bindex 911 5 May 2020 10:25 AM

911

Index

Accelerated depreciation, 447Accounting:

changes and irregularities in, 259–261

financial institutions (see Banks)goodwill amortization, 647mergers and acquisitions (M&A),

655statements (see Financial

statements)Accounting standards. See Generally

Accepted Accounting Principles (GAAP)

Acquired intangibles, 448Acquisitions, 46–48. See also Mergers

and acquisitions (M&A)bolt-on, 166and conservation of value, 46–48in corporate portfolio strategy,

571–573effect on free cash flow, 247–237effect on ROIC, 156revenue growth through, 166–167

Active share, 715Adjusted present value (APV) model,

181–182, 199–200, 852–853tax shields, 202–203unlevered cost of equity, 200–202

Aggressive growth formula, 314Ainslie, Lee, 714Alphabet (Google), 11, 111, 144–145Amazon, 111, 132, 141, 145, 164,

165–166, 167, 409, 410, 415, 720Amazon Web Services (AWS), 568Analysts, sell-side, 717Analyzing performance. See Historical

performance analysisAnders, William A., 571Annual operating plan (AOP), 619–620Apple, 136, 144, 151, 509, 596, 636Arbitrage pricing model, 339–340Aspen Institute Business and Society

Program, 718, 725Asset-based valuations, 316Asset health metrics, 596Asset optimization, in ESG, 92Assets

gains and losses on sales of, 463traded vs. untraded, 826

AT&T, 660Automation, 96, 98, 144Aventis, 572

Balance sheet, 211, 212–213, 217, 283–286, 491–492. See also Income statements

COPYRIG

HTED M

ATERIAL

912 Index

bindex 912 5 May 2020 10:25 AM

Boston Scientific, 114, 456–459, 461–462

Bottom-up forecasting, 275–277Bristol-Myers Squibb, 660Bubbles, 105. See also Financial crisesBusiness models, in digital initiatives,

94–95Business value creation, 3Business Roundtable, 4, 12, 87

Cadbury, 667Capital asset pricing model (CAPM),

58–59, 322, 877–884applying in practice, 331–338beta, 332–337emerging markets, 743for foreign currencies, 546–554global, 546–549, 878–879international, 549–551, 879–880local, 549–550, 881–884market risk premium, 327–328risk-free rate, 328–329

Capital cash flow (CCF) model, 203Capital intensity, 761–762Capitalized expenses, 505–507Capitalized research and

development, 243Capital-light businesses, 499–513

capitalizing expenses investments, 499–507

economic profit as key value metric, 510–513

need for capital, 507and ROIC, 507–510

Capital productivity, 594Capital structure, 261–265, 675–707

complex, 348–349debt/equity tradeoffs, 683–687estimating current, 344–347financial engineering, 48–49,

703–706derivative instruments, 704hybrid financing, 706off-balance-sheet financing, 704–706

Banks, 779–804digital initiatives, 93–94economics of banking, 780–783fee- and commission-trading

activities, 803–804income sources for, 781–783interest-generating activities, 802trading activities, 802–803valuation complications, 796–797convergence of forward interest

rates, 796–797loan loss provisions, 798multibusiness banks, 802risk-weighted assets and equity risk

capital, 799–801valuation principles, 784–796analyzing and forecasting equity

cash flows, 786–787discounting equity cash flows,

787–789economic spread analysis, 791–795equity DCF method, 784–786value driver trees, 786–788, 794–795

Basel III guidelines, 799–801Becht, Marco, 630Below-investment-grade debt, 342–343Best ownership, 565Beta

in cross-border valuation, 547–548in emerging markets, 744, 745equity beta, 336estimating, 332–334, 428–429industry beta, 335–336levered, 860–861market portfolio, 331–338smoothing, 334unlevered, 332

Black, Fischer, 207n18BlackBerry, 143Black-Scholes value, 367Blume, Marshall, 327, 334, 876Bolt-on acquisitions, 166–167Bond ratings, 341–342Bonds, government, 340–342

Index 913

bindex 913 5 May 2020 10:25 AM

four-stage approach to developing, 678–601

guidelines, 676–678leverage, coverage, and solvency,

869–871market-based rating approach,

868–869payout and financing decisions,

693–703debt financing, 702–703equity financing, 701–702shareholder payouts, 693–700pecking-order theory, 867–868valuation metrics, 290–291

Capital turnover, and inflation, 531

Carve-outs, 669, 671–672Cash flow:

availability to investors, 238–239

foreign, forecasting, 541–546relationship to ROIC and growth,

29–33Cash flow perpetuity formula,

50Cash flow return on investment

(CFROI), 515, 517–522equaling IRR, 517–519vs. ROIC, 519–522

Cash flow risk, 63–66Cash flow statement. See Financial

statementsCash-flow-to-equity (CFE) valuation

model. See Equity cash flow (valuation model)

