TheGoldmanSachsGroup,Inc.EquityValuation–Understandingwhat’simportantNovember2009HelenJewell,CFA44-20-7552-9454helen.jewell@gs.comIntroduction•Wearegoingtoconsiderthreeofthemostpopularandeffectivevaluationtools•Returnsbasedanalysis•MultipleAnalysis•DCF•Foreachofthemwearegoingtolookat:•Howtheywork•Whysomeworkbetterthanothers,and….•WhytheyareallsimplydifferentwaysoflookingatthesamethingGoldmanSachsGlobalInvestmentResearch2ReturnsBasedAnalysisKeyIdeaIt’sallaboutthevalue-addedExcessvaluecreatedbyacompanyActualReturnversusRequiredReturnCROCIWACCVersusTotalEVExcessvalueattributedbythemarketActualValueversusInvestedValueGrossCashInvestedIftheseareoutofline,thestockismisvaluedForDirector’sCut,butcanadjustGoldmanSachsGlobalInvestmentResearch4WhyDoesitWork?Youinvest$100minsomeassetsYourrequiredreturnis10%TheactualTheactualTheactualreturnis10%returnis20%returnis5%Theinvestmentshouldbeworth$100mTheinvestmentshouldbeworth$200mTheinvestmentshouldbeworth$50mEVCROCIEVCROCIEVCROCIGCIWACCGCIWACCGCIWACCValueCreatingValueDestroyingGoldmanSachsGlobalInvestmentResearch5CalculatingCROCIOperatingcashflowNon-cashitemsandthecompany’sfinancialstructurehavenoimpact,makingcomparisonsmoremeaningful(ignoringWorkingCapital)plusafter-taxinterestandleaseInterestandLeasex(1–TaxRate)CROCI=Debt-AdjustedCashFlowGrossCashInvestedPre-depreciationandwriteoffvalueoftangibleandintangibleassetsGrossAssetsplusOperatingworkingcapitalpluscapitalisedleasesplusinvestmentsDepreciationpoliciesdonotimpactthisfigureGoldmanSachsGlobalInvestmentResearch6Companiesarecomparedwiththesector1:1line2.01.51.00.5OvervaluedLinerepresentingaveragevaluationforthesectorQuestion:Whyarethesedifferent?DCscore1DCscore1Undervalued0.00.51.01.52.02.5CROCI/WACCQuartile4Quartile3Quartile2Quartile1GoldmanSachsGlobalInvestmentResearch7Whyarethesedifferent?•Capex•Valuableassetswhicharenotrevalued(eg.Intangibles)•Growth…..GoldmanSachsGlobalInvestmentResearch8Whataboutgrowth?•Absolutegrowthisnotthedriverofvalue•Why?•Growthisn’talwaysgood•Returns,notgrowth,havehistoricallybeenshowntodrivevaluations•ReturnsaremorestableandconsistentthangrowthGoldmanSachsGlobalInvestmentResearch9Growthisn’talwaysgood!•Ifmanagementaregeneratinglowerreturnsthanrequiredreturns,thenvaluewillbedestroyed•Ifmanagementaregeneratinghigherreturnsthanrequiredreturns,thenvaluewillbeaddedPriceDownPriceUPPriceStableValueDestroyerValueNeutralValueAddingReturnRequiredreturnReturn=RequiredreturnReturnRequiredreturnGrowthGrowthHighLowLowHighGoldmanSachsGlobalInvestmentResearch10Cashreturnspreads,notgrowth,drivevaluationandperformanceDirector’sCutshowsthehighestcorrelationwithmarketvaluationovertimeinAEJ……aswellasinJapan70%60%50%40%30%20%10%0%70%60%50%40%30%20%10%0%EV/EBITDAvs.DivYieldvs.PEvs.EV/GCIvs.DivYieldvs.PEvs.EV/EBITDAvs.EV/GCIvs.NextyearEBITDAgrowthNextyearDPSgrowthNextyearEPSgrowthCROCI/WACCNextyearDPSgrowthNextyearEPSgrowthNextyearEBITDAgrowthCROCI/WACCSource:GoldmanSachsResearchestimates,GaoHuaSecuritiesResearchestimates.Themarketvaluescompaniesonreturns:Thecorrelationbetweencapitalizationofcashinvested(EVvs.GCI)andeconomicreturnspread(CROCIvs.WACC)issignificantlyhigherthanbetweenmultiplesandgrowthGoldmanSachsGlobalInvestmentResearch11SuperiorreturnsaremoresustainablethansuperiorgrowthTop-quartilereturnsmoresustainablethangrowthinAEJ……aswellasinJapan80%70%60%50%40%30%20%10%0%90%80%70%60%Averageyearsfirstquartilepositionissustained:CROCI:2.4yearsGrowth:1.3yearsAverageyearsfirstquartilepositionissustained:CROCI:2.8yearsGrowth:1.2yearsMorethan95%ofcompaniesdisplayfirstquartilegrowthfor2yearsorless.Approx.85%donotmakeitpast1yearAbout95%ofcompaniesdisplayfirstquartilegrowthfor2yearsorless.Approx.80%donotmakeitpast1year50%40%30%20%10%0%CROCIismuchmoresustainable,withapprox.30%ofcompaniesthateverreturnedatopquartileCROCI,holdingthepositionforlongerthan3consecutiveyearsCROCIismuchmoresustainable,withmorethan35%ofcompaniesthateverreturnedatopquartileCROCI,holdingthepositionfor3consecutiveyearsandlonger12345678910111213141234567891011121314NumberofconsecutiveyearsinfirstquartileNumberofconsecutiveyearsinfirstquartileFirstquartileCROCIFirstquartileGrowthFirstquartileCROCIFirstquartileGrowthSource:Companydata,GoldmanSachsResearchestimates,GaoHuaSecuritiesResearchestimates.Andunderstandingthesustainabilityofreturnsiscriticalforvaluation……GoldmanSachsGlobalInvestmentResearch12Takingthemethodologyonestepfurther–understandingthebehaviourofQ1andQ4CROCIcompanies•CompanieswhohaveQ1CROCIandwhocansustainthislevelofCROCIwillbeascribedapremiumbythemarket(theymayappeartobeovervaluedbuttheyarenot).ThesizeofthepremiumdependsonhowlongtheywillstayasaQ1CROCIstock•CompanieswhomoveintoQ1CROCIbutforwhothemarketdoesnotbelievethistobesustainablewillnotre-rate(theymayappeartobeundervaluedbuttheyarenot)•CompanieswhichareQ4haveafloorvaluationandsotradeatapremiumtotheline.ThesizeofthepremiumdependsonwhethertheyareasustainedloserornotGoldmanSachsGlobalInvestmentResearch13TheadjustedDirector’sCutmethodology–lookingatthedurationofvalueaddition/destr