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Author: lostowl05661 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 1671  
Subject: Valuing Cemex Date: 2/20/2010 7:19 PM
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I have been reading the tutorial on valuing stocks and I'm a little confused.

First, most of my numbers don't come out right, so obviously I'm not calculating right.

The numbers I am looking for to compare to the tutorial are:

Working Capital/Market Capitalization: My number is .01. The tutorial suggests .5 or better is what to look for.

Cash/Market Capitalization: My number .01. .1 is what the tutorial suggests.

Enterprise Value/Share Holder Equity: My number is 5.6, calculating (MrkCap-Cash+debt)/ShrHldrEqty as (93,793-1091+0)/15287. The Tuturial suggest a ration of 1 or less. This suggests the that CX is Way Above book.

PSR: My number is 6.14, By taking Market Cap/12mo Trail Rev or 93792/15287. However, The MF look up lists the PSR as .64. Where are they getting the numbers or is my formula wrong?

I have a similar issue with Price to Book where I show 5.71 using SharePrice/(BookValue/Shares)and MF shows .59

Finally, I calculate ROIC at .24, but I dont know where to check it.

And I have no idea how to calculate WACC.

So, if anyone is good at running the numbers, could you do an example using CX? I am trying to understand why it is recommended this month when the numbers appear dismal. Also, the Price to Books I have are high but S&P rates the stock as under priced. I just don't get it. Maybe this was a bad one to choose to practice on.
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Author: TLassen Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1617 of 1671
Subject: Re: Valuing Cemex Date: 2/21/2010 12:04 PM
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WACC

Weighted average cost of Capital (Cost of both Equity and Debt) since a company's investment capital can be raised either through stock issuance or from undertaking obligations (loans and bonds) it is imperative you calculate a company's total cost of capital based on both it's equity and debt.

WACC= COE + (COE-COD)*d/e ratio

COE= Cost of equity
COD= Cost of debt
D/E= DEBT to EQUITY ratio

COE calculated as: Current 10 yr risk free rate + premium (expected premium for holding stocks over risk free * beta of company

COD calculated as 10 yr corporate bond rate - tax rate
D/E calculated as Total debt divided by Total debt + stockholder equity.

The above formula accounts for an non-leveraged company's minimum cost of capital equaling it's cost of equity. As the company changes it's capital structure by undertaking more debt it's Cost of Capital increases.

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Author: TLassen Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1618 of 1671
Subject: Re: Valuing Cemex Date: 2/21/2010 12:15 PM
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CX=

COE= .038+.04*2.3= .13 (13%)
COD= .055- 33%= .036 (3.6%)
D/E ratio= 45%

thus WACC= 13 +(13-3.6) * 45 = 17.2% Cost of capital

ROIC less WACC will indicate if CX is creating or destroying investment capital

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Author: mjs111 Big red star, 1000 posts Feste Award Nominee! Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1619 of 1671
Subject: Re: Valuing Cemex Date: 2/21/2010 3:08 PM
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Might help to provide a link to the tutorial you're working with. Also, are you looking through a dated tutorial but using current numbers for the company in question, and then comparing them to the tutorial? Are you sure the source numbers that both you and the author of the tutorial are using are the same?


Working Capital/Market Capitalization: My number is .01. The tutorial suggests .5 or better is what to look for.

A lot of things like this are industry specific. For example, Wal-mart has negative working capital, since it has very little accounts receivable as it's mainly a cash business but has a large amount of accounts payable since it's able to use its size to lever very advantageous payment terms with its suppliers, to the point where Wal-mart is often paid in cash for the products it sells before it has to pay its suppliers for them. This is a very good thing, not a bad thing.

On the other hand, a company like Pfizer has quite a lot of money tied up in working capital, upwards of 40% of revenue. Pfizer can have lumpy cash flows due to patent expirations, acquisitions, and new drug releases. They sell a lot on credit to hospitals and pharmacies, and they have a lot of money tied up in inventory. These aren't bad things but part and parcel with being in the pharmaceutical industry.

Similar to Pfizer, Microsoft has an amount equal to about 40% of revenue tied up in working capital, largely due to the $36 billion in cash the company is holding. Successful software companies more usually than not are cash rich and asset light, and the challenge often becomes one of finding places to invest the money they are generating in equally or more successful projects.


Mike

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Author: iceberg0 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1620 of 1671
Subject: Re: Valuing Cemex Date: 2/22/2010 8:23 PM
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lostowl -

<<Maybe this was a bad one to choose to practice on.>>

"Bad" in the sense CX is a very difficult study even for experienced business appraisers. Foreign based GAAP & filing 20-Fs indicates that right away. Plus those operations in so many foreign countries, ugh.

I'd suggest you seek out a US GAAP filer with mostly US operations to begin study & to reduce confusion. That one will still be a challenge. If you read thru a 10-K and find they seem to want you to understand their business, you are on the right track.

Knowing to compute WACC means you have chosen "fair market value" as your standard of value - acceptable for a NYSE listed security.

Financial statement ratios do help to evaluate the company's financial position. But you'll need an estimate of future operating cash flow to discount at the WACC along with an estimate of future economic growth. There may be non-operating assets/liabilities to appraise separately.

Some say valuation is simple but it is not easy.