Cash return on capital invested (CROCI), 459

cash return on gross investment (CROGI), 459

cash return on assets (CashROA), 459

Ciba, 638–639Cisco Systems, 636Closet indexers, 713, 715

Coca-Cola, 135, 143, 144, 221, 312, 357–358, 490, 723

Colgate-Palmolive, 35Commercial health metrics, 595Commodity price risk, 66Comparables. See MultiplesCompass, 256–257Competitive advantage, 135–143

brand, 137cost and capital efficiency

advantages, 139customer lock-in, 137economies of scale, 140–141innovative business methods,

139–140innovative products, 136persistence of, 144price premium advantages, 136product life cycle, 143quality, 136–137rational price discipline,

137–138scalable product or process,

141–142unique resources, 140

Competitive advantage period, 308–310

Competitive Strategy (Porter), 133Confirmation bias, 616–617Conglomerate discount, 120–121Consensus EPS forecasts, 771Conservation of value principle,

42–49and acquisitions, 46–48and executive stock options, 44financial engineering, 48–49foundations of, 43–44managerial implications, 44and share repurchases, 44–46

Contingent liabilities, 366Contingent NPV, 819–820Contingent valuation. See Decision

tree analysis (DTA); Real-option valuation (ROV)

914 Index

bindex 914 5 May 2020 10:25 AM

Continuing value (CV) estimation, 299–317

asset-based valuations, 316Costco, 902discounted cash flow approaches,

313–315aggressive growth formula, 314convergence formula, 313–314key value driver formula, 300–302recommended formula, 300–303economic profit valuation formula,

303–304key value driver formula, 190–191misunderstandings about, 305–310effect of forecast length on value,

305–307length of competitive advantage

period, 308–310multiples (comparables), 315–316pitfalls in, 310–312naive base-year extrapolation,

310–312naive overconservatism, 312purposeful overconservatism, 312two-stage formula, 907–908

Convergence formula, 313–314Conversion value, 367Convertible bonds/preferred stock,

366–370Corporate growth. See Growth;

Revenue growthCorporate Horizon Index, 4Corporate portfolio strategy,

563–582acquisitions and divestitures,

571–573best-owner life cycle, 569–570constructing a portfolio ofbusinesses, 577–581diversification, 573–576dynamic portfolio management,

571–573ownership and value creation,

565–569

Cost and capital efficiency advantages, 139

Costco, 28, 35, 184, 211, 216–237, 240–243, 248–253, 263–265, 275, 323, 332–342, 346, 482–483, 885–906

Cost of capital, 55–59, 321–349. See also Weighted average cost of capital (WACC)

beta, 332–337capital structure, 344–348in emerging markets, 742–744estimating cost of debt, 340–344below-investment-grade debt,

342–343bond ratings and yield to maturity,

340–342interest tax shield, 343–344estimating cost of equity, 324–340adjusting for industry/company

risk, 330–331arbitrage pricing theory, 330–340capital asset pricing model (CAPM),

58–59, 331–338Fama-French three-factor model,

338–339market return, 324–330estimating in foreign currency, 546–554lack of control, 57–60in multiple business units, 428–430for operating leases, 480as opportunity cost, 56–57for pension obligations, 494–496target weights, 344–347

Cost of debt, estimating, 340–344Cost of equity:

capital asset pricing model (CAPM), 331–338

emerging markets, 744estimating, 324–340 (see also Cost

of capital, estimating cost of equity)

alternatives to capital asset pricing model (CAPM), 338–340

Index 915

bindex 915 5 May 2020 10:25 AM

beta and, 332–337(see also Beta)leverage and, 790–791levered/unlevered, 200–202,

855–862Cost of goods sold (COGS), 272Cost reduction

in digital initiatives, 95–96in ESG, 89–90

Costs, fixed vs. variable, 292Cost structure health metrics, 595Coughlin, Chris, 660Country risk premium, 736–738,

741–742, 745, 747, 750Coverage, 869–871Covidien, 659Credit health, 261–265Credit ratios, and inflation, 532Credit risk, 799Credit spreads, 692Cross-border valuation, 541–558.

See also Currency, foreigncurrency translation approaches,

555–557estimating beta, 547–548estimating cost of capital, 546–554forecasting cash flows, 541–546foreign currency risk, 552–554

Cross-listed shares, 123–124Cross-subsidization, 660Currency:

effects on revenue growth, 237, 256–257

foreign (see also Cross-border valuation)

forecasting cash flows, 541–546forward rate vs. spot rate,

542–546incorporating currency risk in

valuation, 552–554translation approaches, 555–557risk, 66–67

Customer experience, in digital initiatives, 96–97

Customer lock-in, 137–138

Cyclical companies, 769–776forecasting for, 771–774management implications, 775–776share price behavior, 769–774earnings forecasts, 771–774market and DCF valuations, 769–771valuation approach, 774–775

Data, in forecasting, 270–271Debt:

below-investment-grade, 342–343changes in, 239convertible, 702, 706debt-to-value ratio, 347–348defined, 225enterprise DCF model, 194estimating cost of, 340–344valuing, 345–347, 362–364

