Table of content
1.1. Study goals and research question
1.2. Media and entertainment market overview
2. Literature review
2.1. Company ratio analysis
2.1.1. Asset-position ratios
2.1.2. Financial risk and liquidity ratios
2.1.3. Earnings and profitability ratios
2.2. Company evaluation with Discounted Cash Flows
2.3. Company evaluation with multiples
2.4. Company share indicators analysis
2.5. Media and entertainment companies’ valuation specific
2.6. Technical stock analysis
3. Empirical research
3.1. Introduction of the companies
3.1.1. Companies overview
3.2. Method and Procedure
3.3.1. Country analysis
3.3.2. Industry analysis
3.3.3. Company analysis
184.108.40.206. Application of ratio analysis
220.127.116.11.1. Asset-position ratios
18.104.22.168.2. Financial risk and liquidity ratios
22.214.171.124.3. Earnings and profitability ratios
3.3.4. Application of Discounted Cash Flows
3.3.5. Application of multiples
3.3.6. Application of share indicators analysis
3.3.7. Media and entertainment companies’ evaluation specific ratios
3.3.8. Fundamental analysis summary
3.3.9. Application of technical stock analysis
3.3.10. Analysis summary and answering the research questions
4.1. Critical overview of the main findings
4.2. Further implication
1. Financial Statements of 21st Century Fox
2. Financial Statements of CBS
3. Financial Statements of Comcast
4. Financial Statements of Viacom
5. Financial Statements of Time Warner
6. Financial Statements of The Walt Disney Company
List of Figures
Figure 1. Trends in percentage of total personal-consumption expenditures in selected categories, 1980–2013.
Figure 2. “Head and Shoulders” pattern example.
Figure 3. “Cup-and-handle” pattern example.
Figure 4. “Triangle” (symmetrical) pattern example.
Figure 5. “The Flag” pattern example.
Figure 6. “The Rising Wedge” pattern example.
Figure 7. Real GDP, percent change from preceding quarter.
Figure 8. Labor Force Statistics from the Current Population Survey.
Figure 9. Media and Entertainment Spend 2014 – 2019, CAGR by region (%).
Figure 10. US spending 2011-2019, CAGR by business model (%).
Figure 11. Total Returns to Shareholders 2010–2015.
Figure 12. Time Warner 3-years stock chart.
Figure 13. Time Warner 3-years stock chart with patterns.
Figure 14. Time Warner 1-years stock chart.
List of Tables
Table 1. Company ratio analysis’ summary.
Table 2. Data extraction from financial statements of 21st Century Fox, CBS,
Comcast, Via-com, Time Warner and The Walt Disney Company.
Table 3. Company ratio analysis in media and entertainment business.
Table 4. Asset-position ratios calculation.
Table 5. Financial risk and liquidity ratios calculation.
Table 6. Earnings and profitability ratios calculation.
Table 7. WACC calculation.
Table 8. Calculation of average growth rate of Free Cash Flows.
Table 9. Entity Value calculation on the basis of Discounted Cash Flows, WACC-Approach.
Table 10. Discounted Cash Flows summary.
Table 11. Multiples calculation.
Table 12. Share indicators calculation.
Table 13. Developed ratios calculation.
Table 14. Full overview of fundamental company analysis.
The media and entertainment business in US shows stable growth over many years. Present study aims to discover if current share prices reported by the top companies, which are 21st Century Fox, CBS, Comcast, Viacom, Time Warner and The Walt Disney Company, express their intrinsic value and what company is worth to invest. Financial statements reported in 2016 are analyzed with ratios, discounted cashflows, multiples and share indicators. Fundamental analysis is used to define, which company has the best investment opportunities, thus what shares to buy. Technical stock analysis is used to define the best timing to do that. Research determined that Time Warner shows the best investment conditions; however, shares acquisition is not recommended due to missed moment – from the date official statements were issued, share prices have soared. Study also includes country analysis (US) and industry analysis (global media and entertainment market).
Keywords: company valuation, financial analysis, intrinsic and market value, investment decision, US media and entertainment business.
Evaluation of companies in media and entertainment business - Theoretical models of company evaluation and practical application on major US media companies.
Wisely made investments may bring extraordinary positive changes in our life. However, getting the required wisdom may be a challenge for people facing the actual task of managing a capital. Although the wide research and following knowledge about investors, their behavior and environment is available for learning, we still make mistakes, loose fortune, fail at stock exchange and bring business to bankruptcy. Nevertheless, people keep investing and looking for the best ways to get high return with low risk in order to enhance their wealth.
The nontriviality of this task could be explained with multiplicity and complexity of factors, which influence the investment process and its participants. These factors could be divided into rational factors, which can be followed, calculated and mainly studied by economics; and irrational or behavioral factors from the field of psychology and sociology, that are bias, on which the research could not be 100 percent sure and which, therefore, could reduce the rationality of judgements. Both groups of factors are important and make the difference. Yet, the present study aims to focus.
1.1.Study goals and research question
In order to understand the nature of investment process and possibility to make a sensible investment decision, the present study is conducted. On focus are tools used to increase rationality of the choice and avoid bias, while choosing certain shares to acquire. Therefore, rational factors are mainly considered. Behavioral aspects are intentionally not included in the study. However, the awareness of them allows decreasing the influence. The researcher from this point acts like an investor seeking for beneficial shares acquisition. Investment decision is made based on factual numbers used in empirical research.
