About the Book

This Second Edition integrates both accounting and finance concepts to deliver a collection of valuation models, as well as challenge readers to determine which models are most appropriate for specific companies and situations. The authors provide readers with detailed learning outcome statements at the outset, illustrative in-chapter problems with solutions, and extensive end-of-chapter questions and problems with complete solutions. They cover topics including: how an analyst approaches the equity valuation process; the basic DDM; the derivation of the required rate of return within the context of Markowitz and Sharpe's modern portfolio theory; the free cash flow approach; valuation using Graham and Dodd type concepts of earning power and associated "market multiples", as well as residual income models.

About the Author

John D. Stowe is a Professor of Finance and Associate Dean at the University of Missouri-Columbia. He earned his Ph.D. in economics from the University of Houston. Thomas R. Robinson, Ph.D., CPA, CFP, CFA, is an Associate Professor of Accounting at the University of Miami. He earned his Ph.D. in accounting with a minor in finance from Case Western Reserve University. Jerald E. Pinto, CFA, is Director in the CFA Program Division at CFA Institute. He holds an MBA from Baruch College and a Ph.D. in finance from the Stern School. Dennis W. McLeavey, CFA, is Director responsible for curriculum at CFA Institute. He holds a doctorate in production management and industrial engineering from Indiana University. With a foreword by George H. Troughton, Ph.D., CFA, is a Professor of Finance at California State University, Chico. He holds a Ph.D. in finance from the University of Massachusetts-Amherst. Thomas R. Robinson, is Head, Educational Content, in the Education Division of CFA Institute. Jerald E. Pinto is Director, Curriculum Projects at CFA Institute. Dennis W. McLeavey is Head, Education EMEA at CFA Institute.

Table of Contents:
Foreword Acknowledgments Introduction CHAPTER 1 Equity Valuation: Applications and Processes Learning Outcomes 1. Introduction 2. Value Defi nitions and Valuation Applications 2.1. What Is Value? 2.1.1. Intrinsic Value 2.1.2. Going-Concern Value and Liquidation Value 2.1.3. Fair Market Value and Investment Value 2.1.4. Defi nitions of Value: Summary 2.2. Applications of Equity Valuation 3. The Valuation Process 3.1. Understanding the Business 3.1.1. Industry and Competitive Analysis 3.1.2. Analysis of Financial Reports 3.1.3. Sources of Information 3.1.4. Considerations in Using Accounting Information 3.2. Forecasting Company Performance 3.3. Selecting the Appropriate Valuation Model 3.3.1. Absolute Valuation Models 3.3.2. Relative Valuation Models 3.3.3. Valuation of the Total Entity and Its Components 3.3.4. Issues in Model Selection and Interpretation 3.4. Converting Forecasts to a Valuation 3.5. Applying the Valuation Conclusion: The Analyst's Role and Responsibilities 4. Communicating Valuation Results 4.1. Contents of a Research Report 4.2. Format of a Research Report 4.3. Research Reporting Responsibilities 5. Summary Problems CHAPTER 2 Return Concepts Learning Outcomes 1. Introduction 2. Return Concepts 2.1. Holding Period Return 2.2. Realized and Expected (Holding Period) Return 2.3. Required Return 2.4. Expected Return Estimates from Intrinsic Value Estimates 2.5. Discount Rate 2.6. Internal Rate of Return 3. The Equity Risk Premium 3.1. Historical Estimates 3.1.1. Arithmetic Mean or Geometric Mean 3.1.2. Long-term Government Bonds or Short-term Government