Debt equivalents, 213, 225, 239, 364–366Debt financing, 79, 702–73Decision making

in digital initiatives, 98–99strategic management, 610, 614–618

Decision tree analysis (DTA), 809, 820–825, 832–836

Deferred gains, 243–244Deferred taxes, 225–226, 287–288Depreciation:

accelerated, 447in forecasting, 279–280

Derivative instruments, 704Devil’s advocate, 615–616Diageo, 565Digital initiatives, 93–99

defined, 93performance improvements, 94cost reduction, 95–96customer experience improvements,

96–97decision-making improvement,

98–99new business models, 94–95new revenue sources, 97–98value measurement, 93–94

916 Index

bindex 916 5 May 2020 10:25 AM

Dimson, Elroy, 327, 328, 882Direct equity approach. See Equity

cash flow (valuation model)Disclosure. See TransparencyDiscounted cash flow (DCF), 20,

550–551alternatives to, 206–208in banking, 784–786conservation of value, 42cyclical companies, 769–771drivers of cash flow and value, 51and economic-profit valuation, 21,

41with extreme inflation, 531–532scenario DCF approach, 736–742valuation modelsadjusted present value (APV),

181–182, 199–200capital cash flow (CCF), 182decision tree analysis (DTA), 809,

820–825, 832–836economic profit, 181–182, 195–199enterprise DCF, 182–195 (see also

Enterprise discounted cash flow)

equity cash flow, 204–206real option valuation (ROV), 809real-option valuation (ROV),

818–819scenario approach, 382–386, 809scenario DCF approach, 753–754single-path DCF, 809stochastic simulation DCF, 809

Discount rate, 30. See also Cost of capital

Disentanglement costs, 665Diversification:

and conglomerate discounts, 120–121

effect on cost of capital, 57–58in portfolio of businesses, 573–576

Divestitures, 655–673assessing potential value from,

664–667

barriers to, 666–667conflict of interest and, 660in corporate portfolio strategy,

571–573costs associated with, 665–666deciding on, 668–673earnings dilution from, 662executive resistance to, 661–663exit prices, 667legal/regulatory issues, 666–667pricing/asset liquidity, 667research into, 657–658transaction structure choice,

669–673carve-outs, 669, 672–673IPOs, 669, 670, 672private vs. public transactions,

669–670spin-offs, 669, 670–671tracking stock, 669, 673–673value created vs. value forgone,

664value creation from, 657–667

Dividends, 239, 675, 694–695, 701Dot-com bubble, 3, 42–43, 44, 95,

337–338

Earnings per share (EPS), 112consensus earnings estimates, 119earnings volatility, 117–119effect of share repurchases on,

44–46from employee stock options,

115–116guidance, 119–120and investor communications,

723–726and mergers and acquisitions

(M&A), 114, 647–649and share repurchases, 113from write-downs, 114–115

eBay, 111, 122, 131–132, 170, 726, 727EBIT (earnings before interest and

taxes), 426n5

Index 917

bindex 917 5 May 2020 10:25 AM

EBITA (earnings before interest, taxes, and amortization), 227–230, 261–265, 456, 528, 640–641

EBITDA (earnings before interest, taxes, depreciation, and amortization), 227–228, 261–265

EBITDAR (earnings before interest, taxes, depreciation, amortization, and rental expense), 261–265. See also Multiples

Economic profit, 21capital-light businesses, 510–513for continuing value (CV)

estimation, 303–304discounted free cash flowequivalence, 843–847ROIC and size, 40–42valuation models based on,

181–182, 195–199Economic spread analysis, 791–794Economies of scale, 140–141, 636–637,

650Edmans, Alex, 91Elanco, 565Emerging markets, 735–751

estimating cost of capital, 742–744after-tax cost of debt, 745country risk premium, 745weighted average cost of capital

(WACC), 745estimating the cost of equity, 744exchange rate movements, 745incorporating risk in valuationcountry risk premium, 736–738,

741–742scenario DCF approach, 736–739other complications, 745–747triangulating valuation, 747–751

Employee productivity, ESG, 91–92Employee stakeholders, 12Employee stock options, 115–116, 194,

370–372

Employment growth, correlation with TRS, 14

Energy companies, 10Enron, 112, 353Enterprise discounted cash flow,

182–195, 849–852four steps of, 184nonequity claims, identifying/

valuing, 184, 193–195nonoperating assets, identifying/

valuing, 184, 193operations valuation, 184valuing equity, 184, 195valuing operations, 185–193

Enterprise value:converting to value per share,

353–373defined, 353n1in multiples, 394–399, 406–407relationship to equity value,

182–183Environmental, social, and

governance (ESG), 86–88cash flow link, 88common valuation framework, 86overlapping criteria, 87value creation, 87–88cost reductions, 89–90employee productivity uplift, 81–92investment and asset optimization,

92regulatory and legal intervention

reduction, 90revenue growth, 88–89

Equity:defined, 225valuing (DCF model), 195

Equity beta, 336Equity cash flow (valuation model),

204–206, 784–786Equity equivalents, 213, 225–226Equity financing, 701–702Equity investments, 223Equity risk capital, 791, 799–801

