dividend discount model is
best for stable growth firms this intrinsic price may not be acceptable.
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4.3.9TCS
TCS
2003 2004 2005 2006 2007
RETENTION
RATIO 0.451 0.5612 0.456 0.7651 0.6839 0.381
ROE 24.01 20.34 25.88 23.57 20.55 0.14
GROWTH 0.05334
KS 0.152787
DO 660.4
STOCK
PRICE 6994.939375
Interpretation:-
The stock price of TCS as on 19/3/2008 is Rs.810 but the intrinsic value according to
dividend discount model is Rs 6,995 so, the TCS share price is highly under valued. But
there is a vary large difference between the market share price and intrinsic value. So
this difference may because of growth rate in dividends about 400 to 500% .as we know
that dividend discount model is best for stable growth firms this intrinsic price may not
be acceptable.
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4.3.10TECH MAHINDRA
TECH
MAHINDRA 2003 2004 2005 2006 2007RETENTIONRATIO 0 0.6288 0.7566 0.1852 0.9713 0.50838
ROE 0 35.72 35.59 26.76 27.74 0.25162
GROWTH 0.127918576
KS 0.304978
DO 26.62
STOCKPRICE 169.5769236
Interpretation
The stock price of TECH MAHINDRA as on 19/3/2008 is Rs.652 but the intrinsic value
according to dividend discount model is Rs 170 so, the TECH MAHINDRA share price
is highly over valued.
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4.4PE MULTIPLIER MODEL
Company
Price on
19/3/08 EPS P/E
MARKET
CAP WEIGHT
WEIGHTED
P/E VALUE
HCL TECHNOLOGIES 255 14.2 17.957 16,964.65 0.061277 1.100389 under value
I-FLEXSOLUATIONS 925 42.4 21.816 7,743.86 0.027971 0.610215 over value
INFOSYS 1,342.00 64.3 20.870 76,754.00 0.277237 5.786186 equal value
MPHASIS 165 5.9 27.966 3,442.89 0.012436 0.347780 over value
PATNI
COMPUTERS 207 27.6 7.5 2,879.39 0.0104 0.078003 under value
POLARIS
SOFTWARE 73 7.8 9.3589 722.68 0.00261 0.024430 under value
SATYAM 390 20.7 18.840 26,140.30 0.094419 1.778912 under value
TCS 810 36 22.5 79,266.60 0.286312 6.442027 over value
TECH
MAHINDRA 651 43.5 14.965 7,904.78 0.028552 0.427298 under value
WIPRO 377 18.6 20.268 55,034.44 0.198785 4.029144 under value
276,853.5 20.6243879
Interpretation:-
In PE multiplier mode the industrial PE ratio is calculated and whether the stock is under
valued or overvalued is decided by comparing the PE ratio of company with that of the
industry average.
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4.5RELATIVE COMPARISON OF COMPANIES:-
Company INFOSYS HCL I-FLEXMPHASI
S
POLARI
S TCS SATYAM
TECH
MAHIN
DRA WIPRO PATN
Revenue 13,530.0 3116.2 1365.86 1768.1 1041.7 14,942 6410.0 2,929 14047 266
ProfitMargin 45.03 44.7 46.13 32.5 31.6 43.4 40.11 34.2 28.9 35.6
Market Cap 76,754.0 16,964 7,743.8 3,442.8 722.68 79,266 26,140 7,904 55,034 2,87
Gross
margin - 1
yr 45.03 44.7 46.13 32.5 31.6 43.4 40.11 34.2 28.9 35.6
Grossmargin - 5
yr 46.71 59.31 64.01 40.54 32.45 45.2 42.67 - 38.62 37.
EBITD
margin - 1yr 35.15 26.55 28.19 17.08 16.46 33.4 27.47 21.4 25.75 23.1
EBITDmargin - 5yr 35.88 39.28 31.49 21.08 16.1 34.1 28.86 - 25.73 24.6
OperatingMargin -
1yr 31.58 21.98 24.5 5.82 11.8 32.4 25.38 18.2 23.14 19.9
Operating
Margin -5yr 31.46 26.96 28.9 5.26 11.02 31.9 25.21 - 22.86 20.
Sales - 1yr 13,149 3,032.9 1552.34 1760.6 1032.7 14,942 6228.4 2,929 13758 260
Sales - 5yr 37,420 7203 4861.91 4476.2 3719.7 32,410 18892 - 40527 786
debtors
turnover 6.9 6.09 3.99 4.82 5.64 7.83 5.1 7.57 6.05 2.0
fixed assets
turnover 3.91 2.77 2.25 5.48 2.44 5.45 3.9 4.34 6.86 1.8
RoA - 1yr 41 39 19 23 24
39 30 30 37 1
RoA - 5yr 46.8 23.4 23.4 17.6 19.8
23.4 29.8 29.8 36.6 2
RoE - 1yr 41.9 36.72 19.06 20.07 14.46
36.72 28.14 28.14 36.12 9.6
RoE - 5yr 41.214 18.69 20.76 13.16 11.75
18.688 25 24.98 32.39 17.4
RoCE - 1yr 45.99 12.89 20.48 20.93 17.11 29.85 39.73 14.7
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V