Alan Kring Productions in association with the Emergent Light Studio presents
the Illinois State Collegiate Compendium, Academic Lecture in Business and Economics.
This is Business Finance, FIL 240 for autumn semester 2023.
Today, corporate valuation alternatives. Now I'll go on rambling for a while and then at
2.45 I open the quiz and everyone just gets to live the dream taking a quiz
five and when you're done you go. I'll make sure I remember to give you the
password so that you have that. Try to think if there's anything else before we
go in. We're going to look at the numbers. The numbers are not pretty at all today.
It is kind of a wide sweep. The markets are in a bad mood right now for one
reason or another and it's just a sour day on the street. As you can see the
Dow is down a third of a percent and then the S&P is down a rather surprising
1.44 percent and then the NASDAQ is in the toilet at two almost two and a half
percent down. It's just a really rough day out there today and there are a lot of
reasons for that but I mean some of the reasons just seem like they're
speculative. We still have good signs on the economy that it's doing well.
The Fed isn't threatening to raise interest rates. So what is honking off
the markets this much? Now as you can see crude oil is just basically in the
middle of its trading range. It's up a little bit up 2% but it's
nothing to get excited about at all. It's bouncing between 82 and 88
nicely right now as I told you it probably would. Gold is getting rather
close to that resistance at $2,000 an ounce. You see it right there? Not
pleasant at all. An unpleasant little look that the gold has because we're
almost near that line. Something is wrong with this. I'm gonna have to refresh this
screen but there we go. Oh yeah it's it's a rough day out there. So anyway moving
on from where we were with gold. Now crude was down and then it
was up but it's just bouncing around gold up some so that's a little concern.
Notice silver which is not as speculative isn't doing anything
particularly at all and so the gold going up is most likely based on
speculation of bad economic times. However we'll just have to see about
that. The euro is depreciating against the dollar and so is the British pound.
So those economies must be in less have less positive prospects than ours for
what for one reason or another and the yen is depreciating against the dollar
as well. So the US dollar is strengthening for what that's worth.
Notice that the Nikkei rose early in trading. This was in the middle of the
night last night and at night last night and then it just sort of bounced around
and then it did a sell-off close to the end and then it rallied a little tiny bit
at the end. Now the London they did sort of a similar thing. They started out down
and then they rose and then went down and then they came climbing back up
again. So there's a lot of volatility out there. It looks like a lot of
uncertainty but it's not a pleasant day on the street right now at all. Let me
show you a couple of things real quick here. If you are a bear well there are a
couple of things you can do. I'm going to teach you how to make money having
stock prices go down. Most people think the only way you make money is if
stock prices go up. No, they can go down and you can make money off that. It's
called short selling. There is another way that you can profit make money off
stocks falling. You would just take bearish funds ETFs that are on the sour
side. I'll show you a couple. I may have shown you these before. Here's one SQQQ.
That is a bear fund. It's an ETF that's bearish. Well is that an ETF even?
But look at that. On a day when the market is bearish, really bearish, that
son of a dog is up more than seven and a half percent in one day. There's
a way. Well I'm a bear. It's a bear market. How do I make money? Go for these
funds that are contrarian. They go up when the stock market goes down. Let me
try another one here. This is one. This is mostly NASDAQ stuff. Betting on the
NASDAQ going down in the NASDAQ as you can see went down a lot. Here's one
that's contrary on the Dow. Well that one kind of sucks. And then we've got SPXU
SPXU I think. Let's look at that one first. Yep. Bearish. It's a bear fund.