918 Index

bindex 918 5 May 2020 10:25 AM

Equity value:contingent liabilities, 366convertibles, 366–367debt, 362–364employee stock options, 370–372noncontrolling interests, 372–373operating leases, 365pension liabilities, 497postretirement liabilities, 365–366provisions, 364–365relationship to enterprise value,

182–183ESG. See Environmental, social, and

governanceEvent trees, 826–827, 828–829Excess capacity, reducing, 634–635Excess cash, 222–223, 356Executive stock options, 44Exercise value approach, 371Expectations:

decomposing TRS, 74–80treadmill analogy, 70–73, 81–82understanding, 80–81

Expected rate of return on new invested capital. See Return on new invested capital (RONIC)

Extraordinary dividends, 701

Facebook, 111, 142, 149Fair value, 367Fama, Eugene, 326Fama-French three-factor model,

59n6, 338–339Farfetch, 755–756FASB (Financial Accounting

Standards Board) accounting rules, 42–43, 251, 443, 444

Fayard, Gary, 723Federal Reserve Bank of Philadelphia,

326FedEx, 90, 121, 222, 243Fee and commission income,

781Finance subsidiaries, 359–360

Financial Accounting Standards Board (FASB) accounting rules, 42–43, 259, 473, 474

Financial crisis of 2007–2009, 3, 110–111, 328

Financial engineering, 48–49, 703–706derivative instruments, 704hybrid financing, 706off-balance-sheet financing, 704–706

Financial institutions. See BanksFinancial projections

inflation and, 532–538operating lease and, 479

Financial statements. See also Balance sheet; Income statements

in forecasting, 271–272in multiple business units, 420–421operating leases, 482–483reconciliation to net income, 233reorganizing, 186–188, 211–244calculating NOPAT, 227–233capitalized research and

development, 243case study (Costco), 216–239cash flow available to investors,

238–239computing total funds invested,

222–225deferred gains, 243–244

free cash flow, 233–239invested capital, 212–214, 217–212key concepts, 211–216operating leases, 240–242pensions and postretirement

benefits, 242–243reconciliation to net income, 233reconciling total funds invested,

224–225pension obligations, 489–490

Financial subsidiaries, 223Flexibility, 807–840

managing, 815–817recognizing, 815–816structuring, 816

Index 919

bindex 919 5 May 2020 10:25 AM

vs. uncertainty, 810–813valuation, four-step process, 826–831valuation examples, 827–840valuation methods, 808–810compared, 809, 821–822decision tree analysis (DTA), 809,

820–825, 832–836real-option valuation (ROV), 809,

818–819, 821–822, 827–831, 836–840

risk-neutral valuation, 819–820value and, 810–813

Forecasting, 269–294components of a good model,

270–272consensus EPS forecasts, 771in continuing value (CV)

estimation, 305–307CostCo, 894–908costs, fixed vs. variable and, 292cyclical companies, 771–774forecast ratios, 271, 277–278inflation and, 293–294length/deal determination, 269–270mechanics of, 272–294step 1 (prepare/analyze historical

financials), 273–275step 2 (revenue forecasting), 275–277step 3 (income statement

forecasting), 277–283step 4 (invested capital and

nonoperating assets forecast), 283–288

step 5 (investor funds forecasting), 288–291

step 6 (ROIC and FCF calculating), 291

nonfinancial operating drivers, 291–292

stock vs. flow approach, 284Foreign currency. See Currency,

foreignFrameworks. See Valuation

frameworks

Free cash flow (FCF), 233–239 See also Cash flow

defined, 49, 211discounted economic profit

equivalence, 843–847effects of inflation on, 528–530in forecasting, 272, 291key concepts, 215–216operating leases, 478–479projecting, 190–192valuing at unlevered cost of equity,

200–202and weighted average cost of

capital, 192–193, 843–847French, Kenneth, 326Fundamental investors, 103

General Dynamics, 571Generally Accepted Accounting

Principles (GAAP), 116, 356–357, 91, 555–556, 647

General Mills, 92, 331, 565Goodwill amortization, 647Goodwill and acquired intangibles,

221–222, 237, 249–250, 286–287Google, 11, 111, 144–145Governance. See also Environmental,

social, and governance (ESG)and strategic management,

611–612Gross, Bill, 101Gross cash flow, 234–235Gross merchant value (GMV), 757, 760Groupthink, 615–616Growth. See also Revenue growth

across industries, 173–174balancing with ROIC, 24–25components of, 162–163decay analysis, 175–176defined, 50empirical analysis of, 171–176interaction between ROIC and,

27–29, 36–40portfolio treadmill, 171

920 Index

bindex 920 5 May 2020 10:25 AM

real revenue growth vs. GDP, 172–173

relationship to ROIC and cash flow, 29–33

sustaining, 167–171, 175–176trends, 172–173value creation and, 162–167variation in, 173

