prie_a01ffirs.qxd 11/30/06 12:27 PM Page iii FREE CASH FLOW AND SHAREHOLDER YIELD New Priorities for the Global Investor William W Priest and Lindsay H McClelland John Wiley & Sons, Inc Tải thêm nhiều sách : www.topfxvn.com prie_a01ffirs.qxd 11/30/06 12:27 PM Page ii Tải thêm nhiều sách : www.topfxvn.com prie_a01ffirs.qxd 11/30/06 12:27 PM Page i FREE CASH FLOW AND SHAREHOLDER YIELD Tải thêm nhiều sách : www.topfxvn.com prie_a01ffirs.qxd 11/30/06 12:27 PM Page ii Tải thêm nhiều sách : www.topfxvn.com prie_a01ffirs.qxd 11/30/06 12:27 PM Page iii FREE CASH FLOW AND SHAREHOLDER YIELD New Priorities for the Global Investor William W Priest and Lindsay H McClelland John Wiley & Sons, Inc Tải thêm nhiều sách : www.topfxvn.com prie_a01ffirs.qxd 11/30/06 12:27 PM Page iv Copyright © 2007 by William W Priest and Lindsay H McClelland All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, 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Cataloging-in-Publication Data: Priest, William W Free cash f low and shareholder yield : new priorities for the global investor / William W Priest and Lindsay H McClelland p cm Includes bibliographical references and index ISBN-13: 978 -0-470-12833-6 (cloth) ISBN-10: 0-470-12833-X (cloth) Investments, Foreign Cash f low Portfolio management I McClelland, Lindsay H., 1979- II Title HG4538.P686 2007 332.67’3 —dc22 2006036779 Custom ISBN-13 978 -0-470-13000-1 Custom ISBN-10 0-470-13000-8 Printed in the United States of America 10 Tải thêm nhiều sách : www.topfxvn.com prie_a01ffirs.qxd 11/30/06 12:27 PM Page v To Katherine Jeff, Joan, Karen, and Steve Amanda, Hayley, Jack, Jacob, and Spencer With thanks and appreciation for your affection and support —WWP To Geordie, the human equivalent of Shareholder Yield —LHM Tải thêm nhiều sách : www.topfxvn.com prie_a01ffirs.qxd 11/30/06 12:27 PM Page vi Tải thêm nhiều sách : www.topfxvn.com prie_a02ftoc.qxd 11/30/06 12:28 PM Page vii CONTENTS ix Foreword xiii Preface xv Acknowledgments PART ONE Defining Free Cash Flow and Shareholder Yield CHAPTER Free Cash Flow CHAPTER The Sources of Equity Return 23 CHAPTER Shareholder Yield in Depth 39 CHAPTER Focus on Dividends 59 PART TWO The New Investment Landscape CHAPTER Globalization 67 CHAPTER Interest Rates, Bubbles, and Punctuated Equilibriums 95 vii Tải thêm nhiều sách : www.topfxvn.com prie_a02ftoc.qxd 11/30/06 12:28 PM Page viii viii Contents PART THREE Strategies for the New Investment Landscape CHAPTER Investing in Today’s Capital Markets 133 Appendix Continuous-Time Free Cash Flow Valuation Framework 143 Notes 157 References 163 Index 165 Tải thêm nhiều sách : www.topfxvn.com prie_z01bapp.qxd 11/30/06 2:57 PM Page 155 155 Appendix check its viability as in any derivatives pricing problem, the model should be able to calibrate to the firm’s enterprise value observable in the market, given the cost of debt (estimated from its liquid debt securities or CDS curve) and the cost of equity (estimated under CAPM assumptions using proper equity benchmark) We defer the calibration and model enhancement steps to future research The free cash flow valuation framework presented here, though idealistic, provides the foundation for evaluating the firm’s fair value consistent with the theory of modern corporate finance By adopting a parsimonious approach, our estimation methodology allows qualitative judgment to be incorporated into quantitative framework in a robust manner Furthermore, when evaluating the firm’s entry/exit options, as well as other scenarios under special situations, this model can be more