Short. See that short there? Short is bear. Okay so here we go. It's up more than
half of more than four and a half percent. There you go. So you don't have to
wait for a bull market to be a successful investor. This is the message
that we're getting from this kind of thing right here. I want to look at
something real quick here. Look at this. See the beta? This is the SPXU. Look at
the beta. It's negative. That's the contrarian. It's moving against the world
portfolio. That's what a negative beta would tell you. And in a case like this
that's what you want. You want it to move contrary. The opposite. And this one is
almost three, a magnification of three on the world portfolio. Taking that to be
what beta means. Another one. Is that SPX? I think SPXL? No that's a bull. SPXL is a
bull. That one should beat you up. That one's taking a butt back. But these funds
you can go bull or bear on these funds and they're not that expensive to jump
into. This one 70 about 72 bucks a share for it. The one I just gave you the
ultra pro short 12.86 a share. So it's not a costly buy-in to the game and
that's a bear fund. So if you want to be a bear and you want to be a cheap bear
then you would probably reach for something like the S&P 500. I didn't have
things of remember look at the SQQQ. How much is that one? 21 bucks 21.83 a
share. That's for a bear position. Now on the other hand if you want to do bull
stuff you would go TQQQ and it's taking a butt bath today. But notice that that
one is taking a dive because it is a bull position. It's a long position and of
course look at its beta. That is very risky. It's going to magnify the hell out
of the market when it plays its hand. So there you go. One way or
the other these are the funds that you can look at if you want to take bear
positions especially. Now with bull positions they're easy find ETFs that are
normal ETFs or just regular stocks and jump into those. With bear positions you
can do short sales but those are kind of complicated. I'll show you how to do them
but they require margin accounts. This you just buy in and you're on the bear
side of the market and you hope that the bears win. You stop being chipper and
optimistic and you start being pessimistic. These are a way that you can
make money in the bear markets. So the idea that stocks go up that's the only
way people can make money and everyone loses when the stock market goes down.
No horse crap. You just have to know a little bit about the markets and you don't
have to do fancy stuff. Just go for some of these bear funds. These short as we
call them short funds. Okay enough of the boy. Look at that beta on that one.
That's TQQQ but yeah these are some of the things that you can do in
the market. Now the last thing that on stocks and just a few overview words and
I had talked about this earlier but I just want to refresh your mind for a
future quiz. Not for this one and for of course the final. Just the basics of
stocks and a couple of different ways that are alternatives for valuing a
firm and valuing its equity. Now the first thing is just as a refresher from
something for something I did earlier. When I use word stock usually when I use
that word what I'm actually referring to is common stock. However there is another
kind of stock which is called preferred stock. Now understand that these are both
equity and if it's equity it has the residual claim. The bills have to pay be
paid in a timely manner before any stockholder can get a
dividend. Get anything or reinvestment in the company. So that's the first thing
to appreciate is it neither of these has any prior claim over the debt, the
liabilities. However within equity the preferred has the prior claim to
dividends. The preferred has the prior claim. The preferred has to be paid a
dividend if there is preferred in the company issued by the company and only
if the preferred is satisfied per the contract itself then the common stock
can get a dividend or get reinvestment in the company. Now there's a problem
here one last thing. When we refer to common stock when I say stock I probably
mean common stock and within that you have to look at if there is
the classification. There could be more than one kind of common stock. The kind
of common stock, there's the normal kind. You get one vote at a shareholders
meeting for each directors position that's open and that's it. You get
dividends if there's a dividend declared and all of that. There could be another
kind of stock. There could be this ancient founder stock. That would be
stock that was for insiders. It has probably has super majority voting to
allow the insiders to maintain control of the board of directors. It may also
have and I am honestly I'm not sure about this but I think I've seen examples
where the of classifieds where the founder stock had a different dividend
from that of the normal stockholders. Not sure about that but I saw I've seen a
couple of references to it. Now the founder stock is generally generally
subject to rule 144. Rule 144 of the Securities Exchange Act of 1934
restricts the sale of the founder stock because they probably have inside
information. So their certificates at least back when they were printed
certificates were printed would have a big red stamp on them restricted and
that there were rules under which that stock could be leaked. L-E-A-K-E-D. In other
words a founder doesn't have to keep all of his or her stock but he can't just
sell it to a broker. Hi I've got 50 million shares of founder stock. Sell them
all. You can't do that. There are windows that are allowed but you have to have an
