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Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange

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Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange Ivanovska, Nadica, Zoran Ivanovski, and Zoran Narasanov. 2014. Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange. UTMS Journal of Economics 5 (1): 11–24. Preliminary communication (accepted February 24, 2014) FUNDAMENTAL ANALYSIS AND DISCOUNTED FREE CASH FLOW VALUATION OF STOCKS AT MACEDONIAN STOCK EXCHANGE Nadica Ivanovska1 Zoran Ivanovski Zoran Narasanov Abstract: We examine the valuation performance of Discounted Free Cash Flow Model (DFCF) at the Macedonian Stock Exchange (MSE) in order to determine if this model offer significant level of accuracy and relevancy for stock values determination. We find that stock values calculated with DCF model are very close to average market prices which suggests that market prices oscillate near their fundamental values. We can conclude that DFCF models are useful tools for the companies’ enterprise values calculation on long term. The analysis of our results derived from stock valuation with DFCF model as well as comparison with average market stock prices suggest that discounted cash flow model is relatively reliable valuation tool that have to be used for stocks analyses at MSE. Keywords: valuation, securities, free cash flow, equity, stock-exchange. Jel Classification: G1,G12 INTRODUCTION Valuation of an asset can be determined on three ways. First, as the intrinsic value of the asset, based on its capacity to generate cash flows in the future. Second, as a relative value, by examining how the market is pricing similar or comparable assets. Finally, we can value assets with cash flows that are contingent on the occurrence of a specific event as options (Damodaran 2006). 1 Nadica Ivanovska, Ph.D., Assistant Professor, Central Cooperative Bank, Skopje, Zoran Ivanovski, Ph.D., Full Professor, University of Tourism and Management in Skopje, Zoran Narasanov, Ph.D., Assistant Professor, Winner Insurance, Vienna Insurance Group, Skopje, Macedonia. 11 Ivanovska, Nadica, Zoran Ivanovski, and Zoran Narasanov. 2014. Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange. UTMS Journal of Economics 5 (1): 11–24. The basic idea of intrinsic valuation is that, the value of any asset is the present value of the expected future cash flows on the asset, and it is determined by the magnitude of the cash flows, the expected growth rate in these cash flows and the uncertainty associated with receiving these cash flows. There are two wide used models based on discounted cash flows (Dividend Discount Model-DDM as well as Discounted Cash Flow Model-DCF) in order to determine stock intrinsic value. In this paper we use discounted free cash flow techniques for stocks’ valuation at Macedonian Stock Exchange (MSE). DCF valuation faces the choice: to make equity valuation (value just the equity claim in the buiness) or the firm valuation (value the entire business). We use Discounted Free Cash Flow to Firm model for company valuation in order to evaluate value of all investment opportunities of the firm compared with available cash flows that can be directed both to shareholders or creditors. Relative valuation is based on using standardized market values as multiplies of some standard variable as earnings, book value and revenues and comparisons with valuation of similar assets/companies in order to determine if they have fair value or currently are underpriced or overpriced. In their paper based on 104 analysts’s reports (Demirakos, Strong, and Walker 2004) argued that analysts typically choose either a relative valuation models (P/E model) or an explicit multiperiod DCF valuation model as their dominant valuation model. However they found that none of the analysts use the price to cash flow as their dominant valuation model and some analysts who construct explicit multiperiod valuation models still adopt a comparative valuation model as their preferred model. In accordance with the DCF method, the value of a company is a function of three major variables: the expected net cash flows, the expected growth of these cash flows, and the required rate of return. The net cash flows are the result of the company’s in- come generating potential (or earning power) (Nenkov 2010). The future growth in earnings depends on the growth of this earning power. The required rate of return (or cost of capital) depends on the level of risk of the company’s operations and its financial leverage. Finally, the value of the company can be expressed as a function of the earning power, the expected growth in earnings, and the level of risk (Damodaran 2006). Kaplan and Ruback (1995) conclude that DCF valuations approximate around market prices reasonably well. There are also considerable numbers of papers that