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					VALUATION OF SHARES AND OTHER EQUITY IN
THE FINANCIAL ACCOUNTS OF THE SPANISH
ECONOMY (FASE).
The discounted value of future profits


Begoña Gutiérrez del Olmo Moreda
Central Balance Sheet Data Office Specialist




WORKING PARTY OF FINANCIAL STATISTICS-OCDE
Paris, 3 November 2009




STATISTICS DEPARTMENT
VALUATION OF UNQUOTED SHARES AND OTHER EQUITY
IN THE FASE. The discounted value of future profits
                                                        Contents

1.      Introduction to the Spanish valuation methods: Description and
        aggregates
         1. Issues of resident units
         2. Issues of non-resident units held by residents

2.      Discounted value of future profits (method D): Conceptual framework
           References to the method in the reviewed SNA
           Reasons for applying method D as an alternative to method C
           Requirements for applying method D

3.      Description of method D
           Components of the discount factor (dq)
           Process of grossing up




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INTRODUCTION TO SPANISH VALUATION
METHODS: DESCRIPTION AND AGGREGATES                               Issues of residents

                                     Specific criteria
            General criteria                                           Aggregates
                                        (method)

                                 Market capitalisation (A)   Quoted public limited companies
                                                             (Non-financial and banks)
    Market valuation in strict
    sense                        Net asset value (B)         Mutual Funds


                                 Capitalisation / Own        Unquoted banks
                                 funds ratio (C)
   Approximations to market
   valuation                     Discounted value of         Unquoted non-financial public
                                 future profits (D)          limited companies

                                                             Unquoted public limited
                                                             companies (Financial except
                Book value       Own funds (E)               banks)
                                                             Other legal forms (Other equity)



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INTRODUCTION TO SPANISH VALUATION
METHODS: DESCRIPTION AND AGGREGATES                             Issues of non-residents held
                                                                by residents (F)




             Valuation methods based on:
                  – Market value: In case of quoted shares
                  – International Investment Position Statistics: In other cases




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VALUATION OF UNQUOTED SHARES AND OTHER EQUITY
IN THE FASE. The discounted value of future profits
                                                        Contents

 1.      Introduction to Spanish valuation methods: Description and aggregates
          1. Issues of resident units
          2. Issues of non-resident units held by residents

 2.      Discounted value of future profits (method D): Conceptual framework
            References to the method in the Reviewed SNA
            Reasons for applying method D as an alternative to method C
            Requirements for applying method D

 3.      Description of method D
            Components of the discount factor (dq)
            Process of grossing up




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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
                                                                           References to the method in
                                                                           the reviewed SNA


            Reviewed SNA:

                –       13.70 When actual market values are not available, an estimate is required.
                        Alternative methods of approximating market value of shareholders’ equity in a
                        direct investment enterprise follow. These are not ranked according to
                        preference, and each would need to be assessed according to the
                        circumstances and the plausibility of results:
                        …
                        c. Present value/price to earnings ratios. The present value of unlisted
                        equity can be estimated by discounting the forecast future profits. At its
                        simplest, this method can be approximated by applying a market or industry
                        price-to-earnings ratio to the (smoothed) recent past earnings of the
                        unlisted enterprise to calculate a price. This method is most appropriate
                        where there is a paucity of balance sheet information but earnings data are
                        more readily available




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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
                                                                       Reasons for applying method
                                                                       D (as an alternative to method C)

                          Why does Spain use an alternative method?
        Only in case of banks are unquoted companies well represented by
         quoted ones
        Unquoted non-financial public limited companies are not well
         represented by quoted ones because quoted public limited
         companies,
              –are much more larger than unquoted ones

              –usually have a different financial structure from unquoted companies

              –are concentrated among particular economic activities which usually demand a larger
              volume of funds

              –The number of quoted public limited companies is very small relative to the total




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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
                                                               Reasons for applying method
                                                               D (as an alternative to method C)