Growth companies. See High-growth companies

Growth strategies, 38Guidant, 114

Hedging, 66–67Heineken, 66–67High-growth companies, 753–767

uncertainty of, 765–767valuation process, 754–764estimating operating margin,capital intensity, and ROIC, 761–762scenario development, 763–764scenario weighting, 764sizing market, 758starting from future viewpoint,

754–762working backward to current

performance, 762–763Historical analysis, in forecasting, 271Historical market risk premium,

327–328 Historical performance analysis,

247–266credit health and capital structure,

261–265DCF-based models, 812–185guidelines, 266revenue growth, 255–261ROIC, 247–255

Home Depot, 80–81, 118–119Hotel partnerships with REITs, 48Hybrid financing, 706Hybrid securities, 227, 348–349, 355,

366–373

IBM, 166, 220, 635Income statements, 211, 227, 277–283,

492–493. See also Financial statements

Income taxes. See TaxesIndex membership, 122–123Inflation, 525–538

distortion of financial indicators, 531–532

effect of passing on to customers, 527–530

extreme, historical analysis of, 531–532

and financial projections, 532–538in forecasting, 293–294and lower value creation, 525–530

Informed investors, 102–103Initial public offerings (IPOs), 394,

668, 766–767Innovative business methods, 139–140Innovative products, 136Interest expense/income, 281–282Interest expenses, 238Interest tax shield (ITS), 202–203,

348–349Internal rate of return (IRR), 516–519International Financial Reporting

Standards (IFRS), 356–357, 491, 555–567, 647

Internet dot-com bubble, 3, 42–43, 44, 95, 337–338

Intrinsic investors, 713, 714, 718–719Intrinsic value, 22–23, 711–712Invested capital, 214

case illustration (Costco), 217–227defined, 49goodwill and acquired intangibles,

221–222investments in, 236–237key concepts, 212–214in multiple business units, 427–428multiples of, 408operating working capital, 218–220

Growth. (continued)

Index 921

bindex 921 5 May 2020 10:25 AM

other assets and liabilities, 220–221production equipment and

facilities, 220Investment-grade debt, 362–363Investment rate (IR), 50Investment returns, in ESG, 91–92Investments, option to defer, 808,

811–814Investor communications, 709–730

and consensus earnings forecasts, 726–729

earnings guidance, 723–726and intrinsic investors, 718–719intrinsic value vs. market value,

711–712listening to investors, 722–723objectives of, 710targeting by segment, 716–717transparency, 718, 719–722understanding investor base, 709,

712–717Investor funds, forecasting, 288–290Investors:

classification of, 713–717closet indexers, 715intrinsic, 713, 714, 718–719mechanical, 713, 715opinions of, 722–723segmentation of, 713–715traders, 713, 714–715

IPOs (initial public offerings), 394, 668, 766–767

J&J Snack Foods, 72–73, 79–80, 81Johnson & Johnson, 46, 391, 628–565,

689Joint ventures, 668

Kellogg, 491–497, 628Key value driver formula,

300–302

Leases. See Operating leasesLegal interventions, and ESG, 90

Leverage, 263–264, 869–871and beta, 861–862capital structure and credit ratings,

687–692and cost of equity, 790–791and the price-to-earnings multiple,

863–866Line item analysis, 252–253, 277Litigation charges, 462–463Loss aversion, 617–618Lowe’s, 721Lucent, 660LyondellBasell, 57

Marathon Petroleum, 572Market access, accelerating, 635Market bubbles, 105Market price, 367Market return, estimating, 324–330Market risk, 799Market risk premium, 547–548, 744,

873–876Market share performance, defined,

160Market value, 711–712Mars, 92, 143, 144Marsh, Paul, 327, 328, 882Marshall, Alfred, 3Mathematical formulas in value

creation, 49–52McKinsey & Co. research, 4, 8, 89,

141n6, 571, 576, 629, 630, 640, 658, 661, 666, 718, 725

Mechanical investors, 715, 716Merger Management Practice,

McKinsey, 640Mergers and acquisitions (M&A),

625–652better-acquirer characteristics,

649–652priority themes, 649–650reputation management, 650strategic vision, 651buying cheap, 639–640

922 Index

bindex 922 5 May 2020 10:25 AM

consolidation, 634–635, 638defined, 160earnings from, 113effects on revenue growth, 257–258empirical research on success of,

628–633estimation of operating

improvements, 640–644cost and capital savings, 640–643implementation issues, 644revenue improvements, 643–644payment method (cash/stock),

644–646performance improvement

reassessment, 651–652roll-up strategies, 637–638transformational mergers, 638–639value creation and, 626–628value creation strategies for,

633–640value creation vs. accounting focus,

646–649Merton, Robert, 207Microsoft, 95, 111, 112, 142–143, 147,

689, 701Miller, Merton, 43, 199, 335, 855Mitchell, Mark, 629–630Modigliani, Franko, 43, 199, 335, 855Molson Coors, 728Multibusiness companies. See