Bills 3.1.3. Adjusted Historical Estimates 3.2. Forward-Looking Estimates 3.2.1. Gordon Growth Model Estimates 3.2.2. Macroeconomic Model Estimates 3.2.3. Survey Estimates 4. The Required Return on Equity 4.1. The Capital Asset Pricing Model 4.1.1. Beta Estimation for a Public Company 4.1.2. Beta Estimation for Thinly Traded Stocks and Nonpublic Companies 4.2. Multifactor Models 4.2.1. The Fama-French Model 4.2.2. Extensions to the Fama-French Model 4.2.3. Macroeconomic and Statistical Multifactor Models 4.3. Build-up Method Estimates of the Required Return on Equity 4.3.1. Build-up Approaches for Private Business Valuation 4.3.2. Bond Yield Plus Risk Premium 4.4. The Required Return on Equity: International Issues 5. The Weighted Average Cost of Capital 6. Discount Rate Selection in Relation to Cash Flows 7. Summary CHAPTER 3 Discounted Dividend Valuation Learning Outcomes 1. Introduction 2. Present Value Models 2.1. Valuation Based on the Present Value of Future Cash Flows 2.2. Streams of Expected Cash Flows 3. The Dividend Discount Model 3.1. The Expression for a Single Holding Period 3.2. The Expression for Multiple Holding Periods 4. The Gordon Growth Model 4.1. The Gordon Growth Model Equation 4.2. The Links among Dividend Growth, Earnings Growth, and Value Appreciation in the Gordon Growth Model 4.3. Share Repurchases 4.4. The Implied Dividend Growth Rate 4.5. The Present Value of Growth Opportunities 4.6. Gordon Growth Model and the Price-to-Earnings Ratio 4.7. Estimating a Required Return Using the Gordon Growth Model 4.8. The Gordon Growth Model: Concluding Remarks 5. Multistage Dividend Discount Models 5.1. Two-Stage Dividend Discount Model 5.2. Valuing a Non-Dividend-Paying Company 5.3. The H-Model 5.4. Three-Stage Dividend Discount Models 5.5. Spreadsheet (General) Modeling 5.6. Estimating a Required Return Using Any DDM 5.7. Multistage DDM: Concluding Remarks 6. The Financial Determinants of Growth Rates 6.1. Sustainable Growth Rate 6.2. Dividend Growth Rate, Retention Rate, and ROE Analysis 6.3. Financial Models and Dividends 7. Summary CHAPTER 4 Free Cash Flow Valuation Learning Outcomes 1. Introduction to Free Cash Flows 2. FCFF and FCFE Valuation Approaches 2.1. Defining Free Cash Flow 2.2. Present Value of Free Cash Flow 2.2.1. Present Value of FCFF 2.2.2. Present Value of FCFE 2.3. Single-Stage (Constant-Growth) FCFF and FCFE Models 2.3.1. Constant-Growth FCFF Valuation Model 2.3.2. Constant-Growth FCFE Valuation Model 3. Forecasting Free Cash Flow 3.1. Computing FCFF from Net Income 3.2. Computing FCFF from the Statement of Cash Flows 3.3. Noncash Charges 3.4. Computing FCFE from FCFF 3.5. Finding FCFF and FCFE from EBIT or EBITDA 3.6. FCFF and FCFE on a Uses-of-Free-Cash-Flow Basis 3.7. Forecasting FCFF and FCFE 3.8. Other Issues in Free Cash Flow Analysis 3.8.1. Analyst Adjustments to CFO 3.8.2. Free Cash Flow versus Dividends and Other Earnings Components 3.8.3. Free Cash Flow and Complicated Capital Structures 4. Free Cash Flow Model Variations 4.1. An International Application of the Single-Stage Model 4.2. Sensitivity Analysis of FCFF and FCFE Valuations 4.3. Two-Stage Free Cash Flow Models 4.3.1. Fixed Growth Rates in Stage 1 and Stage 2 4.3.2. Declining Growth Rate in Stage 1 and Constant Growth in Stage 2 4.4. Three-Stage Growth Models 5. Nonoperating Assets and Firm Value 6. Summary CHAPTER 5 Residual Income Valuation Learning Outcomes 1. Introduction 2. Residual Income 2.1. The Use of Residual Income in Equity Valuation 2.2. Commercial Implementations 3. The Residual Income Model 3.1. The