Giving a frame to the direction of investment opportunities, the variety of choice is limited to the reasonable amount possible to embrace. Therefore, one industry, namely media and entertainment (M&E) is selected. More precisely the choice will be made among top six global media US companies, in fact comprising the market.
It must be mentioned, that selection of entertainment industry could be actually explained with certain heuristics - “principles by which they reduce the complex tasks of assessing likelihoods and predicting values to simpler judgmental operations1 ”.
Having an experience of working in one of the companies, researcher assumes having more information and knowledge that increases the chance of making a better investment decision getting higher return and lower risk, although there is no any reasonable premises or evidence on that.
Top six companies at US M&E market are 21st Century Fox, CBS, Comcast, Viacom, Time Warner and The Walt Disney Company. They provide various media and entertainment services to their customers around the globe and report impressive revenues every year. In order to conclude if these data truly reliable and which company is best option for investments, the following research questions are settled:
Research question 1: Do current share prices of US media companies reflect their intrinsic value?
Research question 2: Which US media company has the best investment opportunities at the moment?
In order to find an answer to research questions settled, application of financial analysis to official financial statements of the companies, which are defined by the Financial Accounting Standards Board as a “central feature of financial reporting – a principle means of communicating financial information to those outside the entity”2, is used. Fundamental analysis is applied to calculate the intrinsic value of companies’ shares, which is defined as “the value of assets and property materializing in the form of physical and intangible goods and chattels and might be considered as “objective” in the sense that it can be only determined in accordance with the provisions of law”3. Market value, or the price that possible buyer is ready to pay for the company at specific moment of time, is defined to understand if the shares of chosen companies are overvalued or undervalued. Technical analysis is further applied in order to choose the best time to buy the shares. Comparable analysis is used in order to answer the research question number two and define the company with the best investment opportunities.
With the results of the financial analysis, investor is able to conclude, which global media company is the best option for making investments.
1.2.Media and entertainment market overview
M&E US market is the biggest in the world. It comprises many different directions, allowing making advantage of the same product several times. Thus, movie created for theatrical distribution could be further sold for television, online distribution, used in video games, print and consumer products, be a basis for a theme park or licensed for Usage by companies from other industries. That means there could be several revenue streams for one commodity. Although, the prediction of financial success of new idea could be challenging, as creative products outcomes could not always be guaranteed, still the facts show stability in growth rate and optimistic forecasts. Thus, PwC reports 5.1 percent expected CAGR4 for the period 2014-2019, as well as $2.23 trillion global revenues to reach in 20195.
Entertainment relevance and importance is pushed lately not only by efforts of marketing departments of respective companies, but also by the changing life philosophy. Family focus, work-life balance, slow food trends are all the features of new free life quality, which also directly connected to spending on free time activities, provided by media and entertainment industry. In US annually citizens spend 160 billion hours and $320 billion at this market6.
Technology development plays its role as well. Massive production automatization, development of internet and new channels of media products consumption allow people to spend more time and money, which media companies in their turn are willing to collect. More precisely 4.9 percent of total household spending7 accounts for entertainment. Figure 1 illustrates the position of entertainment expenses in household overall costs.
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Figure 1. Trends in percentage of total personal-consumption expenditures in selected categories, 1980–20138.
Although the choice of focusing on M&E industry was made rather irrationally, these figures could support its attractiveness and prospects. However, as superficial information is not sufficient by means of making investment decisions, more detailed M&E business is studied within the industry analysis in chapter 3.3.2.
Financial analysis aims to define the current value of the company by indicating its weaknesses and strengths in terms of sales, income, debt, growth, liquidity and assets9. Benjamin Graham and David Dodd in 193410 proposed to conduct fundamental analysis by means of country, industry and company analysis, in order to evaluate the real market prices of stocks and bonds. The principles are still relevant and used today.
Depending on the “client” ordered the analysis and its aim, the value of the company could be seen differently. In buying-selling context, the value shows both parties the desirable price of the agreement. Valuation of stock listed companies helps to discover the intrinsic value of the shares and helps to understand the better strategy of dealing with them – buy in case they are undervalued, sell in case they are overvalued or hold. For internal usage, the data help strategic planning and financial decisions, for example in case of first public offering11.
Classically the company valuation is based on fundamental analysis, which is respectively applied to official financial statements: balance sheet, income statement and cash flow statement. Companies are obliged to publish these reports in open sources, therefore they are easy to locate and be used for financial analysis. Information about stock prices is needed in following technical analysis. It is also available online.
Although, classical approach is argued to be not sufficient and the latest research becomes more independent from pure accounting information12, it still stays being a certain benchmark. The right choice of valuation methods, which could differ depending on the aim, can provide the knowledge of company fundamental strength. Fundamentally strong company offers a scope of future growth prospects in its stocks13.
There classification of company valuation methods could slightly differ in the literature by terms of naming, however the meaning of the content is the same. The current study is interested in the analysis from position of shareholder, aiming to define the strong companies for long-term investment, therefore the valuation of intrinsic company value and stock market tendencies are on focus. Thus, the methods are structured as follows: ratio analysis (chapter 2.1), which mainly express the general financial health of the company; evaluation with discounted cash flows (chapter 2.2) and multiples (chapter 2.3), showing the intrinsic value of the company. Share indicators (chapter 2.4) express the actual profitability of shares. M&E specific is considered in chapter 2.5. Finally, technical analysis (chapter 2.6) defines, when the best time to buy the desired shares is.
