I confess. I send out a lot of emails and I am sure that you don't read some of them. Since they sometimes contain important information as well as clues to my thinking (deranged though it might be), I will try to put all of the emails into this file. They are in chronological order, starting with the earliest one. They are in chronological order, starting with the earliest one. So, scroll down to your desired email and read on, or if the scrolling will take you too long, click on the link below to go the emails, by month.
Happy new year! I hope you have a wonderful break (good news: it is still break..) and that you will come back tanned, rested and ready to go. This is the first of many, many emails that you will get for me. You can view that either as a promise or a threat. I am delighted that you have decided to take the corporate finance class this spring with me and especially so if you are not a finance major and have never worked in finance. I am an evangelist when it comes to the centrality of corporate finance and I will try very hard to convert you to my faith. I also know that some of you may be worried about the class and the tool set that you will bring to it. I cannot alleviate all your fears now, but here are a few things that you can do to get an early jump:
I will also be posting the contents of the site (webcasts, lectures, posts) on iTunes U. If you have never used it, here is what you need: an Apple device (iPhone or iPad), the iTunes U app on the device and you need to use this enroll code: EXC-JJS-XEA. Alternatively, try this link:
Now for the material for the class. The lecture notes for the class are available as a pdf file that you can download and print. I have both a standard version (one slide per page) and an environmentally friendly version (two slides per page) to download. You can also save paper entirely and download the file to your iPad or Kindle. Make your choice.
One final point. I know that the last few years have led you to question the reach of finance (and your own career paths). I must confess that I have gone through my own share of soul searching, trying to make sense of what is going on. I will try to incorporate what I think the lessons learned, unlearned and relearned over this period are for corporate finance. There are assumptions that we have made for decades that need to be challenged and foundations that have to be reinforced. In other words, the time for cookbook and me-too finance (which is what too many firms, investment banks and consultants have indulged in) is over. To close, I will leave you with a YouTube video that introduces you (in about 3 minutes) to the class.
As the long winter break winds down, I first hope that you are far away from the gray weather in New York, some place warm and sunny. I also hope that you are ready to get started on classes and that you got my really long email a weeks ago. If you did not, you can find it here:
1. Website: In case you completely missed this part of the last email, all of the material for the class (as well as the class calendar) is on the website for the class:
For those of you who have not got around to checking, class is scheduled from 10.30-11.50 in Paulson Auditorium on January 31. See you there!
I promised you with a ton of emails and I always deliver on my promises... Here is the first of many, many missives that you will receive for me….. First, a quick review of what we did in today's class. I laid out the structure for the class and an agenda of what I hope to accomplish during the next 15 weeks. In addition to describing the logistical details, I presented my view that corporate finance is the ultimate big picture class because everything falls under its purview. The “big picture” of corporate finance covers the three basic decisions that every business has to make: how to allocate scarce funds across competing uses (the investment decision), how to raise funds to finance these investments (the financing decision) and how much cash to take out of the business (the dividend decision). The singular objective in corporate finance is to maximize the value of the business to its owners. This big picture was then used to emphasize five themes: that corporate finance is common sense, that it is focused, that the focus shifts over the life cycle and that you cannot break first principles with immunity.
On to housekeeping details.
|1/31/17||As promised, here is the first weekly challenge. It is about corporate governance at one of India’s oldest and best regarded family groups, the Tatas. The group which has been around since 1868, has more than a hundred companies under it, and has had only seven heads over its 150-year life, most of whom came from the Tata family. In 2012, Ratan Tata stepped down and Cyrus Mistry was named the new head. While not an immediate Tata family member, he is related by marriage to the family and he himself comes from a family with deep connections to the group going back in time. It is perhaps because of the group’s history that people were shocked when Cyrus was fired on October 24, 2016, and Ratan Tata reinstated as the head. You can start with the blog post that I had on the group in November:
That lays out my views not just on the Tata group but on family groups in general. Once you have that read, you can then look at the specifics of this week’s puzzle, where I bring the story up to date.
Once you have read these pieces (and other links), there are four questions that I would like you to answer:
1. What do you see as the pluses and minuses of family group control of publicly traded companies?
2. Can you use that trade off to explain why family group companies grew to dominate Asian and Latin American markets? Can you use it to look at the challenges that family groups will face in the future?