opinion of legal counsel that says this is acceptable to do this sale is
acceptable under rule 144 and for this amount. There has to be a notification to
the SEC all that good stuff. So in other words you're a founder. You got 50
million shares. Well you know I'd kind of like to dump a half million of those
shares. Well if the legal counsel says yes under rule 144 you can do that for
this period of time then it would be a go. You would file the proper forms to
be able to do it and all that. You can even find websites where they list
insider trades on stock. You'll see it and sometimes people can't keep an eye
on that. Well what if what if you see the insiders of some corporation all getting
rid of stock at the same time. Well that would be some people's idea of a good
let's get out of this before the founders must know something so let's
get out. So it's one of those things you keep an eye on at the certain websites
will show you that information and it's good to know that oh these insiders are
getting rid of stock. That doesn't necessarily mean that this that these
guys thinks the stock is going to the company's going to hell. You might be if
I've been in companies I have consulted for companies where the founders they
weren't paying themselves hardly anything in salary. They just plowed
forward year after year keeping the company going. So when a window opened
under rule 144 yeah they kind of some of them sold a lot of stock that they could
sell just so they could make up for all the years that they had gone without
much in stock. That's it's not it's not a sign that the company is going to hell
always. It might just be okay we just we just want some money because we haven't
been paid very well and others it's just greed. Yeah I want to buy myself a new
boat yacht or something but it's not always a bad sign. But if you see a bunch
of insiders using 144 at the same time that might be a little bit more
worrisome. What do they know kind of thing. One but one way or the other you
will not be up you don't go out and buy founder stock. Once a founder sells it
it's just regular stock okay. It's just normal stock but and then it's so you're
not you still suddenly become a founder with it. Although that inside those
inside chairs if they have super majority voting rights they're probably
not going to be out there in the market to be sold. However you saw one example
Berkshire Hathaway. You can buy the heavies the big Berks. Now if you just
want to be a Berkshire Hathaway shareholder you buy the baby Berks. Those
are cost you $337 each and what's even suckier about them is that they don't
really pay much of a dividend. It's a decent stock though but I mean it's not
the kind of stock that I would be too interested in buying. Beta is low and all
that but if you want to be one of the big Berks be our K and participate in
the have those super majority voting rights and all that well let's try that
again. BRK. Yeah those cost $513 and whoa did you see that price jump by a couple
hundred dollars there now down a couple well yeah but that's actually very small
percentages but if you want to be in the big league with some heavy duty the
inside stock it's right there for you. Now if you're going to do that let me
know and I'll help you give you some investment advice for a commission fee
which you can I'm sure afford if you could buy a half a million dollars a
share. Some of you will actually have enough money you could do that someday
but you probably wouldn't even if you had a lot of money because you'd have to
have a lot of money to throw a half a million dollars and just plain old
stock which is really what this is. There's nothing extraordinary about it at all
except for the price but anyway that's the inside. Now the preferred stockholders
let me mention those a little about the valuation. I'm going to write
VLT 1.75% cumulative preferred and I've done this before but I'm just doing it
again. Cumulative preferred par value $80 per share. Now what this means is first
of all this word right here cumulative would not necessarily be on a
preferred stock certificate. If it is it's quite a thing but what this says is
that your annual dividend will be equal to 1.75% times the face value of 80. It's
like a coupon. Remember you take the coupon rate times the face value you get
the value of the coupon. That's what this is. Really quickly here let me get a
calculator up here and I'll take 0.0175 times $80. So every year for each
share you own you get $1.40 per share and that $1.40 must be paid before a
common dividend is paid. That's why I put that prior there and if it's not paid
then the dividend then the common shareholders cannot be have a dividend
declared for them. Now if it is cumulative preferred if the company
doesn't pay the preferred dividend one year it has to pay it plus the new
dividend the next year and that goes on and on. So as long as it's cumulative
preferred as long as the company hasn't caught up with its preferred dividends
the common shareholders will not get a dividend. So that's the nice thing about
cumulative. It's not pleasant though if you're a common shareholder. If you were
looking around for some common stock you like dividends. It's a little
fixed income and you notice oh wait this company has cumulative preferred. That
means if the company ever fell down and couldn't cover its preferred dividend
you wouldn't get a dividend as a common stock shareholder. Furthermore if it's
cumulative that company could not be able to pay its preferred dividend for
years and you will never see a dividend until it catches up if it ever does.