2.1.Company ratio analysis
Variety of ratios used in fundamental analysis is constantly developing; however, there is a basic scope of figures that is more commonly used. In general, ratio analysis focuses on information contained in financial statements of the companies. It makes sense to look at the ratios in comparison, either with previous years in order to evaluate the company’s performance, or with other companies within the industry in order to evaluate competitive advantage14. Ratio analysis itself could be not sufficient for making investment decision. However, it is still important starting point as serves an indicator of company’s current strength or weakness. Once indicating an improvement, investor can win paying attention at early stage, or vice versa. Successful companies usually have solid ratios, as any negative deviations may provoke a significant shares sell-off15.
Asset-position ratios indicate overall health of the company16 and help to understand how the company uses its assets in order to perform on the market, in other words how effective it is in using the assets. They represent mainly traditional approach to accounting, meaning that company’s value is basically expressed in its balance sheet, however they do not consider development dynamic affected by industry situation, human resources or possible organizational problems17.
Structure of assets highly depends in the industry in which the company operates; therefore, the choice of ratios to analyze should consider the environment. If company produce physical products, inventory turnover plays an important role. On the other hand, for the companies working for example mostly with intangible assets this ratio is not so relevant.
Inventory Turnover = Net sales / Inventory
Development of IT business showed that it is not necessary to own many assets in order to perform well on the market. Companies like Facebook or Groupon, having in fact no tangible assets, developed into high profitable organisations.
Analyzing the asset-position ratios it is important to look at such factors as interrelation between revenue and company’s fixed assets, reinvestment and depreciation strategy, as well as relationships between short-term and long-term assets.
Fixed assets, which are property, plant and equipment (PP&E), are expensive. If the company does not use its assets effectively, it in fact incurs losses as the fixed assets lose value with time18. Therefore, for the company it is better to have them optimized. Fixed Assets Ratio and Fixed Assets Turnover help to measure efficiency of PP&E Usage.
Fixed Assets Ratio = Long-term Assets / Total Fixed Assets
Fixed Assets Turnover = Revenue / Total Fixed Assets
Interpretation of the results could be ambiguous as many factors can have an input. Thus, low level of Fixed Assets Ratio could be received because of low depreciation, or focusing more on short-term perspectives. It is also highly dependent on the industry. Companies with high amount of intangible assets would rather have this ratio low; however, it does not mean not effective usage of assets.
Fixed Assets Turnover from this point is more informative, as it shows precise amount of money earned by each unit of assets and therefore can roughly evaluate the efficiency. Low ratio can indicate low sales or overinvesting in fixed assets. Usually Fixed Assets Turnover is said to be better rather high, which would mean that company uses its assets well. On the other hand, if it is too high, it could be a reflection of operating over capacity19 and can increase the risk of equipment’s run-out.
In order to manage fixed assets properly, the company should consider future renovation, upgrade, as well as new acquisitions. The fund that is assigned to this purpose is called Capital expenditure (CAPEX). An expense is considered to be a capital expenditure when the asset is a newly purchased capital asset or an investment that improves the useful life of an existing capital asset20. The amount of this fund depends on the industry; however, it is always better for the company to have the possibility to invest in itself. The absolute size of CAPEX can be found in the financial statement. Relative financial strength of the company from this point of view is also measured with multiple and will be reviewed in the respective chapter.
Growth or decrease, by means of sufficient investments in fixed assets can be indicated by Reinvestment Ratio.
Reinvestment Ratio = Capex in Fixed Assets / Depreciation on Fixed Assets
Deviation from one is not crucial for this ratio. However, the company should not keep it on the level below for a long time, as that would mean that the company is shrinking.
One more ratio in this relation is Rate of Wear – indicates the condition of owned PP&E.
Rate of Wear = Depreciation on Fixed Assets / Historical Costs of Fixed Assets
High meanings of Rate of Wear can artificially inflate the profitability ratios, therefore should be always considered together in order to track the real source of the profit received and make the corresponding financial decisions.
Another fund that indicates the strength or weakness of current financial situation of the company and therefore is worth to consider in analysis is Working Capital21 . In absolute meaning, it is simply the difference between current assets and current liabilities, which indicates if the company has enough short-term assets to pay its short-term debts. Working Capital Ratio is a key ratio for evaluating fundamental financial health of a company. Its meanings are usually understood as following: meanings below one reflect negative Working Capital, while meanings over two prove that company does not effectively invest. Therefore, meanings between 1.2 and 2.0 are considered as preferable.
Working Capital Ratio = Current Assets / Current Liabilities
This ratio is important to track, as it is a reflection of relationships with creditors. If it declines for a long time, it serves as a warning of significant sales decrease or operational inefficiency, which in a long-term perspective could even lead to a bankruptcy. Working Capital Management is meant to prevent that, as well as to improve earnings and profitability of the company. It focuses on inventory management and management of accounts receivables and accounts payables. Exaggerating, the main goal is to keep a certain amount of cash available.
Depending on the company’s aims, management should decide how the structure of assets should look like, further track ratios and control the right balance, timely making the financial decisions.