3. Given the Tata Group's current standing and the evolution of the Indian economy/market, do you think that the pluses still outweigh the minuses?
4. Do you believe the governance problem has been resolved with the appointment of Mr. Chandrasekaran as the new CEO of Tata Sons? Why or why not? If no, what would you like to see done at the company to make you feel more comfortable with your investment in a Tata company?
As you can see, these are open ended questions where there is no right answer. To be clear, there is no grade attached to answering these weekly puzzles but I believe that there is a payoff in understanding. I have created a forum on NYU classes (this may be one of the few things that I use NYU classes for) where, if you feel the urge to share, you should. Until next time!
In today's class, we started on what the objective in running a business should be. While corporate finance states it to be maximizing firm value, it is often practiced as maximizing stock price. To make the world safe for stock price maximization, we do have to make key assumptions: that managers act in the best interests of stockholders, that lenders are fully protected, that information flows to rational investors and that there are no social costs. We started on why one of these assumptions, that stockholders have power over managers, fails and we will continue ripping the Utopian world apart next class.
1. Administrative Stuff: I went through the structure for the class and mentioned the quiz dates. As noted in class, if you are going to miss a quiz, the 10% from that quiz will be moved to the rest of the exam grade for the class and if you take all three, your worst quiz will get marked up to the average on your remaining exams. Here are a few other details:
3. DisneyWar: In next week’s session, I will be talking about the dysfunctional state of Disney in the 1990s. If you want to review these on your own, try this book written by James Stewart. It is in paperback, on Amazon:
4. Company Choice: On the question of picking companies for your group, some (unsolicited) advice:
If you want to print off the financial statements for your company, I would recommend that you start with the annual report for the most recent year. You should be able to pull it off the website for the company, under investor relations. If you want to keep going, and it is a US company, go to o the SEC site (http://www.sec.gov). If it is a non-US company, you will have to find the equivalent regulatory body in your country. For some of your companies, you will find less data than on others. Don’t fret. This too shall pass. More on this in tomorrow’s email.
|2/2/17||It is never too early to start nagging you about the project. So, let me get started with a checklist (which is short for this week but will get longer each week. Here is the list of things that would be nice to get behind you:
Project hub: To find out pretty much anything you need to about the project, get questions answered or look at past project reports, here is where you should go: http://people.stern.nyu.edu/adamodar/New_Home_Page/cfproj.html
Find a group: If you have trouble finding one, try the orphan spreadsheet for the class (https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1ZQhI4GzHT4DJSN4RGBUvy7r_I3QLl545nqm6VG5Z-ts/edit?usp=sharing ). If you have a group and need an orphan to adopt, try the spreadsheet as well.
Pick a company/theme: This will require some coordination across the group but pick a company and find a theme that works for the group. Each person in the group picks a company and the companies form the theme.
Annual Report: Find the most recent annual report for your company. If it is a US company, also download the 10K from the SEC website.
Updated information: If your company has quarterly reports or filings pull them up as well.
Board of Directors: Get a listing of the board of directors for your company & start your preliminary assessment.
In doing all of this, you will need data and Stern subscribes to one of the two industry standards: S&P Capital IQ (the other is Factset). It is truly a remarkable dataset with hundreds of items on tens of thousands of public companies listed globally, including corporate governance measures. I believe that you have automatic access to Capital IQ and you should fine it in your Stern Life Dashboard. You will not regret it and it will not only save you lots of time in the future but will give you another weapon you can use in analysis. That’s about it, for now.
|2/3/17||As promised, here is the first of the weekly in-practice webcasts. These are 10-15 minute webcasts designed to work on practical issues in corporate finance. This week’s issue is a timely one, if you are working on picking companies for your project (as you should be..). It is about the process of collecting data for companies, the first step in understanding and analyzing them. The webcast link is below:
I don’t think it is too painful to watch and you may even find it useful. I have also put the link up on the webcast page for the class:
The webcasts for the first two classes should be on there, if you missed (physically, metaphysically or mentally) and the links to the project and syllabus that I handed out in the class. At the risk of nagging, please do get the lecture note packet 1 printed off or bought before Monday’s class. It is now available (or was at least yesterday) in the bookstore. One final note. I had mentioned that you had access to S&P Cap IQ yesterday but I did receive a couple of emails from people who were unable to access it still. Let me work on that today.
