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

STATISTICS DEPARTMENT

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 MoredaCentral Balance Sheet Data Office Specialist

WORKING PARTY OF FINANCIAL STATISTICS-OCDE

Paris, 3 November 2009

Statistics Department 2

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

1. Introduction to the Spanish valuation methods: Description and aggregates1. Issues of resident units2. 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

Contents


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

General criteria Specific criteria

(method)Aggregates

Market valuation in strict sense

Market capitalisation (A)

Quoted public limited companies (Non-financial and banks)

Net asset value (B) Mutual Funds

Approximations to market valuation

Capitalisation / Own funds ratio (C)

Unquoted banks

Discounted value of future profits (D)

Unquoted non-financial public limited companies

Book value Own funds (E)

Unquoted public limited companies (Financial except banks)Other legal forms (Other equity)


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



1. Introduction to Spanish valuation methods: Description and aggregates1. Issues of resident units2. 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


Contents


DISCOUNTED VALUE OF FUTURE PROFITS (METHOD D): CONCEPTUAL FRAMEWORK

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

References to the method in the reviewed SNA


Why does Spain use an alternative method?

–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

Unquoted non-financial public limited companies are not well represented by quoted ones because quoted public limited companies,


Reasons for applying method D (as an alternative to method C)

Only in case of banks are unquoted companies well represented by quoted ones


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”.


Reasons for applying method D (as an alternative to method C)Method D is the most commonly used by financial analysts

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.



Some figures to measure the problem


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

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)

(2) Source: INE and data estimated by the Banco de España Central Balance Sheet Data Office

Source : Central Directory of Firms (DIRCE) of the National Institute of Statistics (INE) and author's calculations based on CNMV data

NON-FINANCIAL FIRMS IN SPAIN. 2005

Number (1) Employees (2) GVA (2)

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



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 assets2. Revaluation criteria3. Financing practice in each country4. Relationships between firms and banks5. Tax systems6. Guarantees offered to lenders7. Pensions8. 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


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


Requirements of the method

The application of this method requires:



1. Introduction to Spanish valuation methods: Description and aggregates1. Issues of resident units2. 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


Contents


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

DISCOUNTED VALUE OF FUTURE PROFITS (METHOD D): DESCRIPTION OF THE METHOD

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

Risk-free interest rate

Risk premium

Expected growth rate of profits

ONPq

dq

Capitalisation = MVq =

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



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/ONPqThree components of dq:

Risk free interest rateRisk premiumExpected growth rate of profits



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)

0

3

6

9

12

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

Discount factor Expected growth rate of profitsRisk-free interest rate Risk Premium



Likewise, the following expression can be deduced for unquoted shares:

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

ONPnq ONPnq

dnq dq + 0,03MVnq= =




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




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.

Process of grossing up


COMPARED EVOLUTION OF REVALUATION RATES: Quoted and unquoted shares

Process of grossing up

-30%

-20%

-10%

0%

10%

20%

30%

40%

2001 2002 2003 2004 2005 2006 2007

Quoted FASE Unquoted MENF Unquoted FASE


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

-20

-10

0

10

20

30

40

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

Ordinary Net Profit (nq) Discount factor


BEGOÑA GUTIÉRREZ DEL OLMO

THANK YOU FOR LISTENING

Date post:	12-Jan-2016
Category:	Documents
Upload:	zita
View:	26 times
Download:	0 times

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

Documents