Waseda Financial Investment Team

24th October 2011

Market Update Seesaw trading

◦Tue: Rose on news of 2T rescue fund◦Wed: Fall on Sakorzy statement that

debt talks were stuck◦Fri: Stocks rallied on hope that

weekend EU summit provide answers to debt crisis S&P futures up 1.1% DOLLAR FELL AGAINST YEN TO POSTWAR

LOW

Techs fell on thai floods

Economic dataPhilly Fed Business outlook

◦ Business Activity +8.7 vs -10.0 (exp) & -17.5 prior◦ New orders +7.8 from -11.3◦ Shipments to +13.6 from -22.8

USD leading indicators—0.2%, 0.3%USD CPI 3.9% from 3.8%

◦ PPI Index ex food and energy 2.5% from 2.5%EUR Debt GDP ratio—85.4%, 85.1% CHF ZEW survey -54.5 vs -75.7

◦ CHF trade balance 1.85B vs 0.76BGerman ZEW -48.3 vs -43.3China Real GDP 9.1% vs 9.5%

China defaults?

Company News20 companies announced spinoff

◦Abott lab, Kraft, Sara Lee, Conoco Phillips

Groupon’s IPO◦Valuation of 10.76Bn

Apple earnings miss expectations Goldman report loss (428m)

Stock or Business?

If you're an investor, you're looking on what the asset is going to do, if you're a speculator, you're commonly focusing on what the price of the object is going to do,

and that's not our game.

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

- Warren Buffet

How to start?Buy a good

companyAt a good price

Qualitative

Quantitative

I'll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty.

Durable Competitive Advantage

ExamplesSwitching costsBrandSpecial access to scarce

resources◦Eg Debeers in 20th C

Low cost ◦Eg Walmart

Network effect

How to identify?Evaluate historical profitability

◦ROE, ROA, ROICStable market share?Drivers of profit

◦Easy to imitate?Competitive advantage periodIndustry’s competitive structure

Southwest airlines Vs KO

ExamplesCoca ColaPepsi ColaHersheysMcdonald

Sectors without durable CAAirlineTechAuto industryPharmaceutical (?)

Why important?Eliminate sectorsForecast

Buying at the right priceForecastingValuation

◦Discounted Cash Flow◦ Asset-based valuation◦Comparables◦Residual Earnings◦Abnormal Earnings

Discounted Cash FlowIntrinsic value= PV of all cash flows from

businessPV

◦$1 today. Interest rate= 5%◦ How much next year?

Savings account◦Interest rate 5%◦After Year 1, CF=$105◦Value of account?

PV of bond

Year 1 Year 2 Year 3 Year 4

Cash Flow 100 100 100 100+1000

PV 100/1.05 100/1.05^2

100/1.05^3

(1100)/1.05^4

• Discount rate 5%• Redemption value $1000•Coupon $100

Price of bond= $1177.30

Steps of DCF valuationForecast FCF to horizon

◦FCF= Cash from operations- Cash from Investment

Discount FCF to PVCalculate continuing value at horizon

with estimated growth rateDiscount CV to present Discounted CV+ Discounted FCFSubtract Net debtValue of Equity

No of shares= Price per share

Step 1: Forecast FCF to horizonHorizon 2 Years

　 　 2000 2001Cash from Operations

3657 4097

Cash from Investment

947 1187

FCF 2710 2910

Step 2: Discount FCF to PV　 　 2000 2001Cash from Operations

3657 4097

Cash from Investment

947 1187

FCF 2710 2910Discount rate (1.09^t)

1.09 1.1881

PV of FCF2486.23

92449.28

9

Total PV4935.5273

13

Step 3: Calculate CV from Year 3Assume FCF will grow at rate of

5%CV at Year 3= FCF of Year 2 *

1.05 Discount rate- 1.05

Discount CV to Year 1

　 　 2000 2001Cash from Operations 3657 4097Cash from Investment 947 1187FCF 2710 2910Discount rate (1.09^t) 1.09 1.1881PV of FCF 2486.239 2449.289Total PV 4935.527313Continuing Value 64293.83PV of CV 54114.83081

Step 5: Value of equity　 　 2000 2001Cash from Operations 3657 4097Cash from Investment 947 1187FCF 2710 2910Discount rate (1.09^t) 1.09 1.1881

PV of FCF 2486.239 2449.289Total PV 4935.527313Continuing Value 64293.83PV of CV 54114.83081Enterprise Value 59050.35812Book value of net debt 4435

Value of equity 54615.35812No of shares outstanding 2472

Value per share 22.09359147

Sources of UncertaintyDiscount rateGrowth rate ForecastsCash from Operations/

Investments