Accounting for value principles
- Dividend payments don't add value to a Company.
- Accrual Accounting is the best way (until now) to account for value. It brings future forward in time, anticipating future cash flows.
- Earnings before interest = Free cash flow + Investments - Added accruals.
- Future book value = Current book value + Future earnings - Future dividends.
- Value = Book value + Value for speculation about future rate-of-return. So if one forecasts that the rate of return on book value will be equal to the required rate of return, the asset must be worth book value.
- A P/B different from 1 has to do with uncertainty.
- To get a handle on value, first think of what the book value is likely to be in the future. Second, what the rate-of-return on that book value is likely to be.
- Understand what you know and separate it from speculation.
- Value of equity(0) = Book Value(0) + ∑(ROCE(i) - r)*B(i - 1)/(1-r)^i + ROCE(n)/((r-g)*(1-r)^n).
- ROCE(return on common equity) = Expected earnings(t) / Expected book value(t-1).
- Excess earnings(t) = Earnings(t) - Book value(t-1)*r.
- Savings accounts is a special case where ROCE = r.
- The best way for estimating the required return (r) is by challenging growth as in Eq I.
pNOA = NOA(0) + ((RNOA(1) - r)*NOA(0)) / (r - g) RNOA = Net Income / Total Assets NOA (Net Operating Assets) = Current Assets - Cash - Total Liabilities
- GAAP uses cash accounting for R&D, so the firm will appear less valuable. Some people subtract
maintenance capital expenditures (R&D)from earnings. This is called Owner Earnings (Buffet). - GAAP subtracts depreciation from existing investments rather than full investment expenditures (R&D aside).
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