That's how bad it is. Preferred dividend preferred common as I said preferred
stock used to be kind of popular not really anymore. Don't see much of it not
as much as you used to and one thing companies they are it's like a real
commitment. Now one thing that I have seen is preferred that is convertible
where the company can't or it could be the invest it could be the preferred
shareholders can decide to turn the preferred into the value equivalent of
common. That's I I don't know maybe it's just me and the numbers that I look at
but I've seen more of that now than I did 20 years ago. Preferred being issued
but it has a convertibility provision in it that it can be turned into common
stock which of course would be good for the common stockholders out there in a
way because otherwise that preferred would hold off dividends for the common
it could forever but if it can if the company converted it to common stock
then they're all on the same playing field. That's that would be one good
thing about. The bad thing about that would be if that stock is converted into
common stock it waters down the common stock. Okay suppose that there are 10
million shares of common stock outstanding and a million shares of
preferred could each be converted to a share of common. That would mean that
suddenly there were not 10 million shares of common stock there were 11
million shares of common stock. So that would water down your percentage
ownership for your common stock holdings if you're just a common stock
holder. There's one other thing no by the way common stock is a preferred stock
is easy to price it's a joke because it's a no growth perpetuity. That dividend
goes on forever. So let's say that's a discount rate for preferred stock right
now the dividends from preferred stock is let's say 2% 2.00%. So the price of
the preferred would be nothing but a dollar forty over point oh two that being
dividend the flat dividend divided by the discount rate. It's a it's a classic
no growth perpetuity and if I do that it should come out below $80 take 1.40
divided by 0.02 yeah that's $70. Notice just like bonds if the market wants 2%
and the company pays 1.75% then the price will be at a discount to par. It's
like bonds when the required rate of return by the investors the yield is
higher than the coupon then the bond will sell it at a discount to par. It's
the same thing. It's a very easy much easier formula but there you go. That's all
there is to that. One thing I would be remiss if I didn't bring it up. With
common stock getting off preferred stock for a month getting away from
preferred stock. Now this refers primarily to common stock. Generally
speaking, common stock will have preemptive rights. It works like this. I've
got 10 million shares of stock outstanding and I want to do a public
offering for 5 million shares.
Suppose that you own a million shares. That would mean that your position, your
your ownership of the company stands at 1 million shares over 10 million shares.
So you have a 10% ownership of the company. Now suppose the company says
we're going to do a public offering of 5 million shares. That would mean that the
total after the new issue would be 15 million. That would take you down to a
million over 15 million. That would reduce your ownership position. Take you
go down to 6.67% ownership. Preemptive rights mean that you have first dibs to
keep your position. So in other words, you would have a preemptive right to buy
5,500,000 shares. So that your final position would be 1,500,000 shares
over 15 million shares which of course would mean that you're back up to 10%
ownership.
Whoops, 1,500,000 over 15 million which puts you back up to 10%. You have the
right to hold your ownership stake. You don't have to, but you have the right to.
Now the interesting part of this is, well I'll get into that in just a minute. This is
just preemptive rights. That's all it means is that you, this, there are 5
million shares. There has to be enough shares that can be bought during a
certain time period by existing owners up to the point where they would hold
their position. Now I might choose, well I can't really afford 500,000 shares. I
could buy 200,000. So you could subscribe for 200,000 under your preemptive rights.