General Residual Income Model 3.2. Fundamental Determinants of Residual Income 3.3. Single-Stage Residual Income Valuation 3.4. Multistage Residual Income Valuation 4. Residual Income Valuation in Relation to Other Approaches 4.1. Strengths and Weaknesses of the Residual Income Model 4.2. Broad Guidelines for Using a Residual Income Model 5. Accounting and International Considerations 5.1. Violations of the Clean Surplus Relationship 5.2. Balance Sheet Adjustments for Fair Value 5.3. Intangible Assets 5.4. Nonrecurring Items 5.5. Other Aggressive Accounting Practices 5.6. International Considerations 6. Summary Problems CHAPTER 6 Market-Based Valuation: Price and Enterprise Value Multiples Learning Outcomes 1. Introduction 2. Price and Enterprise Value Multiples in Valuation 2.1. The Method of Comparables 2.2. The Method Based on Forecasted Fundamentals 3. Price Multiples 3.1. Price to Earnings 3.1.1. Alternative Defi nitions of P/E 3.1.2. Calculating the Trailing P/E 3.1.3. Forward P/E 3.1.4. Valuation Based on Forecasted Fundamentals 3.1.5. Valuation Based on Comparables 3.1.6. P/Es in Cross-Country Comparisons 3.1.7. Using P/Es to Obtain Terminal Value in Multistage Dividend Discount Models 3.2. Price to Book Value 3.2.1. Determining Book Value 3.2.2. Valuation Based on Forecasted Fundamentals 3.2.3. Valuation Based on Comparables 3.3. Price to Sales 3.3.1. Determining Sales 3.3.2. Valuation Based on Forecasted Fundamentals 3.3.3. Valuation Based on Comparables 3.4. Price to Cash Flow 3.4.1. Determining Cash Flow 3.4.2. Valuation Based on Forecasted Fundamentals 3.4.3. Valuation Based on Comparables 3.5. Price to Dividends and Dividend Yield 3.5.1. Calculation of Dividend Yield 3.5.2. Valuation Based on Forecasted Fundamentals 3.5.3. Valuation Based on Comparables 4. Enterprise Value Multiples 4.1. Enterprise Value to EBITDA 4.1.1. Determining Enterprise Value 4.1.2. Valuation Based on Forecasted Fundamentals 4.1.3. Valuation Based on Comparables 4.2. Other Enterprise Value Multiples 4.3. Enterprise Value to Sales 4.4. Price and Enterprise Value Multiples in a Comparable Analysis: Some Illustrative Data 5. International Considerations When Using Multiples 6. Momentum Valuation Indicators 7. Valuation Indicators: Issues in Practice 7.1. Averaging Multiples: The Harmonic Mean 7.2. Using Multiple Valuation Indicators 8. Summary Problems CHAPTER 7 Private Company Valuation Learning Outcomes 1. Introduction 2. The Scope of Private Company Valuation 2.1. Private and Public Company Valuation: Similarities and Contrasts 2.1.1. Company-Specifi c Factors 2.1.2. Stock-Specifi c Factors 2.2. Reasons for Performing Valuations 3. Defi nitions (Standards) of Value 4. Private Company Valuation Approaches 4.1. Earnings Normalization and Cash Flow Estimation Issues 4.1.1. Earnings Normalization Issues for Private Companies 4.1.2. Cash Flow Estimation Issues for Private Companies 4.2. Income Approach Methods of Private Company Valuation 4.2.1. Required Rate of Return: Models and Estimation Issues 4.2.2. Free Cash Flow Method 4.2.3. Capitalized Cash Flow Method 4.2.4. Excess Earnings Method 4.3. Market Approach Methods of Private Company Valuation 4.3.1. Guideline Public Company Method 4.3.2. Guideline Transactions Method 4.3.3. Prior Transaction Method 4.4. Asset-based Approach to Private Company Valuation 4.5. Valuation Discounts and Premiums 4.5.1. Lack of Control Discounts 4.5.2. Lack of Marketability Discounts 4.6. Business Valuation Standards and Practices 5. Summary Glossary References About the Authors About the CFA Program Index