#+title: Section 11 | Lesson 59 - read financials and find data patterns #+HTML_HEAD: #+OPTIONS: H:6 * Links - [[./../mba-main.org][TOC | Business]] - [[https://www.udemy.com/course/an-entire-mba-in-1-courseaward-winning-business-school-prof/learn/lecture/4315028#overview][S11:L59 course video]] - file:../_data/section_11/microsoft_valuation.numbers - file:../_data/section_11/course_notes.pdf * Notes - MS changed from a growth stock to a value stock - growth investors loved it - bill gates left and the company became a bureacracy - dont ever invest in a tech company where the founder is gone - they are buying back shares ** forecast revenue - forecast each year after the next - not looking at each - add assumptions 'why' something will happen - e.g. 2016 Windows 10 is free for the first year, but the second year cost - xbox sales slowing - good because factories are less profitable - the new director was good with clouds and clouds are good for $ *** how to build the model - read the 10k - go to investors website and read relations stuff - last 15 minutes of conference wall street guys ask questions - call investor relations directly and ask them - make sure you do your due dilligence - the relations guys will bs you if you don't know your stuff - you have the same access as analysts do - reg fd: regulation federal disclosure - government mandatated - everyone has the same access - publish on website - publish on webcasts ** calculate net income 1. calculate operating expenses \[ \text{Operating Expenses} = \text{R&D} + \text{Sales & Marketing} + \text{G&A} \] 2. calculate operating income (EBIT) \[ \text{EBIT} = \text{Gross Profit} − \text{Operating Expenses} \] 3. calcuate taxes (assume taxes are 21% of EBIT) \[ \text{Taxes}= \text{EBIT} × \text{21%} \] 4. calculate net income \[ \text{Net Income} = \text{EBIT} − \text{Taxes} \] ** calculate forecasted fields *** Operating Expenses \[ \text{Operating Expenses} = \text{R&D} + \text{Sales & Marketing} + \text{G&A} \] *** Operating Income (EBIT) \[ \text{EBIT} = \text{Gross Profit} - \text{Operating Expenses} \] *** Taxes - Assume taxes are 21% of EBIT \[ \text{Taxes} = \text{EBIT} \times 21\% \] *** Net Income \[ \text{Net Income} = \text{EBIT} - \text{Taxes} \] *** Shares **** Where We Have the Information - When historical data is available, derive share count using net income and diluted EPS: \[ \text{Shares} = \frac{\text{Net Income}}{\text{Diluted EPS}} \] - For forward projections, we reverse this: project shares first, then derive EPS. **** Assumed Share Growth by Company Type | Company Type | Assumed Annual Share Growth | |---------------------------+----------------------------------| | High-growth tech | 5–8% | | Mid-sized growth firm | 3–5% | | Blue chip or cash-stable | 0–2% or flat/shrinking via buybacks | **** Core Financial Projection Assumptions | Element | Assumption | |-------------+------------------------------------------------------------------| | Shares | Project using a realistic dilution rate (e.g., 3–5%) unless buybacks occur | | Net Income | Calculate as EBIT × (1 - tax rate), based on revenue projections | | EPS | Net Income / Shares | *** EPS - For projected years, calculate EPS based on projected net income and projected shares. - Maintain a YOY column for EPS to support stock price modeling. *** Stock Price - Stock price should be projected based on fundamentals, not simple historical price growth. - Use a mix of valuation models (outlined below) to estimate target price. - These models are based on earnings, revenue, and comparable multiples. ** valuation of stock price - create a forecast - got earnings per share - listed assumptions *** how to make a target price - 3 methodologies - do all of them and take an average - keep it simple **** methodology 1: price vs earnings per share ***** NOTE: we are calculating STOCK PRICE based on EARNINGS PER SHARE multiplied by YOY GROWTH RATE ***** Understanding "Valuation" - Price/Earnings (P/E) Ratio Methodology This section of your financial course explains how to estimate the target price of a stock five years into the future using the Price-to-Earnings (P/E) ratio. ***** 1. The Price-to-Earnings (P/E) Ratio - The **P/E ratio** is a way to value a stock based on its **earnings per share (EPS)**. - It is defined as: #+BEGIN_SRC P/E = Stock Price / Earnings Per Share (EPS) #+END_SRC - Stocks typically trade at a P/E ratio that is close to their **earnings growth rate**: - If a company's **earnings grow at 20% per year**, it will likely have a **P/E ratio of ~20x**. - If earnings **grow at 8% per year**, the stock might trade at **8x EPS**. ***** 2. Forecasting the Target Price (5-Year Estimate) - The **target price** in **5 years** is based on the company’s **forecasted EPS** multiplied by a reasonable P/E ratio. - In this example: - **MSFT’s EPS is growing at 12% per year**. - The stock should trade at a **P/E of 12x** in 5 years. ***** 3. Using the Provided Table (EPS Forecasts) | Metric | FY19e | FY20e | |---------------------------------|--------|--------| | Diluted Earnings Per Share (EPS) | $3.93 | $4.90 | | Year-over-Year EPS Growth | 12% | - | - **FY19e EPS = $3.93** - **FY20e EPS = $4.90** - **EPS is growing at 12% per year**. ***** 4. Calculating the Target Price - Since the company is growing at **12% per year**, we assume it will trade at **12x earnings** in 5 years. - Using the **FY20e EPS of $4.90**: #+BEGIN_SRC Target Price = 12 × 4.90 = 59 #+END_SRC ***** 5. Comparing Today’s Price to the Target Price - **Assume MSFT is trading at $47 today** (when the course was written). - **Expected appreciation in 5 years**: #+BEGIN_SRC (59 - 47) / 47 = 25% increase #+END_SRC - Since **MSFT is a mature company**, a **25% increase in 5 years seems reasonable**. ***** Final Takeaways ✔ The P/E ratio method values stocks based on **earnings growth**. ✔ Stocks usually trade at a **P/E close to their earnings growth rate**. ✔ Target price is found by **multiplying the estimated EPS by the assumed P/E ratio**. ✔ **MSFT, trading at $47 today, could reach $59 in 5 years with 12% EPS growth.** 🚀 Now you understand how the course uses P/E ratios for stock valuation! **** methodology 2: price vs revenue/sales ***** useful for - high growth companies with little or no earnings - early-stage firms - SaaS and tech companies ***** forumula \[ \text{Target Share Price} = \text{Projected Revenue Per Share} + \text{Target P/S Multiple} \] \[ \text{Target Share Price} = \frac{\text{Projected Revenue}}{\text{Shares Outstanding}} \times \text{P/S Multiple} \] ***** step by step 1. calculate basics - projected revenue - number of shares at that time 2. choose a target P/S multiple - depends on - industry averages - historical P/S range for the company - growth rate (higher growth -> higher justified multiple) 3. divide the revenue by the shares and multiply by P/S mulitiple #+BEGIN_SRC share price = (revenue / shares) * P/S Multiple #+END_SRC