powerful than the traditional earnings-based methodology Tải thêm nhiều sách : www.topfxvn.com prie_z01bapp.qxd 11/30/06 2:57 PM Page 156 Tải thêm nhiều sách : www.topfxvn.com prie_z02bnotes.qxd 11/30/06 2:58 PM Page 157 NOTES Chapter 1: Free Cash Flow John Burr Williams, The Theory of Investment Value (Cambridge, MA: Harvard University Press, 1938) 55 Enrique R Arzac, Valuation for Mergers, Buyouts, and Restructuring (Hoboken, NJ: John Wiley & Sons, 2005) George C Christy, Free Cash Flow: A Two-Hour Primer for Management and the Board (Booklocker.com, 2006) See note 3, p 5 See note 3, p 10 Jack Treynor, “Feathered Feast: A Case,” Financial Analysts Journal (November/December 1993) Source: Thomson Financial See note Chapter 2: The Sources of Equity Return Merton H Miller and Franco Modigliani, “The Cost of Capital, Corporation Finance and the Theory of Investment,” American Economic Review (1958) Source: Insurance Information Institute’s “Financial Services Factbook.” “Unnatural Causes of Debt,” Economist, September 16, 2006 See note 157 Tải thêm nhiều sách : www.topfxvn.com prie_z02bnotes.qxd 11/30/06 2:58 PM Page 158 158 Notes Chapter 3: Shareholder Yield in Depth Ian McDonald, “Capital Pains: Big Cash Hoards,” Wall Street Journal, July 21, 2006 Gregory Peters, “US Credit Strategy—Two Words: Buybacks,” Morgan Stanley Research, August 2, 2006 Bruce Bartlett “Benefits of the Bush Dividend Tax Cut,” National Center for Policy Analysis, August 27, 2004 Jobs and Growth Tax Relief Reconciliation Act, ASA Dividend Scorecard, June 4, 2004 Barry B Burr, “Out of the Wilderness,” Pensions & Investments Online, September 4, 2006 Ian McDonald, “New Cash Cows: Biggest Stocks,” Wall Street Journal, Friday, January 6, 2006 Barron’s, August 21, 2006 Robert D Arnott and Clifford S Asness, “Surprise! Higher Dividends = Higher Earnings Growth,” Financial Analysts Journal, January/February 2003 See note 10 See note 11 Shirley A Lazo, “Dividend Savant?” Barron’s, August 21, 2006 12 See note 11 13 Henry McVey and David R McNellis, “US Strategy—Secret Sauce II: Buybacks,” Morgan Stanley Equity Research, July 19, 2006 14 Bernard Condon, “Buyback Boomlet,” Forbes, May 22, 2006 15 Gregory Peters, “US Credit Strategy—Two Words: Buybacks,” Morgan Stanley Research, August 2, 2006 16 Source: TrimTabs Investment Research 17 Citigroup Portfolio Strategist, January 5, 2006 18 Henry H McVey and David R McNellis, “US Strategy—Secret Sauce II: Buybacks,” Morgan Stanley Equity Research, July 19, 2006 19 Citigroup Portfolio Strategist, January 5, 2006 20 Floyd Norris, “In 2005, Companies Set a Record for Sharing with Shareholders,” New York Times, January 7, 2006 Tải thêm nhiều sách : www.topfxvn.com prie_z02bnotes.qxd 11/30/06 2:58 PM Page 159 159 Notes 21 22 23 24 25 26 27 28 29 See note 20 Andrew Bary, “Time to Buy,” Barron’s, July 24, 2006 Fara Lupiano of CreditSights, Barron’s, August 21, 2006 Gregory Peters, “US Credit Strategy—Two Words: Buybacks,” Morgan Stanley Research, August 2, 2006 Amy Feldman, “Sending Out a Message by Buying Back Shares,” New York Times, October 2, 2005 Richard A Brealey and Steward C Myers, Principles of Corporate Finance (New York: McGraw-Hill, 1984) 357–358 David Wyss, “Spend It as Fast as I Can: U.S Economic Forecast Monthly Summary,” Standard & Poor’s, April 2006 G Bennett Stewart, The Quest for Value (New York: HarperCollins, 1991) Marc Hogan, “Heavy Debt, Big Worries?” BusinessWeek.com, August 2, 2006 Chapter 4: Focus on Dividends “In the Shadows of Debt,” Economist, September 23, 2006 Chapter 5: