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Valuation Methods and Shareholder Value Creation
Pablo Fernández
Academic Press, San Diego, CA.
Valuation Methods
and
Shareholder Value Creation
(Academic Press, San Diego, CA., 2002)
Pablo Fernández
PricewaterhouseCoopers Professor of Corporate Finance
IESE Business School
Madrid, Spain
+34-91-357-0809 (Phone)
+34-91-357-2913 (Fax)
Web site: http://web.iese.edu/PabloFernandez/
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Valuation Methods and Shareholder Value Creation
Pablo Fernández
Academic Press, San Diego, CA.
Abstract
Valuation Methods and shareholder value creation is a complete book about business valuation and value
creation. The book explains the nuances of different valuation methods and provides the reader with the
tools for analyzing and valuing any business, no matter how complex. With 631 pages divided into four
parts, Valuation and shareholder value creation uses 140 diagrams, 211 tables, and more than 100
examples to help the reader absorb these concepts.
This book contains materials of the MBA and executive courses that I teach in IESE Business School. It
also includes some material presented in courses and congresses in Spain, US, Austria, Mexico,
Argentina, Peru, Colombia, UK, Italy, France and Germany. The chapters have been modified many
times as a consequence of the suggestions of my students since 1988, my work in class, and my work
as a consultant specialized in valuation and acquisitions. I want to thank all my students their comments
on previous manuscripts and their questions. The book also has results of the research conducted in the
International Center for Financial Research at IESE.
Part I – Basics of Valuation Methods and Shareholder Value Creation
Part II – Shareholder Value Creation
Part III – Rigorous Approaches to Discounted Cash Flow Valuation
Part IV – Real options and brands
The third part examines in greater depth discounted cash flow valuation and starts with the analysis of the
eight most commonly used methods for valuing companies by cash flow discounting:
- Free cash flow discounted at the WACC;
- Equity cash flows discounted at the required return to equity;
- Capital cash flows discounted at the WACC before tax;
- APV (Adjusted Present Value);
- The business’s risk-adjusted free cash flows discounted at the required return to assets;
- The business’s risk-adjusted equity cash flows discounted at the required return to assets;
- Economic profit discounted at the required return to equity; and
- EVA discounted at the WACC.
It is shown how all eight methods always give the same value. This result is logical, since the
methods analyze the same reality under the same hypotheses; they only differ in the cash flows taken as
starting point for the valuation.
Downloadable tables and up-dated financial data
Most of the tables and spreadsheets included in the book and up-dated financial data may be found and
downloaded at the author website: http://web.iese.edu/PabloFernandez//valuation.html
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Valuation Methods and Shareholder Value Creation
Pablo Fernández
Academic Press, San Diego, CA.
Table of Contents
Preface
PART I. BASICS OF VALUATION METHODS AND SHAREHOLDER VALUE
CREATION
Chapter 1. Shareholder value creation. Basic concepts.
1.1. Increase of equity market value
1.2. Shareholder value added
1.3. Shareholder return
1.4. Required return to equity
1.5. Created shareholder value
1.6. The ROE is not the shareholder return
1.7. Comparison of General Electric with other companies
1.8. Value creation and value destruction of the S&P 500
1.9. What should the shareholder return be compared with?
Chapter 2. Company valuation methods
2.1. Value and price. What purpose does a valuation serve?
2.2. Balance sheet-based methods
2.2.1. Book value
2.2.2. Adjusted book value
2.2.3. Liquidation value
2.2.4. Substantial value
2.2.5. Book value and market value
2.3. Income statement-based methods. Relative valuation
2.3.1. Value of earnings. PER
2.3.2. Value of the dividends
2.3.3. Sales multiples
2.3.4. Other multiples
2.3.5. Multiples used to value Internet companies
2.4. Goodwill-based methods
2.4.1. The “classic” valuation method
2.4.2. The simplified "abbreviated goodwill income" method or the simplified UEC method
2.4.3. Union of European Accounting Experts (UEC) method
2.4.4. Indirect method
2.4.5. Anglo-Saxon or direct method
2.4.6. Annual profit purchase method
2.4.7. Risk-bearing and risk-free rate method
2.5. Cash flow discounting-based methods
2.5.1. General method for cash flow discounting
2.5.2. Deciding the appropriate cash flow for discounting and the company’s economic balance sheet
2.5.2.1. The free cash flow
2.5.2.2. The equity cash flow
2.5.2.3. Capital cash flow
2.5.3. Calculating the value of the company using the free cash flow
2.5.4. Calculating the value of the company as the unlevered value plus the discounted value of the tax
shield
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Valuation Methods and Shareholder Value Creation
Pablo Fernández
Academic Press, San Diego, CA.
2.5.5. Calculating the value of the company’s equity by discounting the equity cash flow
2.5.6. Calculating the company’s value by discounting the capital cash flow
2.5.7. Basic stages in the performance of a valuation by cash flow discounting
2.6. Which is the best method to use?
2.7. The company as the sum of the values of different divisions. Break-up value
2.8. Valuation methods used depending on the nature of the company
2.9. Key factors affecting value: growth, return, risk and interest rates.
2.10. Speculative bubbles on the stock market
2.11. Most common errors in valuations
Chapter 3. Price earnings ratio, profitability, cost of capital, and growth.
3.1. Evolution of the PER on the international stock markets
3.2. Factors affecting the PER
3.3. Influence of growth (g) on the PER
3.4. Influence of the ROE on the PER
3.5. Influence of the required return to equity on the PER
3.6. Influence of interest rates on the PER
3.7. Growth value and PER due to growth
Appendix 3.1. Price per share, market capitalization, earnings per share (EPS), dividend yield and PER
of the companies included in the Euro Stoxx 50 on 30 May 2001
Appendix 3.2. Breakdown of the price per share between no-growth price and growth value; and
breakdown of the PER (companies included in the Euro Stoxx 50 on 30 May 2001)
Appendix 3.3. Relationship between the PER and growth (g), required return to equity (Ke) and return on
equity (ROE) in a company with constant growth
Chapter 4. Splitting the Price earnings ratio: Franchise factor, growth factor,
interest factor and risk factor
4.1. PER, franchise factor and Growth Factor
4.2. PER*, franchise factor* and Growth Factor
4.3. PER, Interest Factor and Risk Factor
4.4. Value generation over time in companies with growth
4.5. Influence of growth on the franchise factor and on the Growth Factor
4.6. Influence of the ROE on the franchise factor
4.7. Influence of the required return to equity on the Franchise Factor and on the PER
Appendix 4.1. Splitting the PER
Chapter 5. Market value and book value
5.1. Market value and book value on the North American stock market
5.2. Market-to-book ratio on the international stock markets
5.3. Market-to-book ratio and interest rates on the North American stock market
5.4. Relationship between the market-to-book ratio and the PER and the ROE
5.5. Value creation and the difference between market value and book value
5.6. Equity book value may be negative: the case of Sealed Air
Appendix 5.1. Market value and book value of selected US companies
Chapter 6. Dividends and market value
6.1. Evolution of dividends on the U.S. stock market
6.2. Increasingly fewer companies distribute dividends and more buy back shares
6.3. Evolution of dividends on the international markets
6.4. The share value is the present value of the expected dividends
6.5. Share value when dividends have constant growth. Gordon and Shapiro formula
6.6. Share value when dividends grow at a fixed quantity each year
6.7. Binomial valuation model of discounted dividends
6.7.1. Additive binomial model
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