CFA Level 2 Equity & Corporate Finance

Abstract: Two of core finance areas for the CFA is Equity and Corporate, and much of Equity valuation depend on them.

Introduction:

Equity valuations like DCF & multiple based valuations comes in this area.

And the much talked about Investment banking comes in Corporate Finance.

4 areas of working are:

1. DDM & FCF
2. Multiples (Deriving the mathematical formula of multiples and when they are used) including EBITDA EV multiples which are again very interesting
3. Residual Income (various models of RI, again formula derivation is imp)
4. Private Company Valuation

These 4 pillar forms the base of equity research. The questions will require corporate Finance and Financial Reporting Analysis to compute free cash flows, or CFO through indirect method.

These question are also used a company during merger or spinoffs. I got a question in Finance exam, a case of merger and then spinoff where we have to use different models. Hence this question became a mix of M&A and Equity.

Spinoffs also use a lot of Equity valuation to decide the rates and ratios. In my question they used P/B multiple.

Some of the other things in Private Equity are covered in Alternative Assets.

FCFF Valuation on Excel:

Damodaran:

1. EBIT norm
2. RnD
3. Lease Conversion

FCFF Stages:

VF

EV

VE

Price of Share

All things boil down to find out the EBIT and other parameters that grows over a period of time.

Investment Banking:

This area is the best, what I came to know from this area is investment banking is more of MBA which requires a lot of maturity, marketing and negotiation as synergy and such things are very subjective. Two methods were taken from FCFF from the accounting point of view, and other was based on market. Both of them were very interesting. Again multiple based valuation and other requires good accounting, and what I tend to believe is CFA is more about equity valuation and such kind of profiles. But today when I looked at the course of Mater of financial engineering from various sites I came to know that Financial Engg is less about Equity and more about risk and technical analysis.

Ratio in Equity valuation is another important areas: Multiple based valuations.

Two things that are tough to understand are Working capital and Capital Expenditure which needs to looked upon carefully in understanding the Free cash flows as most of them are from indirect methods.

They are sometimes known as trading and transaction multiples. EV multiples coupled with other reports helps a lot in investment banking where you are paying for control. EV is market cap+ debt - cash. Another interesting thing is patent valuation and adjust of items for EBITDA. This is most MnA we use the transaction multiples. Companies of same categories are tough to find. Normalization of earning is hence an important work to do. Also calendarization of statements is imp to do an apple to apple comparison.

Lagging and leading indicators terminology is often used.

Conclusion:

It is all about EV multiples or transaction multiples from the past activities for IB.

Equity Valuation models / stock pricing / Shares CFA

Equity Valuation models / stock pricing / Shares CFA
By: Shivgan Joshi

Introduction
Human mind is very strange, you need to give it the right reason to do something. And the very right reason to study this subject is that stocks can help you decide your portfolio, analyze things, nevertheless this is the largest of the topics in level 2. In this regard this becomes a very important topic. The merger and acquisiton price analysis and other very important phenomenon are dependent on how well you understand this area.

Thus this is a thing that you must motivate yourself to understand a lot.

When it comes to picking a price for a share or deciding to play in investment banking this area again becomes very important.

In totality I am trying to develop some interest in this area before we formally move into it.

Various methods are used for various people for valuations. This subject holds 20% and is the most important subject for the CFA Level 2. Hence learning it here will make things in future very easy and interesting.

One thing that took a very long time to understand is the formula for margin with maintenance call, that the last thing in the CFA level 1 which drove me into understanding more. But finally I figured it out. The 2 calls are made to restrict your loss and protect the broker from incurring any loss due to your investment.

Earning multiplier, and role of dividend in the valuation, and linking ratios for valuation of a stock are some the important things.

A very big confusion point here is how to interpret dividend payout ratio and growth in the company with the effect of retaining income. The company with higher retention will cause faster growth.

Another very interesting thing is with divisor when there is stock split in price weighted index. We find out divisor for split for the values before the next one and then use the same divisor which has an embedded weighted effect in itself. There are some examples which you can see.

Now, lets move something called the divisor-for-adjusting-split, in this case we find the divisor of the base year and use the same after the split and the values of stock has changed. In general what we do is that we find the average price of the base, then do the split and put a divisor X so that average price remains the same and find this new divisor. After than we use the same divisor for the new year when the price has changed significantly.

Growth stock, speculative stock and cyclical stock.

Discussion: If payout ratio increases, then PE multiple increases or decreases?

Conclusion: An overview of interesting and deeply engaging topics for equity required for CFA and other similar exams are given.