2.1.2.Financial risk and liquidity ratios
Ability of the company to pay back its short-term obligations is further measured by financial risk and liquidity ratios. This group of ratios helps to understand if and how quickly the company is able to pay back its short-term debts, as well as evaluate financial risk.
In relation to capital structure, the main aim of the analysis is to define how much of total company assets belongs to owners, that are shareholders, and how much are owned by investors, or creditors. Equity Ratio is commonly used in order to evaluate this correlation22.
Equity Ratio = Total Equity / Total Assets
Although it also depends on the industry, in general higher meaning of Equity Ratio is better for the company. Higher investment levels by shareholders shows potential shareholders that the company is worth investing in since so many investors are willing to finance the company. A higher ratio also shows potential investors that the company is more sustainable and less risky to lend future loans23. Respectively, Debt Ratio shows how many company’s assets are financed by debt, thus creditors.
Debt Ratio = Total Debt / Total Assets
Reverse of Equity Ratio is Debt-to-Equity, so-called Leverage Ratio. It indicates if the company relies more on its own financial resources or on debt financing24.
Leverage Ratio = Total Debt / Total Equity
Respectively, high Leverage Ratio reflect higher financial risk, meaning that the company rely much on creditors. From the point of view of a prospective investor, it would be preferable to buy shares of the company with low meanings of Leverage Ratio.
Current Ratio, which formula is similar to Working Capital Ratio, is seen from perspective if the company is able to pay its short-term debt with assets available.
Current Ratio = Current Assets / Current Liabilities
Higher value of Current Ratio is preferred by prospective investors, as companies with larger amounts of current assets will more easily be able to pay off current liabilities in time without having to sell off long-term, revenue generating assets25. Repayment Period ratio further shows how quickly the company can do it.
Repayment Period = (Financial Debt – Cash) / Operating Cashflow
The higher meaning of this ratio indicates that it would be hardly possible for the company to pay its short-term debts quickly from its Operating Cashflow; therefore, prospective investors should seek for the companies with being Repayment Period rather low . In order to understand how safe this investment would be, it is important to calculate also Interest Coverage Ratio, which shows if the company is able to pay current interest with its available earnings.
Interest Coverage Ratio = EBIT / Interest Expense
With value of the ratio lower than 1.5, ability of the company to meet interest expenses may be questionable, therefore the risk of investment in such company is very high. Making an investment decision, the prospective investor should keep this plank as a minimum acceptable26.
Although the ratios described are widely used in financial analysis, it is always a discussion, if the book values fully reflect the reality. Besides possible difficulties like delay in getting receivables, it is always a chance of earning management generated by management in order to attract investors or avoid the bancruptcy27. Therefore, evaluating the company it is always needed, and sometimes preffered, to look at cash. Operating Cashflow (OCF) reflects the amount of cash from normal business operations, which is sufficient to maintain the process and to grow. Negative meanings of this ratio could detect the need of external financing. Basically it is the differnce between operative cash inflow and outflow. However, the ratio could be calculated indirectly, giving more clear information about company’s operation achievements without regard to secondary sources of revenue like interest or investments28.
Operating Cashflow =
EBIT + Depreciation – Taxes +/- Change in Working Capital +/- Change in Provisions
OCF meaning could be also found in Statement of Cash Flows. The company with high or improving OCF and low share prices is very attractive for making investment, as situation like this would usually mean that the share price of the company is going to increase29.
2.1.3.Earnings and profitability ratios
Profitability ratios represent a company’s overall efficiency and performance30 and show a company's ability to generate profits from its operations. Precisely, they show the income which is earned on company’s assets. Although highly depending in industry, it is one of the most important group of measurements for investors, as they serves to define what is actually possible for them to earn.
Normally, these ratios could be divided in two groups: Margins, which show the relation between profit and sales, and are analyzed to detect positive or negative trends in company’s earnings; and Returns, which show the amount of money that investors get back on their stake, therefore if it makes sense to make an investment.
Within the group of Margins are Gross Profit Margin, Operating Profit Margin (or EBIT-Margin), Net Profit Margin and Cash Flow Margin. All ratios reflect the relation of profit to sales, respectively at different stages of profit recognition.
Gross Profit Margin = Gross Profit / Net Sales
The ratio measures how effective a company can sell its inventory. Higher values are better, as that would mean the company manages its raw materials, labor and manufacturing-related fixed assets well and receive higher profit percentage. That would further mean no issues in paying operating expenses like salaries, utilities and rent or even to fund other parts of the business. As other expenses are not considered in this ratio, Operating Profit Margin, so-called EBIT-Margin, should be calculated.
Operating Profit Margin = EBIT / Net Sales
The ratio uses earnings before paying interest and taxes instead gross profit in order to analyze overall operation efficiency, consolidating all expenses of the company from daily business activity. In fact, it shows the precise amount of money the company earns from each unit of revenue. However, Operating Profit Margin does not have relation to invested capital, therefore it should be always seen together with Return on Investment. Nevertheless, a higher value of this ratio is preferred for the company, as that would mean the company generates enough money from operations to pay fixed costs, therefore it is more stable. When the ratio is too high, it would also mean a strong dependency on operations. If operations start to decline, the company will have to find a new way to generate income31.
In order to see the profitability of the company considering all expenses, Net Profit Margin is more often used.