As you start the weekend, I decided to butt in with the first of my newsletters. As you browse through it (and I hope you do), you will realize that this is not really news or even fake news. It is more akin to a GPS for the class telling you where we’ve been and where we plan to go. It is a good way to get a sense of whether you are falling behind on either the class or the project, especially as we get deeper into the class. So, enjoy your Super Bowl parties and I will see you on Monday!
Attachment: Issue 1 (February 4)
|2/5/17||I am sure that you are at a Super Bowl party now and if you bet on the New England Patriots, not feeling that great! So, I’ll keep this short. This week, we will complete our discussion of the objective function in corporate finance, continuing with stock price maximization tomorrow and alternatives to that objective thereafter. Along the way, we will look at shareholder wealth maximization and corporate sustainability and I may kill a few sacred cows along the way. I also noticed that last semester’s corporate finance orphan list has become mixed up with this one. So, here is a new link for this year’s sheet. I am sorry but that was a Google malfunction on my part:
If you had added your names to the last list, please put them on this list and if you are looking for group members, please look on this list. I will see you in class tomorrow!
Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large. Relating back to class, I have a couple of items on the agenda and neither requires extensive reading or research. I would like you to think about market efficiency without any preconceptions. You may believe that markets are short term, volatile and over react, but I would like you to consider the basis of these beliefs. Is it because you have anecdotal evidence or because you have been told it is so or is it based upon something more concrete? We closed by talking about how managers in publicly traded companies can position themselves best to consider the public good, without being charitable with other people's money. Again, plenty to think about while you are sitting in your CSR class! We have spent a couple of sessions being negative - managers are craven, markets are noisy and bondholders get ripped off. In the next class, we will take a more prescriptive look at what we should be doing in this very imperfect world. As always, reading ahead in chapter 2 will be helpful.
I hope that your search for a group has ended well and that you are thinking about the companies that you would like to analyze. Better still, perhaps you have a company picked out already. If you do, try to find a Bloomberg terminal (there is one in the MBA lounge and there used to be one in the basement)... If you do find one vacant, jump on it and try the following:
If you cannot find a Bloomberg terminal or don't have access to one, try going on Yahoo! Finance and type in the name or symbol for your company. Once you find your company, find the tab that says Holders and click on it. You should get a listing of the top stockholders in your company. In fact, while you are on that page, take note of the percent of your company's stock held by insiders and by institutions. I have also attached the post class test and solution for today's class.
Staying on corporate governance, we will continue tomorrow with our discussion in class and return to the Disney story, picking up with Michael Eisner finally getting pushed out of the firm in 2005 and a new CEO, Bob Iger, coming in. Iger was the ant-Eisner, a CEO who seemed to embrace more openness and willingness to listen to shareholders. It is now 12 years later and this story in the Wall Street Journal about Iger captures how much things have changed:
The objective function matters, and there are no perfect objectives. That is the message of the last two classes. Once you have absorbed that, I am willing to accept the fact that you still don't quite buy into the "maximize value" objective. That is fine and I would like you to keep thinking about a better alternative with three caveats. First, you cannot cop out and give me multiple objectives - I too would like to maximize stockholder wealth, maximize customer satisfaction, maximize social welfare and employee benefits at the same time but it is just not doable. Second, your objective function has to be measurable. In other words, if you define your objective as maximizing the social good, how would you measure social good? Third, take your objective (and the measurement device you have developed) and ask yourself a cynical question: How might managers game this system for maximum benefit, while hurting you as an owner? In the long term, you may almost guarantee that this will happen.
This email has gone on way too long already, but one final note. A little more than two years ago, I took a look at Petrobras, just as a cautionary note on what happens to a company when its objective function becomes muddled (with national interest constraints). You can read it here.
On a related note, I will not keep tabs on your company choices officially, since I leave the choice up to you and will let you live with the consequences. It would be interesting though (to me and to everyone else in the class), if we could see the choices. I have never done this before, but I think it would be useful to keep tabs on numbers that you get for your company as we go through the class. It may help you keep tabs on where you are in the project, relative to everyone else.
Since you have a long weekend ahead of you, with nothing to do but binge watch The Walking Dead and old episodes of Game of Thrones, I thought I would get in two in-practice webcasts this week and nag you about your project (yet again). Since these webcasts are directly connected to what you will or should be doing on the project, the best way to use them is to pick a company and use the webcasts to get the relevant parts of the project done.