   Method D is the most commonly used by financial analysts
    Method D is well considered by Accounting standard setters: IASB. Draft
    about Fair Value Measurement and Valuation techniques:

            Paragraph 38 b): “The income approach uses valuation techniques to
            convert futures amounts to a single present (discounted) amount.
            The fair value measurement is determined on the basis of the value
            indicated by current market expectations about those future amounts”
            Paragraph 44: “… A fair value measurement developed using a present
            value technique might be categorised within Level 2 or Level 3,
            depending on the inputs that are significant to the entire measurement and
            the level in the fair value hierarchy within which those inputs are
            categorised”.

   Where Level 2 o 3 could mean inactive markets.
   Financial crisis reducing so much liquidity as to have listed but iliquidity
   corporations could be an example of this situation.

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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
                                                                                                          Reasons for applying method
                                                                                                          D (as an alternative to method C)

                                Some figures to measure the problem
                                                 NON-FINANCIAL FIRMS IN SPAIN. 2005


                                                                                 Number (1)             Employees (2)         GVA (2)
                                                                            Abs. Number    %                 %                  %

             TOTAL NON-FINANCIAL FIRMS (excluding sole partnerships)             1,122,271    100.00            100.00            100.00
             1.- Public limited companies                                          114,722     10.22              41.89             54.96
                1. Quoted                                                              140      0.01              2.85               9.90
                    1. Continuous market                                               101      0.01              2.80               9.68
                       Of which, IBEX-35                                                28      0.00              2.05               8.05
                    2. Floor trading                                                    39      0.00              0.05               0.22
                2. Unquoted                                                      114,582 10.21                   39.04             45.06
             2.- Privated limited companies                                        978,299      87.17             54.52             41.52
             3.- Other corporate status                                             29,250       2.61              3.59               3.52


          (1) Source : Central Directory of Firms (DIRCE) of the National Institute of Statistics (INE) and author' s calculations based
              on CNMV data
          (2) Source: INE and data estimated by the Banco de España Central Balance Sheet Data Office




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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
                                                                           Reasons for applying method
                                                                           D (as an alternative to method C)
                           The problems of using multi-country ratios
          Additional limitations arise when trying to use multi-country ratio data
           because of the differences between countries’ financial structures1.
           Some of these differences are:

               1.       The amount and the structure of assets
               2.       Revaluation criteria
               3.       Financing practice in each country
               4.       Relationships between firms and banks
               5.       Tax systems
               6.       Guarantees offered to lenders
               7.       Pensions
               8.       Bankruptcy law insolvency rules

  (1) According to the conclusions of the Own funds Working Group of the European Committee of
      Central Balance Sheet Data Offices set out in one of its studies: “Corporate Finance in Europe
      from 1986 to 1996


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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): CONCEPTUAL FRAMEWORK
                                                                 Requirements of the method

         The application of this method requires:

         1. A quality data source for non-financial companies’ profit and loss accounts to
            estimate future profits to be discounted
         2. A market reference to estimate the discounting rate

         3. Demographic statistics for non-financial companies

        In Spain the information comes from:

               Central Balance Sheet Data Office Database: Accounting information and
                a conversion table to go from business accounting to National accounts
               National demographic statistics for corporations: DIRCE from National
                Institute of Statistics




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VALUATION OF UNQUOTED SHARES AND OTHER EQUITY
IN THE FASE. The discounted value of future profits
                                                          Contents



     1.      Introduction to Spanish valuation methods: Description and aggregates
              1. Issues of resident units
              2. Issues of non-resident units held by residents

     2.      Discounted value of future profits (Method D): Conceptual framework
                References to the method in the reviewed SNA
                Reasons for applying method D as an alternative to method C
                Requirements for applying method D

     3.      Description of method D
                Components of the discount factor (dq)
                Process of grossing up




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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
                                                             Components of the discount
                                                             factor (dq)


         This method estimates the market value of shares issued by unquoted
          firms by calculating the present value of the future profits generated by
          such firms
         The method is based on the fact that the market value of quoted firms
          can be obtained by dividing their expected profits by a discount factor

                                                    ONPq          Risk-free interest rate

                           Capitalisation = MVq =
                                                                      Risk premium
                                                     dq
                                                                 Expected growth rate
                                                                      of profits




          Underlying this method is the hypothesis that the profits generated by
           such firms are considered to be perpetual.