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Author: mjs111 Big red star, 1000 posts Feste Award Nominee! Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1621 of 1671
Subject: Re: Valuing Cemex Date: 2/22/2010 9:00 PM
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Try something easier like Lowe's (LOW), Costco (COST), or McDonald's (MCD) These are simple businesses and also have very shareholder-friendly, easy-to-read financial statements.

Mike

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Author: iceberg0 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1622 of 1671
Subject: Re: Valuing Cemex Date: 2/22/2010 9:01 PM
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TLassen -

<< As the company changes it's capital structure by undertaking more debt it's Cost of Capital increases. >>

This is not generally the case for adding small percents of debt capital. Check out some reading material on optimum capital structures.

If you can agree the cost of equity (maybe ~10 to 12%) is higher than the after-tax cost of debt (maybe ~3 to 6%) then imagine how the WACC changes as slight increases of debt above 0% are added to the capital structure. Plot WACC% on Y-axis and debt% from 0% to 100% on x-axis.

WACC starts at y = cost of equity & trends down as %debt increases above zero but then WACC trends higher (maybe more than COE) as debt approaches 100% - where Moody's will lower the credit rating and the bond market increase the interest rate. This suggests a minimum WACC reaching low optimum point somewhere in between 0% and 100%.

The resulting curve might look like a smile higher on the right. Some industry research would suggest optimum debt is around 30% in the capital structure or management adding some debt can be good for owners. For Bill Gates, any MS debt was too much as he had to meet payrolls to his friends in the early days. That habit just continued.

BTW: WACC = (COE * % equity) + (COD * (1-tax rate) * % debt)

For no debt your formula reduces correctly as you point out but for 100% debt it is undefined (e=0).

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Author: TLassen Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1623 of 1671
Subject: Re: Valuing Cemex Date: 2/23/2010 6:02 PM
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Iceberg0,
thanks for your informative comments

'my WACC' calculation (which is really total cost of capital) comes from the old Modigliani-Miller Theorem.

"BTW: WACC = (COE * % equity) + (COD * (1-tax rate) * % debt) For no debt your formula reduces correctly as you point out but for 100% debt it is undefined (e=0)" No that's not right if you multiply using the debt to equity ratio.

The point is that for debt-free companies the total cost of capital equals cost of equity. By adding debt to its structure Stockholders will see added risk and therefore require an increase in expected return (total cost of capital must be increased)

I belong to the Economic Added Value camp so I don't use the traditional WACC formula, as it lowers the cost of capital by adding debt to company structure (debt is cheaper than equity, it is often assumed). BTW I am reasonably well aware of the debates regarding optimum capital structures, but believe the cost of capital has to increase when the capital structure changes by adding debt.

Incidentally I look for the spread between the Return on Investment Capital and Cost of Investment Capital to determine if a company is destroying or creating wealth.(maybe should have stated that upfront before posting my WACC, my bad)

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Author: iceberg0 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1624 of 1671
Subject: Re: Valuing Cemex Date: 2/24/2010 3:15 PM
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TLassen -

<<…the cost of capital has to increase when the capital structure changes by adding debt.>>

Good discussion, thx. You are then using your own discount rate & thus computing a different standard of value: intrinsic value. If your IV happens to roughly equal market price, you are back to WACC & FMV. My finance texts taught smallish debt (<~30%) in capital structures can reduce WACC just by using the relevant numbers & standard theory. JOF articles try to compute optimum debt levels that management should target but Bill Gates ran MS well without paying any attention to them. He was a big disappointment to the bankers I suppose.

lostowl - <<..if anyone is good at running the numbers, could you do an example using CX?>>

Not sure I'm any good but I’ll take a whack at computing CX WACC for ya’ using the bus. appraiser’s build up method, showing my work per my finance prof. or I’d get a rap on my knuckles. I’ll use the data from Value Line sheet dated 1/1/2010 and thus a valuation date of 12/31/2009.

VL Beta is defined as “..weekly percentage changes in the price of a stock and weekly percentage changes in the NYSE Index over a period of five years..” . I’ll take that as reasonable for CX & Beta is 1.75.

Our friends at Ibbotson tell us as of 12/31/2008 the long-horizon expected equity risk premium relative to 20-yr US Treasury bond is 7.1% and has been steady recently so I’ll not adjust it to the val. date. A reasonable defending argument can probably be made for that in court.

The 20yr T-Bond was 4.58% on val. date per the treasury website. CX market cap per VL was $9.5B for which Ibbotson computes an expected size premium of around +0.7% rounded.

COE = Rfr + ERP*Beta + RPs = .0458 + (.071*1.75) + .007 = .17705 or about 17.7%.

VL tells us CX recently issued 7yr. $ denom. notes at 9.5% so I’ll use that as LT COD in USD.

Shr. equity = $16.585B and debt = $18.8B – 3B paid back in 2009 = $15.8B.

Percent equity = 16.585/(16.585+15.8) = 51.2%

Percent debt = 1-.512 = 48.8%

VL has CX tax rate at 16.5%

WACC = (COE * %equity) + (COD * (1-tax rate) * % debt) = (.177 * .512) + (.095 * (1-.165) * .488)

Check my work YMMV; I get ~.129 or WACC ~ 12.9%. Debt reduces it from COE = 17.7%. This WACC is a market derived discount rate vs. one you might use, if you do then that changes standard of value to intrinsic value.

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