1. Assessing Corporate Governance: This webcast looks at ways to assess the corporate governance at your company, using HP from 2013 as an example. I use HP's annual report, its filings with the SEC and other public information to make my assessment of the company.
2. Stockholder Holding Assessment: This webcast is on assessing who the top stockholders in your company are and thinking through the potential conflicts of interest you will face as a result. The webcast went a little longer than I wanted it to (it is about 24 minutes) but if you do have the list of the top stockholders in your company (the HDS page from Bloomberg, Capital IQ, Morningstar or some other source), I think you will find it useful.
I hope that you get a chance to not only watch these webcasts but try them out on your company.
I know that you don’t want to spend too much time on this email. So, let me cut to the chase. Second newsletter is attached, hope you have picked a company and checked out your S&P Cap IQ access. Also, one more nag, when you get a chance, please go in and enter your company choice into the shared Google sheet.
Attachments: Issue 2 (February 11)
|2/12/17||I hope that you survived the miserable weather this weekend. If you did not, you would not be reading this email anyway, and since you are, I will assume that you have either become one of the Walking Dead or that you are a survivor. Tomorrow, we will complete our derivation of the CAPM and talk about alternatives to it, in hyper speed for two reasons. One is that I have zero interest in reinventing modern portfolio theory and showing the mechanics of correlation and covariance. The second is that while I use the CAPM as a tool to estimate hurdle rates, I am not wedded to it and accept all kinds of alternatives (some of which we will talk about tomorrow). If you are still shaky about even the assumptions that underlie the model, my suggestion is that you read chapter 3 from the applied corporate finance book before tomorrow’s class. On Wednesday, we start on the fun stuff of applying the model, starting with what should be a slam dunk (risk free rates) which is increasingly not and then turning to the equity risk premium, a number that analysts often turn towards services to look up but really has deep implications for both valuation and corporate finance. So, much to do and I hope that you come along for the ride. And a final nag: if you have not picked a company, do! If you have, enter the name into the Google shared spreadsheet, please!|
yourself that it will become fun. Anyway, here are a few thoughts about today's class.
If you can, try to make your assessment of whether the marginal investors in your companies are likely to be diversified. Look at both the percent of stock held in your company and the top 17 investors to make this judgment. If your assessment leads you to conclude that the marginal investor is an institution or a diversified investor, you are home free in the sense that you can now feel comfortable using traditional risk and return models in finance. If, on the other hand, you decide that the marginal investor is not diversified, we will come back in a few sessions and talk about some adjustments you may want to make to your beta calculations. You may want to look at the in-practice webcast I sent on the topic last Friday (and is also posted on the webcast page for the class), if you get stuck.
Finally, if you are up for the challenge, try to estimate the risk free rate in the currency of your choice. Of course, if this is US dollars, not much of a challenge… If it is in an emerging market currency, more so since you need default spreads (either from a sovereign rating or a sovereign CDS spread). Here are links to the latest versions of both:
It is time for this week’s puzzle: Yesterday, we talked about risk and return models in finance, and how they are all built on the presumption that marginal investors are diversified. While the argument for diversification is always a slam dunk in class rooms, with statistical evidence at its base, it is surprisingly contested. Thus, there is a significant subset of investors who believe that diversification hurts investors rather than helps them, and while it is easy to dismiss them as uninformed, I think we make a mistake by doing so. In this week’s challenge, I would like you to think about diversification intuitively and personally. In particular, read the full challenge here:
In fact, I can see why some investors may be better off with more concentrated portfolios and I captured the essence of the trade off in a blog post that I did a while back:
Then, please try to answer the following questions:
We started today’s class by tying up the last loose ends with risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:
The rest of today's class was spent talking about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. We looked at three different ways of estimating the equity risk premium.
2. Historical Premiums: We also talked about historical risk premiums. To see the raw data on historical premiums on my site (and save yourself the price you would pay for Ibbotson's data...) go to updated data on my website:
3. Implied equity premium: Finally, we computed an implied equity risk premium for the S&P 500, using the level of the index. If you want to try your hand at it, here is my February 2017 update:
4. Company revenue exposure: As a final step, see if you can find the geographic revenue distribution for your company. You can then use my latest ERP update to get the ERP for your company.