Net Profit Margin = Net Income / Net Sales
This ratio is the most direct way to see how much profit upon every unit is earned, as all expenses, taxes, interest and depreciation are included in calculation. The higher this value is - the better a company performs on the market, and therefore the higher earnings would investors receive. The same logic is applied to Cash Flow Margin32 , which reflect the ability of the company to translate sales into cash, needed to pay dividends, suppliers, debts, as well as invest in new capital assets.
Cash Flow Margin = OCF / Net Sales
Positive profit margin analysis translates into positive investment quality. To a large degree, it is the quality, and growth, of a company's earnings that drive its stock price33. However, it is also important to look closer at Return ratios: Return on Assets (so-called Return on Investment), Return on Equity and Cash Return on Assets. Precisely these indicators show how much investor has in return on his capital being invested.
Return on Assets (RoA) = Net Income / Total Assets
The ratio measures the efficiency of assets Usage by means of overall management in order to get profit. Higher RoA values are preferred, as that would mean the company operates its asset affectively and earn. To define if the level of earnings is sufficient, it is common to weight it by means of expectations from investors. Thus, Weighted Average Cost of Capital (WACC) is calculated, considering expected return rates of shareholders (re) and creditors (rl).
WACC = re * Equity Ratio + rl * Debt Ratio
WACC express the minimum acceptable rate of return at which a company yields returns for its investors34. Therefore, making a decision, investors should pay attention to companies with higher meanings of WACC.
Return on Assets is often compared to Cash Return on Assets (Cash RoA), which reflect business performance more clear and usually used to compare companies wihin one specific industry .
Cash Return on Assets (Cash RoA) = OCF / Total Assets
The ratio excludes influence of income recognition manipulations, therefore providing fairer base for comparison.
More exact ratio for investors to decide if the company is worth to invest is Return on Equity, as it measures the actual return on the money invested. However, this ratio should be explained also with caution, as often the book value of equity, highly depended on capital structure, could deviate from market value, therefore the figures could be not truly reliable.
Return on Equity (RoE) = Net Income / Equity
Earnings and profitability ratios comprise an important part in company evaluation, yet they should be analyzed in comparison with own historical basis, in relation to competitors with similar business functionality35 or to industry benchmarks.
2.2.Company evaluation with Discounted Cash Flows
While ratio analysis mostly focuses on historical movements, investor should also think about the future. To evaluate future possible earnings Discounted Cash Flows (DCF) analysis is widely used in financial practice. It is based on “measuring the value of milk given by a cow”36. Thus, the market value is calculated considering future payment surpluses, thereby reflecting truly intrinsic value of the company. It is the most common way of company evaluation nowadays.
By means of DCF, the company’s value is determined as certain cash flows discounted with the cost of capital:
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Amount of cash should be calculated through Free Cash Flow (FCF)37.
Free Cash Flow (FCF) = OCF - CAPEX
Interest rate used for discounting is calculated according to so-called WACC-Approach, which considers expected return rates of shareholders (re) and creditors (rl) (so-called Cost of Equity and Cost of Debt respectively).
WACC = re * Equity Ratio + rl * Debt Ratio
Cost of Equity re can be calculated based on The Capital Asset Pricing model (CAPM). Being the foundational model of market rationality, CAPM is a tool for determining discounted rate for investments within the firm, for valuing firm itself, for setting sales prices, as well as for purpose of benchmarking38. The CARM was developed by Sharpe, Litner and Mossin in the 1960s and is usually seen in two ways: either as a reformulation of the necessary optimally conditions by means of Markovitz’s portfolio theory; or as a single-factor linear model that relates the expected returns of an asset and a market portfolio39.
The formula for simple linear CAPM could be presented as following:
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where rf is the riskless rate of interest over a single time-period, rm – average expected return of the market over the same time-period, and β indicates the exposure of asset to the market40.
CAPM is based on the concept that “for a given exposure to uncertain outcomes, investors prefer higher rather than lower expected returns”41. It is considered to be not pure accurate in “predicting” the stock returns; nevertheless, “CAPM remains a major benchmark tool due to mathematical simplicity and offering quick quantitative insight”42.
Future expected cash flows are usually defined based on strategic planning and sales forecasts of the company. Indeed, these are only expected values. In practice, a certain amount risk is involved and there will always be some discrepancies between planned and realized values43.
Market value of a company is usually higher than a book value expressed in financial statements, therefore making a decision on buying specific shares, investor ideally seeks for options when current share price is lower than intrinsic.
2.3.Company evaluation with multiples
In order to make DCF and financial forecasts more accurate, multiples approach is used. It is based on idea of similarity of assets and prices at which they are sold; therefore, it is used for analysis of comparable companies, allowing to determine the value of one company in relation to another44.
Using in valuation commonly multiples are either to compare current multiplies with historical, or with peers or market sector. Current Multiplies reflect comparison of current price or enterprise value with historical or forecast profits, generally one year of historical and two years of forecast profits. Historical Multiples express comparison of historical price or enterprise value with historical profits (cash flow, etc.)45. It is important to use the right multiple for analysis. However, this choice is rather subjective and rely on common sense.
Generally, multiples could be divided into two groups: enterprise multiples, expressing the value of the whole enterprise, and equity multiples (or share indicators, reviewed in the following chapter), which focus on value of shareholders’ claims on the assets and cash flow of the business46.
Enterprise Value (EV) is a cost of buying the whole business. It is less affected by capital structure, accounting differences and non-core assets (investments and other operational activities from non-main business) than Equity Multiplies, therefore are more reliable to use for companies comparison.