compare all three valuation models in order to determine their accuracy. In their paper Penman and Sougiannis (1998) contrasts dividend discount techniques, discounted cash flow analysis, and techniques based on accrual earnings when each is applied with finite-horizon forecasts. They provide evidence that valuation errors are lower using accrual earnings techniques rather than cash flow and dividend discounting techniques. Market price is more closely related to long-term “expected earnings” (or “average earnings”, or the “the earning power”), rather than to temporary deviations in current earnings, which are within the acceptable range. This fact outlines the close relationship between relative valuation and discounted cash flow valuation, since both are based on expected average earnings or cash flows in the long run (Nenkov 2010). There is also growing uncertanity if DCF Models are suitable for emerging and transition economies. However, Pereiro (2006) in his paper finds that DCF techniques like NPV, IRR and payback are very popular among corporations and financial advisors. 12 Ivanovska, Nadica, Zoran Ivanovski, and Zoran Narasanov. 2014. Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange. UTMS Journal of Economics 5 (1): 11–24. The aim of this study is to investigate how precise and accurate is DCF valuation for stock market price predictions at Macedonian Stock Exchange (MSE). We analyse two companies listed at MSE: Granit SC Skopje and Vitaminka SC Prilep. We present whole process of comprehensive DFCF valuation for both companies. After completed valuation we compare stocks’ intrinsic values with average stock market prices at MSE in order to see if market prices are near stock values. FUNDAMENTAL ANALYSIS AND DISCOUNTED FREE CASH FLOW VALUATION OF GRANIT–SKOPJE SC STOCKS AT MACEDONIA STOCK EXCHANGE There are numerous factors that affect the stock price and they are almost impossible to predict. As one of the best ways to fight against many factors that make the uncertainty, arises fundamental analysis as one of the most widely used methods for estimating price movements of securities (Baresa, Bogdan, and Ivanovic 2013). In fact DCF analysis which is in focus of our research started with companies’ fundamental analysis. Granit SC, Skopje is construction company with main accitivity as projecting, construction and audit in construction industry with several branches in Germany, Russia, Albania, Bulgaria, Ukrain, Croatia and Monenegro. By using DFCF model as well as fundamental analysis of audited financial statements and all public available information for the company, we evaluate Granit SC, Skopje stock (ISIN Code: GRNT). Fundamental analysis as a tool enable to derive basic assumptions in order to forecast company Free Cash Flow. In order to create Pro- Forma Income Statements and for fundamental analysis we use company’s key data for period 2006–2010, as follows (MSE and authors calculations): Table 1. Data from Granit SC, Skopje Financial Statements (in 000 denars) 2010 2009 2008 2007 2006 Total Income 3.486.889 3.927.692 2.989.679 2.239.916 2.093.443 EBIT 243.598 198.295 190.473 30.857 82.469 EBT 296.915 336.924 400.508 348.138 267.076 Equity 3.291.195 3.074.020 2.857.524 2.376.777 2.143.208 Total Liabilities 2.754292 4.291.078 2.227.526 2.284.316 2.248.485 Total Asset 6.045.487 7.365.098 5.085.050 4.661.093 4.391.693 Market Capitalization 1.697.091 2.398.321 1.812.112 6.443.705 1.714.565 25.08.2010. EBITDA 525.149 452.844 339.347 30.857 230.082 WC 448.009 790.004 482.198 350.962 205.048 By using fundamental analysis we derive basic ratios (liquidity, activity, leverage and profitability). We also make cross-sectional analysis using averages for similar companies and industry averages in the region of South-East Europe (SEE). Fundamental analysis results will be used for determination of basic assumptions for DCF Valuation Model development. 13 Ivanovska, Nadica, Zoran Ivanovski, and Zoran Narasanov. 2014. Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange. UTMS Journal of Economics 5 (1): 11–24. Table 2. Fundamental analysis of Granit SC, Skopje 2010 2009 2008 2007 2006 ROS 6,98% 5,04% 6,37% 1,37% 3,93% EPS 99 109,69 130,40 113,35 86,96 ROA 4,84% 4,57% 8,21% 7,69% 6,07% ROE 8,90% 10,96% 15,04% 15,40% 13,37% P/E 5,81 7,42 4,52 18,51 6,42 BV per Share 10.117,04 10.00,86 866,87 735,82 650,27 P/B 0,51 0,81 0,68 2,85 0,86 Dividend per Share 10 20 23,00 23,00 22,73 Dividend Yield 1,69% 3,89% 1,09% 4,07% NetProfit Margin 8,29 8,57 13,66 15,54 12,75 Current Ratio 1,17 1,20 1,24 1,17 1,093 Quick Ratio 0,76 0,97 0,84 0,75 0,78 Inventory Turnover 1,04 2,68 1,55 0,99 2,65 Total Assets Turnover 1,14 1,39 1,09 0,97 1,05 Debt Ratio 45,55 58,26 45,77 99,75 51,19 Debt Equity Ratio 20,27 57,01 36,85 28,13 4,74 Total Assets/ Equity 6,48 7,94 5,46 2,45 4,71 Table 3.
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