Beta reminder: Pease do try to find a Bloomberg terminal. Click on Equities, find your stock (pinpoint the local listing; there can be dozens of listings....) and once you are on your stock's page of choices, type in BETA. A beta page should magically appear, with a two-year regression beta for your company. Print if off. If no one is waiting for the terminal, try these variations:
|2/16/17||If my nagging is paying off, you should have picked a company by now and if you have, you can move on to the equity risk premium part of your project. The first step is to review the material from yesterday’s class first, so that you understand the basics of equity risk premium estimation. Once you have done that, you should print off or download (I prefer the latter) the annual report or 10K for your company. As you browse through the document, look for any information that the company gives you on where it does business. Most companies will give you a breakdown of revenues geographically, though not always at the level of detail that you like, and some may even go further and give you EBITDA or assets geographically. Take what you can get and stick with revenues as your measure of geographic exposure. Your final task is to create a weighted average of the equity risk premiums and while you can use the equity risk premium spreadsheet below and your task can range from simple to slightly messy, depending upon your regional breakdowns:
1. If you have your company’s exposure to individual countries: Your task is simple. You can use the equity risk premiums that I have for those countries and take a weighted average.
2. If you have your company’s regional exposure and it matches my regional breakdown: I computed weighted averages for Asia, North America, South America, Western Europe, Eastern Europe/Russia, Asia and Australia/NZ. If your company breakdown is similar or close, you can use my weighted averages.
3. If you have your company’s regional exposure but it does not match mine: You will have to be ingenious, but it is not too difficult to do. Within the country risk premium spreadsheet, you will notice a worksheet that says regional weighted averages, with GDP and ERP for every country, classified by region. Set the GDPs of any country/ region you don’t want to count in your average to zero and the spreadsheet will compute the ERP for your designated region. Thus, if you has a US company that breaks down revenues into the US and the rest of the world, all you need to do is set the GDP for the US to zero and the global weighted average that you get will now be for the rest of the world. If you have no idea what I am talking about, watch the in-Practice webcast which will be put up tomorrow. And one more nag: please remember to enter your company name in the Google shared spreadsheet. We are moving slowly in filling it up but we are getting there:
In advance of a long weekend, I thought I would be delusional and give you the tools to get caught up on the project (as if there is any chance of it happening). There are two in-practice webcasts for this week, one on estimating risk free rates in a currency and the other on computing an ERP for a company:
2. ERP for a company: This webcast looks at both how I estimate equity risk premiums for countries and how to estimate the equity risk premium for an individual company, even one that uses an eclectic geographic breakdown of revenues:
I hope that you get a chance to take a look at one or both.
As you begin a long weekend, I am sorry to intrude (not really, but I thought it was the polite thing to say anyway). The newsletter for the week is attached. It contains scintillating writing, breaking news and mind-blowing insights. I know that we have not got to valuation yet, but I have always believed that you don’t need to take valuation to understand valuation. You can test out that proposition by reading my Snap IPO valuation, if you have the inclination:
Attached: Issue 3 (February 18)
|2/19/17||I should probably give you a day off, since the weather is amazing and you have a long weekend, but I cannot help myself. I will keep it short, though. Since we have only one class this week, we will start on our discussion of relative risk (or beta, if you prefer Greek). In advance, it would really help if
1. You have picked a company
2. Downloaded the financials for the company
3. Chosen a currency to do your analysis in
4. Estimated a risk free rate in that currency
5. Estimated an ERP for your company, given its operating exposure
6. Printed off the beta page for your company from a Bloomberg terminal (If you don’t know where to find one, there are a few in the MBA lounge.)
In fact, if you are well along in this process, please go to the Google shared spreadsheet and enter your company details (so far).
I will be reaching out tomorrow to those of you who have not visited the page and that is not a threat, just a promise!