Valuation by partsMultiple expansion, 47Multiples, 389–411

adjusting for nonoperating items, 380–404

alternative multiples, 406–411as alternative to discounted cash

flow, 207comparables analysis, 389–390in continuing value (CV)

estimation, 315–316EBITA vs. EBITDA, 398–399in emerging markets, 705–706

enterprise value to EBIT, 396–397enterprise value to EBITA (or

NOPAT), 394–397enterprise value to revenues,

406–407forward-looking, 392–394of invested capital, 408NOPAT vs. EBITA, 400–401of operating metrics, 408–411peer group selection, 404–406PEG ratios, 407–408price to earnings, 395–396principles, 390–391sum-of-parts valuation, 391

Naive overconservatism, 312Nestlé, 133Net capital expenditures, 236Netflix, 117, 144, 194, 409–410Net income, reconciliation to, 233Net interest income, 780–781,

795–796Net investment, defined, 49Net operating profit after taxes

(NOPAT), 49Net operating profit less adjusted

taxes. See NOPLATNet present value (NPV), 810–813. See

also Contingent NPVNetscape Communications, 110Network effects, 95, 143, 761Neutrogena, 46Noise investors, 103Nonconsolidated subsidiaries, 223Noncontrolling interests, 194–195,

227, 372–373. See also Nonconsolidated subsidiaries

Nonequity claims, 184, 193–195, 353Nonfinancial operating drivers,

291–292Nonfundamental investors, 102Nonoperating assets, 222–224,

355–359discontinued operations, 360

Mergers and acquisitions (continued)

Index 923

bindex 923 5 May 2020 10:25 AM

excess cash and marketable securities, 356

excess pension assets, 361excess real estate, 360finance subsidiaries, 359–360forecasting, 287–288identifying/valuing, 184, 193loans to other companies, 359nonconsolidated subsidiaries,

356–359tax loss carryforwards, 361–362

Nonoperating expenses, 455–470amortization of acquired

intangibles, 460–463asset write-offs, 461defined, 353, 455gains/losses on sale of assets, 463intangibles, 460–463litigation charges, 460–463one-time vs. ongoing, 455–456persistence of special items, 459reorganizing income statement, 465restructuring charges, 461–462separating from operating expenses,

455–456, 456–458special items, 459

Nonoperating income, 238, 280–281Nonoperating taxes, 238NOPAT (net operating profit

aftertaxes), 219–220calculating, 227–233continuing value and, 302–303,

314–315defined, 49, 211, 212key concepts, 214–215in multiple business units, 426for operating leases, 477–478

Novartis, 638–639

Off-balance-sheet financing, 704–706One-time expenses, 455–456Operating analysis, 253–255Operating cash flows, projecting/

testing, 679–680

Operating-cost productivity, 594Operating expenses:

forecasting, 279separating from nonoperating

expenses, 455–456, 456–458Operating leases, 240–242, 365,

473–485accounting for, 474–476alternative method for, 483–484capitalized, 241–242enterprise DCF model, 194enterprise valuation with, 476–478as form of debt, 476free cash flow, 478–479incorporating into financial

projections, 479valuing, 483–484

Operating margins:in high-growth companies, 761–762and inflation, 531

Operating metrics, multiples of, 408–411Operating taxes:

accrual-based, 445–447converting to operating cash taxes,

445–449deferred, 449–451on reorganized balance sheet,

449–450valuing, 450–451determining, 439–445public statements, 441–443Walmart, 444–445estimating, 230–232forecasting, 282–283

Operating working capital, 218–220, 236, 285–286

Operational risk, 800Operations valuation, 185–193Opportunity cost, cost of capital as,

56–57Optimism, excessive, 616–617Options, real, 207–208Organizational health, 597Overconservatism, 312

924 Index

bindex 924 5 May 2020 10:25 AM

Payout ratio, 256–265Pecking-order theory, 867–868Peer groups, 404–406PEG ratios, 407–408Pensions and postretirement benefits,

223–224, 242–243, 361, 365–366analyzing and valuing,

489–494cost of capital, 494–496expected return and earnings

manipulation, 493–494forecasting, 287–288overfunded, 223–224unfunded, 457–497value of equity, 497

PepsiCo, 312, 490, 628Percentage of property, plant, and

equipment (PP&E), 286Performance analysis. See Historical

performance analysisPerformance review, 620–622Perpetuities, 843–845Petajisto, Antti, 715Phillips, 572, 671Pillsbury, 565Planning

annual operating plan (AOP), 619–620

strategic, 619Polo, Andrea, 630Porter, Michael, 133Portfolio management,

571–573Portfolio momentum, 160Portfolio treadmill, 171Pottruck, David, 618PP&E (percentage of property, plant,

and equipment), 286Preferred stock, 194Pre-mortem, 617Price premium advantages, 136Price-to-earnings ratio (P/E)

leverage, 864–866stock returns, 106–107

Principles of Corporate Finance (Brealey, Myers, and Allen), 43

Privately held subsidiaries, 358–359Procter & Gamble (P&G), 35, 57, 89,

133–134, 144–145, 164–165, 547, 566–567, 573, 635–636, 693–694

Productivity, and ESG, 91–92Property, plant, and equipment

(PP&E), 286Provisions, 463–469

defined, 463income-smoothing, 365, 468–469long-term operating, 365, 466–467nonoperating, 365ongoing operating, 364, 465–466restructuring provisions, 467–468taxes and, 469