Enterprise value (EV) = No. of Shares * Share Price + Net Deb – Current Cash
Ideally, in order to be complete, EV should include all claims of the company, while debt should be adjusted to reflect market value and seasonable variations.
There are various multiples on the base of EV, which are used depending on situation. Most commonly used is the Enterprise Value Multiple (Enterprise Value to Earnings before Interest, Taxes, Depreciation and Amortization), as it is not affected by differences in tax management, depreciation policy and differences in capital structure.
Enterprise Value Multiple = EV / EBITDA
Looking at this multiple, investor can get a sense of whether or not a company is undervalued47. Variation with using EBIT instead will respectively exclude influence of depreciation and amortization.
EV/EBIT Multiple = EV / EBIT
More clearly comparable picture about operational performance gives EV/FCF Multiple, which compares the total valuation of the company with its ability to generate cash flow.
EV/FCF Multiple = EV / Free Cash Flow
The lower the ratio of enterprise value to the free cash flow figures, the faster a company can pay back the cost of its acquisition or generate cash to reinvest in its business48.
Using multiples approach has certain advantages: usefulness, simplicity and relevance made them very popular in evaluation of investment opportunities. However, disadvantages, like lack of dynamics (multiples are calculated at a single point of time) and issues of proper comparability (even in the same industry Usage of different accounting policies, as well as mispricing affects the figures) could lead to confusing results.
2.4.Share indicators analysis
Equity Multiples are share indicators that express the market value of shareholders stake in an enterprise. Although highly dependent on economic and market conditions Price/Earnings ratio (P/E) is the most commonly used.
Price/Earnings = Share Price / Earnings per Share
Earnings per Share = Net Profit / No. of Shares
The lower value of P/E ratio is preferable within analysis of similar stocks in order to make an investment decision, unless there are other reasons for this ratio to be small. High P/E ratio would mean that investors are expecting higher earnings growth in the future compared to the overall market, as investors are paying more for today's earnings in anticipation of future earnings growth49. An important weakness of the P/E ratio is that it does not explicitly take into account balance sheet risk, as well as the amount of investment required to support future growth50.
Amount of cash generated by each share is expressed by Price/Cash Earnings ratio. Benefit of using cash flows instead of earnings in this case is that it could not be easily manipulated, therefore is more reliable. However, it should be still used as a compliment as does not consider such factors as changes in net debt or working capital.
Price/Cash Earnings = Share Price / OCF per Share
Closely related to P/E ratio is Price/Earnings Growth (PEG), which gives insight into the degree of overvalue or undervalue of share prices.
Price/Earnings Growth (PEG) = P/E ratio / Earnings per Share (EPS) Growth
If PEG ratio = 1, the market is correctly valuing share prices with P/E ratio in accordance with current estimated earnings per share growth. If PEG ratio < 1, EPS growth is potentially higher than one used for valuation, therefore the share prices are undervalued51. Commonly PEG ratio is more suitable for valuing high-growth companies with returns and growth rates close to the market.
Price/Sales ratio is also similar to P/E ratio, measuring the price of a company's shares based on annual sales, instead of earnings. Since earnings is often manipulated, many investors rely more on pure sales data.
Price/Sales = Share Price / Net Sales per Share
Price/Book Value (P/B) indicates how much shareholders are paying for the net assets of a company, thus a value of a company's assets expressed on the balance sheet. It is the difference between the balance sheet assets and balance sheet liabilities and is an estimation of the value if it were to be liquidated52.
Price/Book Value = Share Price / (Total Assets - Intangible Assets and Liabilities)
This ratio is the most valuable for companies with prevailing tangible assets and usually should be analyzed together with RoE. Low meanings of P/B ratio could evidence on undervalued share price. However, it could also reflect fundamental problems within the company and should be not chosen for analysis in this case.
In order to define the volume of dividends, that is cash investor would be able to receive back on the investment, Dividend Yield is used. It depends on the nature of a company's business, its posture in the marketplace (value or growth oriented), its earnings and cash flow, and its dividend policy53. The probability of dividend payment is indicates with Dividend Coverage Rate (DCR), so-called Dividend Payout Ratio.
Dividend Yield = Dividend per Share / Share Price
Dividend Coverage Rate (DCR) = Earnings per Share / Dividend per Share
DCR reflects how much money a company is returning to shareholders, versus how much money it is keeping to reinvest in growth, pay off debt or add to cash reserves54. Being rather a question of dividend policy, still the higher the DCR value supports the probability of higher dividend payments. It is common to consider this indicator also for the future, thus in forward-looking perspective. A steadily rising ratio normally indicates a healthy, maturing business.
Corporate financiers frequently use market dividend yield as a benchmark for capitalizing dividends in order to estimate the appropriate value for a stock in an initial public offering55.
In order to evaluate overall amount returned to investor, it is common to use Total Return of Shareholders (TRS). It measures the full returns earned by an investment over the period of ownership, including any dividend cash flows paid during that period56.
TRS57 = (Share Price End – Share Price Begin + Total Dividends)/Share Price Begin
It makes sense to look at this ratio in a long-term perspective, as during a short period the meanings could be rather low and do not fully reflect the whole picture for investor.