Both economics and finance are built on the pillar of risk aversion, i.e., that investors need to be paid extra (over and above an expected value) to take risks. That notion of risk aversion has been challenged and modified over time, but it still is at the heart of how we measure risk and come up with expected returns. Economists agree that not only does risk aversion vary across individuals but it also varies, for the same individual, across time. In this puzzle, which has no right answer, I would like you to wrestle with the question of how risk averse you, explanations that you can offer for that risk aversion and the consequences for your business and investment decision making. You can find the full details of the puzzle here:
One of the side products of the growth of robo advisors is a proliferation of tools that investors can use to assess how risk averse they are. This article in the New York Times nicely sets the table. In the article, though the links to free risk assessment services are no longer free. There are, however, plenty of risk aversion tests online. Here are a couple that you can try at no cost:
Today's class covered the conventional approach to estimating betas, which is to run a regression of returns on a stock against returns on the market index. We first covered the estimation choices: how far back in time to go (depends on how much your company has changed), what return interval to use (weekly or monthly are better than daily), what to include in returns (dividends and price appreciation) and the market index to use (broader and wider is better). We also looked at the three key pieces of output from the regression:
If you can get your hands on the beta page for your company, you should be able to make these assessments for your company. You can also get a guide to reading the Bloomberg pages for your company by clicking below:
|2/24/17||In keeping with project Thursday, I hope that you have had a chance to print off the Bloomberg beta page for your company. Once you have it, do check the adjusted beta and confirm for yourself that it is in fact equal to
Adjusted Beta = Raw Beta (.67) + 1.00 (.33)
I mentioned in class that I initially was curious about where these weights were coming from but I think I have found the original source. It was a paper written more than 30 years ago (which I have attached to this email) that looked at how betas for companies change over time and concluded based upon a small sample and data from 1926-1940 (I am not kidding!) that they converged towards one, with roughly the magnitudes used by Bloomberg. Why has it not been updated with larger samples and better data? Well, that is what happens when "here when I got here" becomes the response to questions about numbers we use all the time. I have also forwarded this email to the beta calculation guy at Bloomberg. I hope that they have let him out of that basement room, where he was locked up. Tomorrow’s second In-Practice webcast will cover how to read a regression beta.
I went through the Bloomberg regression beta page in class and suggested that you try doing the same with your company. In this week’s webcast, I take a look at Disney's 2-year weekly regression (from February 2011- February 2013). I have the Bloomberg page attached. I am also attaching the spreadsheet that I used to analyze this regression, which you are welcome to use on your company. The webcast is available at the link below:
Attachment: Risk Checker spreadsheet
|2/26/17||The first quiz is coming a week from tomorrow, but this week, we will continue with our discussion of regression betas. Tomorrow, we will look at alternatives to regression betas starting and that discussion will spill into Wednesday. Along the way, we will look at how to estimate the beta of a company after a merger and the betas for different parts of a multi-business company. If you want to read ahead in chapter 4 of the book, please do so. It is one of the most critical parts of the class, especially since it will feed into almost everything else we do later in the class.|
We spent most of today's class talking about the determinants of betas. Before we do that, though, there is one point worth emphasizing. Betas measure only non-diversifiable or market risk and not total risk (explaining why Harmony can have a negative beta and Philip Morris a very low beta).
1. Betas are determined in large part by the nature of your business. While I am not an expert on strategy, marketing or productions, decisions that you make in those disciplines can affect your beta. Thus, your decision to go for a price leader as opposed to a cost leader (I hope I am getting my erminology right) or build up a brand name has implications for your beta. As some of you probably realized today, the discussion about whether your product or service is discretionary is tied to the elasticity of its demand (an Econ 101 concept that turns out to have value)... Products and services with elastic demand should have higher betas than products with inelastic demand. And if you do get a chance, try to make that walk down Fifth Avenue...
2. Your cost structure matters. The more fixed costs you have as a firm, the more sensitive your operating income becomes to changes in your revenues. To see why, consider two firms with very different cost structures
3. Financial leverage: When you borrow money, you create a fixed cost (interest expenses) that makes your equity earnings more volatile. Thus, the equity beta in a safe business can be outlandishly high if has lots of debt. The levered beta equation we went through is a staple for this class and we will revisit it again and again. So, start getting comfortable with it.
I also introduced the notion of betas being weighted averages with the Disney - Cap Cities example. I worked out the beta for Disney under two scenarios: an all-equity funded acquisition of Cap Cities and their $10 billion debt/ $8.5 billion equity acquisition. As an exercise, please try to work out the levered beta for Disney on the assumption that they funded the entire acquisition with debt (all $18.5 billion). The answer will be in tomorrow's email.
