business-haroun/mba/ch59.org

Section 11 | Lesson 59 - read financials and find data patterns

• Links
• Notes
  • forecast revenue
    • how to build the model
  • calculate net income
  • calculate forecasted fields
    • Operating Expenses
    • Operating Income (EBIT)
    • Taxes
    • Net Income
    • Shares
      • Where We Have the Information
      • Assumed Share Growth by Company Type
      • Core Financial Projection Assumptions
    • EPS
    • Stock Price
  • valuation of stock price
    • how to make a target price
      • 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
        • 1. The Price-to-Earnings (P/E) Ratio
        • 2. Forecasting the Target Price (5-Year Estimate)
        • 3. Using the Provided Table (EPS Forecasts)
        • 4. Calculating the Target Price
        • 5. Comparing Today’s Price to the Target Price
        • Final Takeaways
      • methodology 2: price vs revenue/sales
        • useful for
        • forumula
        • step by step

Links

• TOC | Business
• 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:

  P/E = Stock Price / Earnings Per Share (EPS)

• 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:

  Target Price = 12 × 4.90 = 59

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:

  (59 - 47) / 47 = 25% increase

• 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

   share price = (revenue / shares) * P/S Multiple