1.Complete a DCF analysis on AT&T (ticker symbol T) .2.Complete a DDM analysis on AT&T.Upload one Excel file which contains a separate worksheet for each analysis. Briefly explain your assumptions for the parameters to be used in the models, such as k or g.Please use the DCF and DDM model based on the PPT I upload,and search the AT&T data by yourself.(You can download 10-k or other reports on https://www.sec.gov/edgar/searchedgar/companysearch.html?

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AD 717:

Investment Analysis and

Portfolio Management

Section A1

Term Project

Stock report on the stock you have been assigned in the beginning of the

semester, including:

• Description of the company, including its industry, position in the market,

competitors, headwinds and tailwinds, management, etc.

• Determine Beta with the Capital Asset Pricing Model

• Valuation using DCF or DDM, estimating a low, medium, and high share

value (depending on your assumptions which you need to justify in your

writeup)

• Statement of risks

• Given three investor profiles, explain the suitability of an investment in

“your” stock for these investors.

Valuation by Comparables

• Compare valuation ratios of firm to industry averages.

• Ratios like price/sales are useful for valuing start-ups that have yet to

generate positive earnings.

Review: Capital Asset Pricing Model

• Expected excess return should account for risk of the security.

• Beta describes the sensitivity of a security to the market:

E 𝑟𝑖 − 𝑟𝑓 = 𝛽(E 𝑟𝑚 − 𝑟𝑓 )

• Large beta: Aggressive or cyclical stocks

• Low beta: Defensive stocks

• Negative beta: Stock moves opposite to the market.

What is beta? Result of a regression, and it means 𝛽 =

Cov 𝑟𝑖 ,𝑟𝑚

Var 𝑟𝑚

.

Market capitalization rate

• Once we know beta, and assuming CAPM is true, we know the

required return for a stock to hold it in our portfolio:

𝑘 = 𝛽 E 𝑟𝑚 − 𝑟𝑓 + 𝑟𝑓

• If the stock is priced correctly, k should equal expected return.

• k is called the market capitalization rate.

Fundamental analysis

• Fundamental analysis models a company’s value by assessing its

current and future profitability.

• The purpose of fundamental analysis is to identify mispriced stocks

relative to some measure of “true” value derived from financial data.

How?

•

•

•

•

Balance Sheet Models

Dividend Discount Models (DDM)

Price/Earnings Ratios

Free Cash Flow Models

Financial Statements

• Income Statement:

• Profitability over time

• Balance Sheet:

• Financial condition at a point in time

• Statement of Cash Flows:

• Tracks the cash implications of transactions.

Income Statement

Balance Sheet

Cash Flow Statement

Accounting?!

Economic earnings

• Sustainable cash flow that can be paid to stockholders without

impairing productive capacity of the firm

Accounting earnings

• Affected by conventions regarding the valuation of assets

Benchmarking – consider comparable figures

• Compare the company’s ratios across time.

• Compare ratios of firms in the same industry.

• Cross-industry comparisons can be misleading.

Other comparability problems

• Accounting Differences

• Inventory Valuation

• Depreciation

• Inflation and Interest Expense

• Fair Value Accounting

• Quality of Earnings

• International Accounting Conventions

Intrinsic value

• The intrinsic value (IV) is the “true” value, according to a model.

• The market value (MV) is the consensus value of all market

participants

Trading Signal:

IV > MV Buy

IV < MV Sell or Short Sell
IV = MV Hold or Fairly Priced
Dividend Discount Models (DDM)
• Owning stock is owning claim to future earnings, which will be paid
out to investors via dividends and / or reinvested to keep growing
𝐷1
𝐷2
𝐷3
𝑉0 =
+
+
+ …
2
3
(1 + 𝑘)
1+𝑘
1+𝑘
• V0: current value; Dt: dividend at time t; k: required rate of return
• DDM says the stock price should equal the present value of all
expected future dividends into perpetuity.
• Math leads to:
𝐷0 (1 + 𝑔)
𝐷1
𝑉0 =
=
(𝑘 − 𝑔)
(𝑘 − 𝑔)
Dividend Discount Models (DDM)
Example:
A stock just paid an annual dividend of $3/share. The dividend is
expected to grow at 8% indefinitely, and the market capitalization rate
(from CAPM) is 14%.
𝐷0 (1 + 𝑔)
𝐷1
𝑉0 =
=
(𝑘 − 𝑔)
(𝑘 − 𝑔)
D1
$3.24
V0 =
=
= $54
k − g .14 − .08
Implications:
The constant-growth rate DDM implies that a stock’s value will be
greater:
1.The larger its expected dividend per share.
2.The lower the market capitalization rate, k.
3.The higher the expected growth rate of dividends.
The stock price is expected to grow at the same rate as dividends.
• How do we estimate the growth rate of the dividends?
Growth = Return on Equity x Retention Rate
Implications:
Interpretation
• The value of the firm equals the value of the assets already in place,
the no-growth value of the firm,
• Plus the NPV of its future investments,
• Which is called the present value of growth opportunities or PVGO.
What happens if the company reinvests its earnings with lower return
than its capitalization rate?
Price-to-earnings ratio
The ratio of PVGO to E/k is the ratio of firm value due to growth
opportunities to value due to assets already in place (i.e., the nogrowth value of the firm, E/k ).
𝑃0 1
𝑃𝑉𝐺𝑂
=
1+
𝐸1 𝑘
𝐸/𝑘
When risk is higher, what happens to P/E?
k increases, so P/E decreases.
Price-to-earnings ratio
Price-to-earnings ratio
Discounted Cash Flow
Value of a company is the discounted sum of all future cash flows
from today until eternity.
Worksheet!
Free cash flow to the firm, FCFF, equals:
After tax EBIT
Plus depreciation
Minus capital expenditures
Minus increase in net working capital
Discounted Cash Flow
What did we miss in our analysis?
• We looked at the FCF from 2023 and discounted it.
• But hopefully, the company is still around after 2023, otherwise many
of our assumptions would have been bad assumptions.
• Consider the terminal value.
• EBITDA multiple approach: use comparable multiple.
• Treat 2023 FCF like we did for our dividend with (1+g)/(k-g) to consider it as a
perpetuity.
Enterprise value: present value of all cash flows and perpetuity.
Subtract debt and add cash.
Homework:
Finish DCF for MSFT and run DCF and DDM for
...
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