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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
                                                                 Components of the discount
                                                                 factor (dq)

   About ONPq (Ordinary Net Profit):
           It’s to be the expected profit for the following year. Failing that, it is used
           the average of last five years
           Calculated as Gross Value Added at factor cost minus personnel costs, net
           financial charges and operating depreciation and provisions


About dq:
        It’s to be the implicit discount factor or Internal Rate of Return of quoted
        companies: Capitalization/ONPq
        Three components of dq:
              Risk free interest rate
              Risk premium
              Expected growth rate of profits



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COMPARED EVOLUTION OF THE COMPONENTS OF dq :
Risk-free interest rate, risk premium, expected growth rate
of profits and discounted rate                                           Components of the discount
                                                                         factor (dq)

             Discount factor           Expected growth rate of profits
             Risk-free interest rate   Risk Premium
12



  9



  6



  3



  0
        1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007


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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
                                                                  Components of the discount
                                                                  factor (dq)
   Likewise, the following expression can be deduced for unquoted
   shares:
                                      ONPnq               ONPnq
                        MVnq=                     =
                                        dnq             dq + 0,03
               Where 0,03 is the illiquidity premium:
               This premium should consider not only the illiquidity but, also, the
                  possibility that unquoted public limited companies’ profits are not as
                  perpetual as those of quoted ones. Therefore, an increase in the
                  discount rate, because of the different time horizons, must be
                  considered
               The level of this premium has been quantified according to theoretical
                  analysis of the gap between perpetual income and temporary
                  income


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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
                                                                 Components of the discount
                                                                 factor (dq)

         dq is calculated as the median of the discount rates of all the quoted non-
          financial corporations traded on the continuous market, which means
          excluding floor-traded companies

         Extremely volatile corporations are stripped out of the aggregate by
          means of the trust interval, which is defined as the average plus/minus twice
          the standard deviation.

         Sector differentiation is only applied in the case of the electricity sector
          because of its specific features




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DISCOUNTED VALUE OF FUTURE PROFITS
(METHOD D): DESCRIPTION OF THE METHOD
                                                              Process of grossing up

       The Central Balance Sheet Data Office Database provides information on
        approximately 30,000 unquoted public limited companies

       Using the conversion table which allows one to go from business accounting to
        National Accounts, a full chart of accounts, including those relating to other
        changes in volume and revaluation, is prepared.

       There must be a process of grossing up, from the original aggregate to the
        whole unquoted non-financial public limited corporations aggregate.

       Finally, whole unquoted non-financial public limited corporations’ estimated
        values by this way is used, with several adjustments coming from other
        Institutional Sectors, for preparing Financial Accounts of the Spanish
        Economy.




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COMPARED EVOLUTION OF REVALUATION RATES:
Quoted and unquoted shares
                                                               Process of grossing up



                  Quoted FASE     Unquoted MENF     Unquoted FASE
 40%

 30%

 20%

 10%

   0%

-10%

-20%

-30%
                 2001      2002       2003        2004     2005       2006       2007


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COMPARED EVOLUTION OF UNQUOTED SHARES
REVALUATION RATES COMPONENTS:
ONPnq and discount factor                                   Definitions




               Ordinary Net Profit (nq)   Discount factor
 40

 30

 20

 10

   0

-10

-20
         1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007


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    BEGOÑA GUTIÉRREZ DEL OLMO



    THANK YOU FOR
      LISTENING




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                                21

				
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