2.5.Media and entertainment companies evaluation specific
58 Evaluation of companies in media and entertainment business usually relies on standard ratios; however, importance of those differs from other industries.
Analysis of M&E company often starts by terms of availability of free cashflow, or what is left after capital expenditures and operation costs. It is important for this industry to have opportunities to repurchase stock, reduce corporate debt, pay cash dividends, acquire other companies, or invest in promising internal projects. Therefore, EBITDA is the important figure, by means the higher its meaning is, the better.
Following importance of cash flow situation, liquidity ratios namely, debt/equity relations are next on focus. Even inside the industry, acceptable levels of these ratios could be different depending on business segment; therefore, average level of those would be sufficient from perspective of the whole corporation.
Within share indicators analysis surprisingly little input to analysis of M&E companies bring price-to-earnings ratios, as industry specific and common management and accounting policy significantly influence share prices. Thus, earnings recognition could happen much later than product completion (for example, for the movie). Moreover, they could not match the previous forecasts, thereby affecting the whole earnings and the overall picture. Consideration of these ratios should be made cautiously. More useful in this relation are price-to-sales ratios. Stable sales results reflect the reality the most, therefore important for making investment decision. Generally, they are correlated with profit margin.
As international multimedia companies comprise many different business directions with own specific, it is important to have the whole picture being comparable. Therefore, Enterprise Value, which further could be contrasted to EBITDA is important figure for analysis. Appling to similar companies in the same industry, this multiple allows diminishing differences in capital structures and take the companies to comparable analysis. Although normally used in case of company sale59, could be illustrative for small investors as well.
Being not really disclosed in the classical financial analysis, nowadays, such item as Goodwill becomes more and more important while valuating a company’s performance. It is explained as unidentifiable assets, which express future economic benefits. “It is recognized during acquisition process and meant to be a fair valuation of both tangible and intangible assets”60. Goodwill recognition is typical for international media companies, as in practice it roughly represents the value of a brand name. However, it could be seen in both good and bad light, as in fact often not evaluated correctly. Thus, by some researchers it is said being “unclear whether there are real costs that are not already included in share prices and the various agency contracts”61. Goodwill becomes a “balancing item, the difference between the purchase consideration given (cost of the business combination) and the fair value of the identifiable net assets acquired”62. However, the Goodwill account usually includes errors. “Writing off Goodwill immediately lead to distorted results, when tangible assets are undervalued, which then leads to overstated net income”63. Therefore, it is always a risk of the financial evaluation reflecting false conclusions, when the Goodwill meaning in the balance sheet is very high. Following this logic, the Goodwill Ratio is included to the comparable analysis of the present study.
Goodwill Ratio = Goodwill / Total Assets
Is this is a highly controversial item, from investor’s perspective it would be less risky to have the meaning rather low.
One more essential feature of media companies’ operational business is Royalties or Royalty Fees - a payment to an owner for the use of intellectual property  . Normally Royalty is s part of standard contract for content creation services, for example with scriptwriters, songwriters, composers, actors etc. Literally, every activity that lead to creation of copyright, which are inalienable, accompanied by the obligation of Royalty payment. The final amount if this expense is the subject of negotiations, which however also should comply with the minimum rates approved by the trade unions. As this is a long-term mandatory obligation of certain payments, the researcher believes that this figure could show, how well the company can manage negotiations with creative partners, therefore Royalty Ratio was developed.
Royalty Ratio = Royalties / Operating Expenses
Low meanings of this ratio would express the better ability of a company to plan production costs. Respectively, high meanings of Royalty Ratio would mean the higher risk of decrease in future income.
The summary of company analysis ratios, based on theoretical overview above, is presented in Table 1. Roughly preferable values are defined from investor’s perspective.
Table 1. Company ratio analysis’ summary.
65 Abbildung in dieser Leseprobe nicht enthalten
2.6.Technical stock analysis
Another approach to support the investment decision does not connected to detailed evaluation of the specific company, but looks deep in the history and rely on a belief that it tends to repeat itself. Technical analysis looks on the history of the stocks, past returns, and aims to define patterns, which could repeat in the future66.
Although being a subject of anecdotes, it is used by many traders and analysts, who develop the investing strategy ignoring the condition both the company and the market. Moreover, often they prefer to be not aware of the asset they are analyzing in order to avoid possible bias, connected to possible influence of external factors, as well as personal emotions on a decision-making. The routes of the technical analysis go deep to nature and actually are based on phenomena of tides and waves.
Technical analysis suggests that a long-term rally frequently is interrupted with a short-term decline. If the price of an asset has risen more than one percent from its value five days earlier, that is a “green light” to buy this asset. This rule is widely used in stock, commodity and foreign exchange markets67. Research has shown that such rules have predictive power in equity markets68 and in foreign exchange markets69.
Technical analysts base their behavior according to three principles. First, all relevant information about an asset is already considered in its price history, so there is no need of fundamental valuation of an asset. Moreover, asset price could change before any meaningful change in fundamentals. Second, vital principle, asset price moves in trends. Detecting the trend is the core of technical analysis, as the wrong decision made in the moment of buying or selling the certain stocks could be crucial for the whole investment activity. Third, the history repeats itself, thus while analyzing the price movements, investors or traders look for the familiar situation to act in the same way as in the past. Therefore, financial analysis is based on identifying the trend and its reversal in order to form a trading strategy70.