Purposeful overconservatism, 312

Quality, 136–137

R&D. See Research and developmentRational price discipline, 148–149Real options, 207–208, 814, 817Real-option valuation (ROV), 809,

817–820, 836–840Regulation, and ESG, 90REITS (real estate investment trusts),

48Replicating portfolios, 207, 818–819Reputation management, 650Rerating, 47Research and development (R&D), 6,

243Reserves. See ProvisionsRestructuring reserves, 239Retirement liabilities, unfunded, 194,

489–497Return on assets (ROA), 248Return on invested capital (ROIC),

18–19, 20–21, 131–156, 247–255, 308

alternative measures of, 515–523

Index 925

bindex 925 5 May 2020 10:25 AM

cash flow return on investment (CFROI), 517–519

analyzinggoodwill and acquired intangibles,

249–250balancing with growth, 24–25capitalizing expenses investments,

499–507capital-light business models,

507–510competitive advantage and, 135–143cost and capital efficiency

advantages, 139decay analysis, 154–156decomposing, 250–255defined, 49–50, 211differences across industries,

148–152drivers of, 132–135effect of acquisitions on, 156empirical analysis, 145–156equaling IRR, 516–517focus on high- vs. low-ROIC

companies, 28in forecasting, 272, 291in high-growth companies,

761–762historic trends, 145–146interaction between growth and,

27–29, 36–40and length of product life cycle, 143line item analysis, 252–253managerial implications, 36–40operating analysis, 253–255persistence by industries, 152–154production outsourcing and,

509–510and product renewal potential,

144–145projecting, 190–192relationship to growth and cash

flow, 29–33stability of, 152–156stock returns, 108–109

Return on new invested capital (RONIC), 302, 308, 312

Revenue forecasting, 275–277Revenue growth, 159–176. See also

Growthanalyzing, 255–256accounting changes and

irregularities, 259currency effects, 256–257mergers and acquisitions, 257–258from attracting new customers, 165and balance with ROIC, 159decay analysis, 175–176decomposing, 259–261and digital initiatives, 97–98drivers of, 160–162empirical analysis, 171–176and ESG, 88–89historical trends, 172–173from increasing market share, 165from new product development,

164from persuading existing customers

to buy more product, 164–165projecting, 190–192rates across industries, 173–174sustaining, 167–171, 175–176through acquisitions, 166–167through incremental innovation,

165through price increases, 166through product pricing and

promotion, 165–166transition probability, 176–177and value creation, 162–167value of major types of, 163variation in, by industry, 161variation in, over product life cycle,

143volatile, by industry, 173

Risk:cash flow risk, 63–66diversifiable vs. nondiversifiable,

822–825

926 Index

bindex 926 5 May 2020 10:25 AM

exposure level, 63–66hedging, 66–67price of, 57–59

Risk-free rate, 328–330, 744Risk-neutral valuation, 819–820Risk-weighted assets (RWA), 799–801Robotic process automation (RBA),

93, 96Rockwell Automation, 35ROIC. See Return on invested capital

(ROIC)Roll-up strategies, 637–638RONIC (return on new invested

capital), 302, 303, 308, 312Rossi, Stefano, 630RSC, 46Ruback, Richard, 203Ryanair, 135

Sale-leaseback transactions, 48–49, 243

Sales productivity, 594Sanofi Aventis, 572Scalability of products/processes,

141–142Scenario analysis, 60–61, 377, 382–386Scenario DCF approach, 736–742,

753–754, 809Scenario development, 763–764Scenario weighting, 764Scholes, Myron, 207Securities and Exchange Commission,

69Securitized receivables, 473Sell-side analysts, 717Sensitivity analysis, 377, 380–382Service Corporation International,

637–638Shareholder capitalism, 9–11Shareholder payouts, 693–700Shareholder returns. See Total

shareholder returns (TSR)Shareholder value creation, 5–6Share repurchases, 44–46, 239, 675,

677, 696–701

EPS growth, 113Shiller, Robert, 101Short-termism, 6–9Siemens, 223, 658–6597, 667, 670Simplified intermediate forecast, 270Single-path DCF, 809Social responsibility, 11–12Sodexo, 12, 256–257, 259Solvency, 870–871Spin-offs, 668, 669–670Split-offs, 668, 669Stability bias, 614Stafford, Erik, 629–630Stakeholder interests, 11–14Statement on the Purpose of a