You could subscribe for any amount up to what would bring you back to your
original position. Anything you buy after that, you're on your own for it. The real
question though, do you want to exercise your preemptive rights? There are reasons
why you would want to to maintain your position of control in the company,
but there are some reasons why you might not want to do that. Some of those reasons
go to this. The company is going to buy, sell stock. Let's say it's a
seasoned offering. In other words, the company's been public. It's got
outstanding stock out there. It just wants to raise more money by selling
stock. The problem is this. First of all, why would a company want to raise equity
capital? As you'll see next week and the week after that, equity capital is a lot,
usually a lot more expensive than debt capital. So in other words, the cost
a company selling common stock to raise money is going to be lifting its
weighted average cost of capital. So why would it do that? But there's another
reason too. Company, think about the logic. If you are the insiders of a
company and you're looking at the stock price and projecting what it will do
based upon the company's knowledge of the prospects for cash flows and all
that. You look at the stock price. Would you as the company want to sell
your stock price when you had determined that the stock was near its high or near
its low? In other words, if I'm going to sell 500,000 shares of stock and I'm
going to sell that and I think that right now the company's stock is at $20 a
share. Later I think that I see projecting that in about a year it's
going to be $10 a share. When would I sell through that offering? Would I sell
it through the offering now when it's $20 a share or would I wait until it
fell to $10 a share? The obvious answer is I'd sell it when it was at $20 a
share. So in other words, there is good reason to believe the company sells
stock when their internal numbers tell them that the stock is near its high.
And then it's going to fall from that high. Otherwise, why would they sell the
stock when they wait? Oh no, we better wait until it falls to $10 a share so
that we raise 5 million times 10 instead of 5 million times 20. No, they're
going to sell a stock when they project that it is going to be near its high
when the offering goes live. That's the problem. You have to be suspicious of
stocks. So if you're exercising preemptive rights, you would be exercising
those like all the other suckers who are going to buy the stock during the
offering. So you would want the company to give you some kind of a deal to
exercise your preemptive rights. Otherwise, you're just buying it at the
high like every sucker out there in the open market is going to. That's a good
reason not to exercise your preemptive rights. A good reason to exercise them is
that that maintains your control over the company. You had 10% control and if
you don't exercise your preemptive rights, your control goes down to 6 and
2 thirds percent, which is might not be something you want. You want to maintain
your control because that's the only way you think that the company can do what
you want it to. What you and other investors have in mind instead of a
bunch of newbies jumping in on it and getting positions. That's about stock and
all that. That's the latest it's been today.
I think, oh, I don't know.
Let me show you one last thing. Valuing the company. The classic approach would
say that the value is going to be the sum from i equals 1 to infinity of the
free cash flow at year i divided by 1 plus weighted average cost of capital
to the i-th power. In other words, the infinite stream of annual free cash
flows, for example, discounted back to the present. Theoretically, that's great.
Practically speaking, it's a pain in the butt because you have to project the
free cash flows for every year from now to eternity. Typically, we don't do that.
We go out about 10 years and every year whatever we're projecting the free cash
flow to be is going to be even more and more uncertain. It's done though. We do it
that way and that's the way I teach it in some classes. There are other ways to do
it too and I'll go through one of those right now. Now there is a complicated
formula for enterprise value, EV enterprise value, but there is a quick
dirty way to do it. You go to the financial site like Standard Poor's
Global Net Advantage and you get the enterprise value average of the industry
and then you divide that by the earnings before interest and taxes and
depreciation and allowance of the industry and then you multiply that by
earnings before interest and taxes and depreciation and amortization of the
company and this will give you the enterprise value of the company. Like I
said, there's a complicated formula to get enterprise value directly. You do this
and that and all that. This is the way that I've seen it being done. It's
quite popular. You just go to Standard Poor's Net Advantage and you say, all
right this company is in this industry. What's the enterprise value of the
industry? The number will be right there. Okay, what is the average EBITDA of the
industry? It's right there in the Global Net Advantage and then you take the
company itself and you look at its financials and calculate EBITDA. In
other words, earnings before interest and taxes, operating income, plus depreciation
and amortization, which you can get from the free cash from the statement of
cash flows. That'll give you a decent estimate of enterprise value, which is
one of the ways that we can say the value of this company is. It's just one of
those things we do and it's a short dirty way. The book emphasizes the more
complicated way, but I think it actually mentions that. The mention should be, oh
by the way, this is the easy way. This is the way we do it usually. But anyway,
you've got a quiz to take. I want you to crank it up and when you are finished
with that quiz, that's all I have for you. I thank you.