If you are ready to get started on preparing for the first quiz, here are the links that you need:
|2/28/17||I hope that you are out in the park or on that walk down fifth avenue, testing out your beta reading skills. This week’s challenge is on betas and I have used two companies, Valeant and GoPro as my lab experiments. First, check out the description of the puzzle (with the beta pages for both companies):
Once you have browsed through it, here are the questions that I would like you to consider:
For Valeant, list out the key regression statistics (alpha, beta and R squared) in the four regressions. Do you notice any patterns? Can you explain them?
If you are analyzing Valent and were required to use one of these regression betas, which one would you use and why?
With the beta that you decided to us, estimate the range on the beta and what it means for your estimate of cost of equity.
During the period of the regression, Valeant lost almost 80% of its market value and was involved in multiple scandals and management turnover. What effect, if any, do you think this crisis has had on your estimated regression betas (increased them, decreased them, left them unchanged)? Explain why.
With GoPro, why is the standard error on the beta so high? What are the consequences for using GoPro's regression beta?
On a different note, the first quiz is on March 6 (next Monday). Here are a few notes on the quiz:
What it will cover: The quiz will cover all the material we get through before tomorrow’s class (roughly side 174 or 175 in the packet). It will be on risk free rates, equity risk premiums and betas for the number crunching part and there will be a section on corporate governance, for those of you like the fuzzy stuff. In chapters in the book, it will cover from chapter 1 through midway in chapter 4, when I estimate betas for companies.
How to prepare: The best start, if you have missed a class or classes, is by watching that class. If you start early, I would also recommend working through the post class test and solution for each class. Once you feel comfortable with that, you can start on the past quizzes. The quizzes go back to 1997 and I would suggest starting with the most recent quizzes and working backwards. The links are below:
Past quizzes: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1.pdf
Past quiz solutions: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1sol.xls
Quiz Review: I am truly sorry that I will not be able to do the quiz review in person (and I promise that I will be back to doing that on the next two quizzes) but I have leave for Lagos, Nigeria, right after my afternoon class tomorrow and won’t be back until Sunday. Don’t worry! I will still be checking emails and answering questions, if you have any. However, I do have the review session from last year recorded on YouTube and you can watch it when you get a chance. The slides that I used are also in the attachment:
Review webcast: https://youtu.be/ZPo46wQGfe0
Review slides: http://www.stern.nyu.edu/~adamodar/pptfiles/acf3E/reviewQuiz1.ppt
TA review sessions: The TAs are all incredibly knowledgeable and helpful. Please avail yourself of the TA review session on Thursday. The sign up sheet is at this link: https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1EU5ifKxB3uep697TLSjdkO0od-TDbPOsK9InHLa-u1w/edit?usp=sharing.
I know that today's class was a grind with numbers building on top of numbers. In specific, we looked at how to estimate the beta for not only a company but its individual businesses by building up to a beta, rather than trusting a single regression. With Disney, we estimated a beta for each of the five businesses it was in, a collective beta for Disney's operating businesses and a beta for Disney as a company (including its cash). If you got lost at some stage in the class, here are some of the ways you can get unlost:
Catching up with past promises, if you remember, we looked at the beta for Disney after its acquisition of Cap Cities in the last class. The first step was assessing the beta for Disney after the merger. That value is obtained by taking a weighted average of the unlevered betas of the two firms using firm values (not equity) as the weights. The resulting number was 1.026. The second step is looking at how the acquisition is funded. We looked at an all equity and a $10 billion debt issue in class and I left you with the question of what would happen if the acquisition were entirely funded with debt. (If you have not tried it yet, you should perhaps hold off on reading the rest of this email right now)
I mentioned that there the class will be spilt on Monday for the 10.30-11 quiz slot. I was lucky enough to get KMEC 2-60, which is a bigger room and here is the seating arrangement for the quiz:
Three very quick notes.
2. Class yesterday:
And this email is from Nigeria.
|3/3/17||I know that you are in no mood for in practice webcasts or working on your project, but I have a webcast on the mechanics of estimating bottom up betas. I use United Technologies to illustrate the process and I go through how to pull up companies from Capital IQ. Even if you don't get a chance to watch it after the quiz, it may perhaps be useful later on. Here are the links:
United Technologies 10K: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/UT10K.pdf
Spreadsheet to help compute bottom up beta: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/bottomupbeta.xls
The last spreadsheet has built into it the industry averages that I have computed for different sectors in the US in 2015. You can easily replace it with the global averages from 2016 that I also have on my site and tweak the spreadsheet. Give it a shot!