The emphasis throughout is on actionable insights and sustainability. The authors debunk some well-entrenched misconceptions about value, especially about price earnings multiples, and provide a wealth of advice about valuation pitfalls. They also explain how to communicate with employees and investors about value, and they consistently provide examples from major industries and companies to illustrate their main recommendations.
They begin by presenting the argument that "deviations from intrinsic value tend to be short-lived" in the stock market, backing up the claim by drawing from a wealth of data on the stock market and discussing stock market inefficiencies at length.
Next they describe a model of value creation with three parameters: growth, the return on invested capital (ROIC), and the weighted average cost of capital (WACC). Those parameters can be integrated into at least three well-known valuation models--the discounted cash flow (DCF) model, the economic profit model, and the adjusted present value (APV) model. The authors demonstrate the equivalence between these models and how their parameterization streamlines the forecasting process. For example, the equivalence relation between the DCF and economic profit models provides opportunities to double-check calculations. In particular, the parameterization helps provide reasonable first approximations.
The model is integrated into a conceptual framework for value creation that is analogous to the product life cycle model in marketing. It provides contextual managerial guidelines for each stage of value creation. Linking financial forecasts to economic forecasts is an essential feature of this model (especially the economic profit version of it), as is linking financial drivers of value to operational drivers of performance. The first linkage is to strategy, and the second is to tactics. The discussions about strategy are grounded in managerial economics and include considerations, for instance, about signaling effects and information asymmetry.
Most of the valuation worksheets the authors include have built-in double checks, such as reconciliations between net income and net operating profit less adjusted taxes, free cash flow and cash flow available to investors, and so forth. This proves very useful since financial statements have to be reorganized in order to provide comparable data, which can be an error-prone process. The authors don't shy away from difficult restatement problems such as operational leases and expensed investment (such as R&D and advertising), employee stock options, various types of provisions, pensions and postretirement medical benefits, minority interest, and inflation. They discuss the valuation implications of such things as hybrid securities and off-balance-sheet financing. And they provide guidance about ranking cash flow estimates according to their order of confidence in order to present incremental valuations instead of scenarios in cases when a decision might depend on the occurrence of a series of progressively more unlikely events.
The discussions of performance measurement and management present a conceptual framework similar in principle to the balanced scorecard but with more specific guidance about operational drivers directly related to growth and ROIC. A chapter on valuing mergers and acquisitions (emphasizing synergies) and another on valuing divestitures (detailing transaction types) add a new dimension in value management: the active management of a portfolio of businesses increases value.
The authors use the last section of their book to address special cases, including valuing multi-business companies through the tricky deconsolidation of financial statements, valuing flexibility using either decision trees or real options, cross-border valuation (in spite of accounting and tax differences), valuation in emerging markets (from the perspective of an international investor), valuing high-growth companies (picturing a plausible future and looking back), valuing cyclical companies (giving equal weight to the repetition of the cycle and the start of a new trend), and, finally, valuing financial institutions such as banks and insurance companies.
The authors recommend triangulation of results in order to improve the accuracy. They demonstrate useful equivalences between decision tree analysis and real option valuation when nondiversifiable risk isn't great enough that it would change the investment decision; modeling risks explicitly in the cash flow projections and adding a country risk premium in the discount rate; and three ways to compute equity cash flows for the valuation of financial companies.
The presentation of statistics and accounting is commendable. Their prose is crisp and clear, their argumentation is bulletproof, and their exhibits are very well designed. Their book is an engrossing read for anyone with a background and interest in corporate finance. --Jean-Victor Cote, CMA, email@example.com
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|Date:||Jul 1, 2007|
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