This short tutorial is designed to walk you through each step of valuing a company on the Intrinio Valuation engine.
The Valuation platform enables you to scenario test the value of companies under different circumstances. For example, you could run and save three different valuations that show the value of a company as a base case, bearish/downside or bullish/upside.
In this tutorial, we’re going to calculate the intrinsic value of Michael Kors (NYSE: KORS) under the scenario of a recession in 2016.
Step 1: Go to www.intrinio.com and sign in. If you have not already registered, click “Register” in the upper right hand corner and follow the directions to verify your email.
Step 2: Click on “Valuation” in the top header bar, and then "Create a Valuation" in the sub-menu bar.
Step 3: In the first entry box, name your Valuation “Michael Kors 2016 Recession Scenario”. In the second entry box, type KORS. You'll see "KORS - Michael Kors Holdings Ltd." pop up - click on it. Then click “+Save”.
Step 4. The default Valuation will immediately open up, and you’ll see your Valuation title at the top, as well as the default Intrinsic Value, the most recent stock price, and the default Margin of Safety.
The Intrinsic Value represents the inherent worth of a company. It is the present value of all of the future cash flows the company will generate. Typically, it differs from the current stock price. When the Intrinsic Value is lower than the stock price the company is overvalued, and when the Intrinsic Value is higher than the stock price the company is undervalued. The Margin of Safety represents the difference between the intrinsic value of a stock and its market price. In theory, the further a stock’s price is below its intrinsic value, the greater the margin of safety against future uncertainty and the greater the stock’s resiliency to market downturns. In short – a higher Intrinsic Value and a higher (and positive) Margin of Safety is better.
The Initial Intrinsic Value and Margin of Safety that you see at the top are simply a baseline. They are calculated based off of default assumptions derived from both Wall Street Consensus Data and Mean Reversion calculations. Valuation is as much of an art as it is a science – it requires human input. You’ll want to adjust the assumptions used in the model to more accurately reflect the true intrinsic value of KORS during a recession. These initial numbers are simply a starting point.
We see that initially, without adjusting any assumptions, our base-case analysis shows KORS to be undervalued.
Step 5: This first page we’re on is the Assumptions page. We’ve boiled the Valuation down to 5 main assumptions that drive the DCF model. 3 Cash Flow assumptions (Revenue Growth, NOPAT Margin and Invested Capital Turnover) in a graphical form, and 2 Cost of Capital assumptions (Credit Spread and Company Specific Risk Premium) with slider bars. You can flexibly adjust all of these values here on the Assumptions page.
First off is the Revenue Growth graph. You’ll see the historical data pull in on the left hand side and the default assumptions for future revenue growth populate on the right hand side. Given that KORS is a luxury goods company we will want to drop the Revenue Growth assumptions. Luxury goods companies do not preform well during recessions.
Click on the green dot above the year 2016 and drop it down to -2.50%. Drag 2017 down to -1.00%, drag 2018 down to 1.00%, drag 2019 down to 0.85% and don’t change 2020. (You can also double click on the dot and manually type it in.) Click the green “Save” button in the upper right hand corner. You’ll see the intrinsic value re-calculate at the top.
Step 6: The next assumption is the NOPAT or (Net Operating Profit After Tax) Margin. For a luxury company like KORS, during a recession, we can expect this Margin to collapse as well. Click on the green dot above 2016 and drag it down to 10%. Drag 2017 down to 9%, drag 2018 down to 8%, and drag 2019 down to 9%. Click the green “Save” button in the upper right hand corner. You’ll see the intrinsic value re-calculate at the top.
Step 7: The last cash flow assumption is Invested Capital Turnover. During a recession, it’s typical for a luxury goods company to have stabilized Invested Capital Turnover. The default values here are already fairly stabilized, so let’s leave this as it is.
Step 8: The first Cost of Capital assumption is the Credit Spread on the Cost of Debt.
This is an evaluation of the riskiness of the debt. Increasing it adds a premium to the Cost of Debt based on the risk that the company will default on their debt. The Credit Spread is calculated in Basis Points (bps). This is a common unit of measurement for interest rates and other financial percentages. One bps is equal to 1/100th of a percent (0.01% or 0.0001). In other words, a 1% change = 100bps and a 0.01% change – 1bps.
During a recession, debt becomes substantially more risky and more companies default. Let’s raise the Credit Spread. Click and drag the green dot up the slider bar to 350 bps. Click the green “Save” button in the upper right hand corner. You’ll see the intrinsic value re-calculate at the top.
Step 9: The last assumption is the CSRP (Company Specific Risk Premium). This additional premium has been added to account for company specific risk scenarios as well as any faults in the CAPM model. This is where you can account for any personal knowledge about the company or insights you’ve gained from research. Some factors to consider when increasing or decreasing this premium include:
- Company size
- Access to Capital Markets
- Breadth of Customer Base
- Geographic Area
- Key Executive Dependency
- Limited Product Line
- Litigation/Regulatory Risk
- Industry Volatility
For example, when valuing smaller companies, you’ll want to increase the CSRP. The CSRP is a fairly long-term assumption, so it shouldn’t be altered too much based on a recession in 2016. However, equity does become more risky during recessions, so let’s increase this premium to 1.5%. Click the green “Save” button in the upper right hand corner. You’ll see the intrinsic value re-calculate at the top.
And you’re done! At the time we ran this Valuation, we calculated the intrinsic value of KORS in the event of a recession in 2016 to be approximately $52/share and slightly undervalued, regardless of the recessionary conditions. KORS would be a wise investment in this scenario, under these assumptions.
The only changes needed to complete a Valuation are on the “Assumptions” page. However, a wealth of additional information is provided within the Valuation. Other tabs such as the “WACC” and “DCF” show you exactly how those calculations are being made and exactly how your assumptions translate into cash flows. We also provide each of the financial statements (Income Statement, Balance Sheet, Statement of Cash Flows) as well as a multitude of Metrics and Ratios. All of this additional information is meant to aid you in adjusting your assumptions to arrive at an Intrinsic Value and make wiser investment decisions.
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