CFAs and MBAs will encounter the word beta early in their finance courses. Beta is a critical component in corporate finance. There are different types of betas and multiple aspects to betas. There are different types of betas and multiple aspects to betas This article considers the various aspects of beta in finance.
It’s one thing to understand the difference between Type 1 and Type 2 errors. And another to remember the difference between Type 1 and Type 2 errors! If the man who put a rocket in space finds this challenging, how do you expect students to find this easy!? Elon Musk’s tweet: Is this a type 1 or Type 2 error? If you teach statistics, you already […] Read more
Publically listed companies have to disclose specified information on their taxes in their annual reports/form 10-Ks. This includes:
Effective tax rate for years covered.The income tax benefit or expense.The components of deferred tax assets and deferred tax liabilities.Reconcillation of the differences between the US statutory rates and income tax expense reported in the income statement.Actual taxes paid.Expected changes/risks involved in any tax positions taken.Allowances that may impact tax liabilities; and more.
These disclosures are found throughout the 10-k starting with the MD&A all the way up to the notes to the financial statements.
But when valuing an asset, we are interested not in the past but the future. We are trying to estimate the free cash flows of the business. Taxes will impact our free cash flows. In this context, what can actual taxes paid tell you about future cash flows and valuation?
Investors look at a variety of valuation multiples when making investment decisions. A fundamental valuation multiple investors traditionally look at is the PE ratio which is the ‘Price-Earning’ ratio. The PE multiple is calculated by dividing the share price/earnings per share or Equity Value/Net income.
Traditionally, the PE ratio has hovered around the 10-15x range. Of course, the good companies have taken on valuations on the higher end (around 15x earnings) and mediocre companies around the lower range (around 10x earnings). Exceptional companies with high growth and good operating margins have seen PE ratios around 30x earnings. These include well-regarded companies such as Google, Apple, and Microsoft. Many analysts have been screaming overvaluation whenever they see high PE ratios!
Today, we see many companies valued at 100x earnings. Many of these companies do not even have earnings. Can we justify these valuations? When? We address these questions here.