Corporation (Business Roundtable), 4, 12, 87

Staunton, Mike, 327, 328, 882Stochastic simulation DCF, 809Stock market, 101–128

bubbles, 105 (see also Financial crises)

cross-listings, 123–124diversification, 120–121earnings (see Earnings per share

(EPS))fundamentals of, 102–111index membership impact on

company, 122–123informed investors vs. noise

investors, 102–103market mechanics, 122relationship of company size to

value, 121–122stock splits, 125–126total returns to shareholders (see

Total shareholder returns (TSR))

understanding expectations, 80–81Stock splits, 125–126Stranded costs, 665–666Strategic health, 596Strategic management

analytics, 585–607adopting granular perspective,

586–588

Risk: (continued)

Index 927

bindex 927 5 May 2020 10:25 AM

monitoring results, 605–607setting targets, 604–605simpler alternative, 589–592taking enterprise view, 588–589three processes, 586value drivers, 592–597, 607value driver trees, 598–604, 607mindsets, behaviors, and processes,

586, 609–622debiased decision making, 614–618spending to maximize value, 609strong governance, 611–614synchronized processes, 618–622three elements, 610–611

Strategic vision, 651Strategy, streamlined process in, 619Subsidiaries, 194–195Synchronized processes, 611, 618–622

Tapestry, 249Target-setting, 604–605Target weights, 344–347Taxes, 439–452

deferred, 225–226, 449–451forecasting, 282–283operating, 439–449 (see also

Operating taxes)provisions and, 469

Tax loss carryforwards, 224, 361–362Tax-loss carryforwards, 450–451Tax on a maturity mismatch (TMM), 792Tax penalty on equity, 791Tax shields, valuing, 202–203Technology bubble, 104, 105, 110–111Thaler, Richard, 101Top-down forecasting, 275–277Total debt, 281Total funds invested

computing, 222–224reconciling, 224–227

Total shareholder return (TSR), 6, 69–82

correlation with employment growth, 14

decomposing, 74–80defined, 69

diversification and, 575earnings guidance and, 724enhanced approach to analyzing, 77expectations treadmill, 70–73impact of debt financing on, 79key drivers of, 76managerial implications, 81–82as measure of management

performance, 77–80and spin-offs, 670traditional approach to analyzing,

74–77traditional vs. enhanced

decomposition, 77Tracking stock, 668, 672–673Traders, 715–716Trade sales, 669Transformational mergers, 638–639Transparency, 718, 719–722Triangulation, 750–751TSR. See Total shareholder returns Tyco, 659, 660Tyson Foods, 72–74, 79–80, 81

Uncertainty. See FlexibilityUnilever, 89, 122, 133, 415, 547, 696Unique resources, 140United Parcel Service (UPS), 121, 122,

141, 220, 225, 230, 279, 404, 594United Rentals, 46Unlevered cost of equity, 857–858

Valero Energy, 572Valuation by parts, 415–433

corporate overhead costs, 421–422cost of capital, 428–430enterprise to equity value buildup,

418–419estimating invested capital,

427–428estimating NOPAT, 426–428financial subsidiaries, 425–426individual unit financial statements,

420–428intercompany receivables and

payables, 424–425

928 Index

bindex 928 5 May 2020 10:25 AM

intercompany sales and profits, 422–424

intercompany transactions, 422–425mechanics of, 416–420multiples of peers valuation,

430–432public information, 426ROIC breakdown, 418valuation summary, 428

Valuation frameworks, 181–208chart of, 182DCF alternatives, 206–208DCF-based approachesadjusted present value (APV),

181–182, 199–200capital cash flow, 203economic profit, 181–182, 195–199enterprise discounted cash flow,

182–195(see also Enterprise discounted cash flow)

equity cash flow, 204–206digital initiatives, 95ESG and digital initiatives, 86

Valuation metrics, 265, 290–291Valuation results, analyzing, 377–386

art of valuation, 386consistency check, 378–380model validation, 377–380plausibility check, 380–381scenario analysis, 382–386sensitivity analysis, 380–382

Valuation summary, in forecasting, 272

Valuedefined, 4–5spending to maximize value, 609

Value conservation principle. See Conservation of value principle

Value creation:from acquisitions (see Mergers and

acquisitions (M&A))balancing ROIC and growth, 24–25economic profit, 40–42

and ESG, 85–86examples, 17–25, 35–36fundamentals, 27–53importance, vs. value distribution,

127math of, 49–52and revenue growth, 162–167ROIC and growth, 27–29senior management tasks, 585and share repurchases, 113

Value distribution, 127Value drivers, 592–597, 607

flexibility, 814–815long-term, 596–597medium-term, 595–596short-term, 594–595

Value driver trees, 593, 598–603, 607, 794–795

Value measurement, in digital initiatives, 93–94

Value per share, calculating, 353, 373

WACC. See Weighted average cost of capital (WACC)

Walmart, 444–4445Webvan, 131–132Weighted average cost of capital

(WACC), 56–57calculating, 322–323components of, 321Costco, 902defined, 50discounting free cash flow at,

192–193in emerging markets, 745in forecasting, 271, 290–291in operating leases, 480

Whole Foods, 132, 720WorldCom, 112Write-downs, 114–115, 461Write-offs, 455

Zeneca, 572Zimmer, 660

Valuation by parts (continued)

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