“Technical analysts believe that their methods will permit them to beat the market. Economists have traditionally been skeptical of the value of technical analysis, affirming the theory of efficient markets that holds that no strategy should allow investors and traders to make unusual returns except by taking excessive risk”71.
There are two ways to proceed with technical analysis: charting or mechanical rules. Working on charting, the main task is to observe and define an archetype of the particular chart. Once it is detected, the following strategy – to buy or to sell stocks – will be chosen according to respective “rules” of the chart. Mechanical way is based on applying mathematical functions. In present paper, the charting method is on focus.
Being highly influenced by the skills and experience of the analyst, charting is neither more nor less than drawing and interpreting the patterns. To identify trends in the patterns, first the peaks (highest values) and troughs (lowest values) in the price movement should be detected. The series of peaks and troughs form downtrends and uptrends. The analyst then define a trendline, which reflects the direction and the speed of changing of the asset price. If the uptrend is defined, the “buying” strategy is supported, if downtrend prevails, the most common decision is to sell the assets. The analysis proceeds with identifying possible reversals72.
1 Tversky and Kahneman (1975) p. 141.
2 Healy and Wahlen (1999), p. 365.
3 Námor (2008), p. 167.
4 Annual growth rate
5 cp. PwC (2015), p. 1.
6 cp. Vogel (2014), p. XIX.
7 cp. US Bureau of Labor Statistics (2015), p. 1.
8 cp. Vogel (2014), p. 24
9 cp. Sharma and Mehra (2016), p. 8.
10 cp. Graham and Dodd (1934).
11 cp. Fernandez (2007), p. 3.
12 cp. Dagiliene et al. (2006), p. 28.
13 cp. Sharma and Mehra (2016), p. 2.
14 cp. Investopedia (2017): Ratio Analysis.
15 cp. Investopedia (2017): Ratio Analysis.
16 cp. Sharma and Mehra (2016), p. 2.
17 cp. Fernandez (2007), p. 3.
18 cp. Investopedia: Fixed Assets.
19 cp. My Accounting Course (2017): Financial Ratios.
20 cp. Investopedia (2017): Capital Expenditure.
21 cp. My Accounting Course (2017): Financial Ratios.
22 cp. Investopedia (2017): Equity Ratio.
23 cp. My Accounting Course (2017): Financial Ratios.
24 cp. Investopedia (2017): Leverage Ratio.
25 cp. My Accounting Course (2017): Financial Ratios.
26 cp. Investopedia (2017): Interest Coverage Ratio.
27 cp. Healy & Wahlen (1999), p.366
28 cp. My Accounting Course (2017): Operating Cash Flow.
29 cp. Investing Answers (2017): Operating Cash Flow.
30 cp. The Balance (2017): Profitability Ratio Analysis.
31 cp. My Accounting Course (2017): Financial Ratios.
32 cp. The Balance (2017): Cash Flow Margin.
33 cp. Investopedia (2017): Profitability Indicators.
34 cp. Investopedia (2017): WACC.
35 cp. Sharma and Mehra (2016), p. 9.
36 Capinski and Patena (2009), p. 7.
37 cp. Investopedia (2017): Free Cash Flow.
38 cp. Dempsey (2013), p. 7.
39 cp. Zabarankin et al. (2014), p. 508.
40 cp. Dempsey (2013), p. 8.
41 Dempsey (2013), p. 10.
42 Zabarankin et al. (2014), p. 508.
43 cp. Capinski and Patena (2009), p. 18.
44 cp. Investopedia (2017): Multiples Approach.
45 cp. UBS Warburg (2001), p. 11.
46 cp. UBS Warburg (2001), p. 3.
47 cp. Investopedia (2017): Investment Valuation.
48 cp. Stokcopedia (2017): Ratios.
49 cp. Investopedia (2017): Investment Valuation.
50 cp. UBS Warburg (2001), p. 38
51 cp. Investopedia (2017): Investment Valuation.
52 cp. Investopedia (2017): Investment Valuation.
53 cp. Investopedia (2017): Investment Valuation.
54 cp. Investopedia (2017): Dividend Payout Ratio.
55 cp. UBS Warburg (2001), p. 41.
56 cp. Stockopedia (2017): Total Shareholder Return.
57 cp. Accounting Tools (2017): Total Shareholder Return.
58 cp. Vogel (2014), pp. 572-573.
59 cp. My Accounting Course (2017): Enterprise Value.
60 Nethercott and Hanlon (2002) as cited in Wines et al. (2007), p. 865.
61 Beatty and Weber (2006); Bens (2006) as cited in Li and Sloan (2015), p. 20.
62 Wines et al. (2007), p. 865.
63 Johnson and Tearney (1993), p. 58.
64 cp. Investopedia (2017): Royalty.
65 from investor’s perspective
66 cp. Roberts (1959), p. 1.
67 cp. Neely (1997), p. 23.
68 cp. Brock et al. (1992) as cited in Friesen et al. (2008), p. 1089.
69 cp. Friesen et al. (2008), p.1089.
70 cp. Neely (1997), p. 24.
71 Neely (1997), p. 27.
72 cp. Neely (1997), p. 25.
- Quote paper
- Ekaterina Valeeva (Author), 2017, Evaluation of companies in media and entertainment business. Theoretical models of company evaluation and practical application on major US media companies, Munich, GRIN Verlag, https://www.grin.com/document/463244