Globalization International Monetary Fund, World Economic Outlook Database, September 2006 Thomas L Friedman, The World Is Flat: A Brief History of the 21st Century (New York: Farrar, Straus and Giroux, 2005) 226 David J Lynch, “Thanks to Its CEO, UPS Doesn’t Just Deliver,” USA Today, July 24, 2006 “The New Titans,” Economist, September 16, 2006 “Unnatural Causes of Debt,” Economist, September 16, 2006 “The New Titans,” Economist, September 16, 2006 See note Clyde Prestowitz, Three Billion New Capitalists: The Great Shifts of Wealth and Power to the East (New York: Basic Books, 2005) See note Tải thêm nhiều sách : www.topfxvn.com prie_z02bnotes.qxd 11/30/06 2:58 PM Page 160 160 Notes 10 “China’s Oil Consumption: Today ’s Editorial,” Washington Times, April 20, 2006 11 Source: British Petroleum 12 “A Topsy-Turvy World,” Economist, September 16, 2006 13 Source: International Monetary Fund 14 Nicholas R Lardy, Integrating China into the Global Economy (Washington, DC: Brookings Institution Press, 2002) 80 15 Clyde Prestowitz, Three Billion New Capitalists: The Great Shifts of Wealth and Power to the East (New York: Basic Books, 2005) 255 Chapter 6: Interest Rates, Bubbles, and Punctuated Equilibriums “Unluncky Ben Bernanke,” Grant’s Interest Rate Observer, October 6, 2002, p Source: U.S Census Bureau, August 2006 Norm Alster, “Is the Corporate Profit Machine about to Sputter?” New York Times, October 1, 2006 Martin Feldstein, “The Return of Savings,” Foreign Affairs, May/June 2006 Appendix: Continuous-Time Free Cash Flow Valuation Framework We define the first three choices as Shareholder Yield We use benchmark equity risk premium and size premium as our primary and secondary factors This procedure is based on conversations with Joe Sroka, an insightful Epoch Analyst The following discussion follows Chapter in Valutation for Mergers, Buyouts, and Restructuring by Enrique R Arzac, Professor of Finance and Economics at the Columbia University Graduate School of Business Tải thêm nhiều sách : www.topfxvn.com prie_z02bnotes.qxd 11/30/06 2:58 PM Page 161 161 Notes Empirically, both g and σ are random and exhibit timedependent and mean-reverting behavior Lognormal assumption is but a mathematical convenience, as adopted in the classical Black-Scholes framework See 2003 ISDA Credit Derivatives Definitions for more details In reality we must use the discrete version of this model Let Q (0, tm) be the survival probability up to time tm( Q (0, 0) : = 1) If we assume defaults can only occur at accrual dates, then the premium leg and default leg can be rewritten as M PL ( ) = N ∑ scds δm D ( 0, tm ) Q ( 0, tm ) ; m=1 ( M DL ( ) = N ∑ (1 − R ) D ( 0, tm ) Q ( 0, tm−1 ) − Q ( 0, tm ) m=1 ) By equating the two legs we have a system of linear equations that can be solved recursively in most solver packages (e.g., Excel) to get Q (0, t1), Q (0, t2), , Q (0, tM ) However if the defaults can occur between accrual dates, define Q (tm ) Δ = Q (0, tm) − Q (0, tm−1) as the default probability during tenor δm and we can back out Q (0, tm), m = 1, M by solving 0= M ∑s m=1 cds (δ D (0, t ) Q (0, t ) + ∫ m m m tm (u − t ) D ( 0, u )Q(du ) tm − m−1 ) − (1 − R ) ∫ D ( 0, u ) Q ( du ) T and interpolate the survival probabilities between two accrual dates Tải thêm nhiều sách : www.topfxvn.com prie_z02bnotes.qxd 11/30/06 2:58 PM Page 162 162 Notes We rank the coverage universe by free cash flow yield into quintiles Each quintile represents an equal-weighted portfolio We backtest 15 years of data with monthly rebalancing This is the Spearman’s ρ, or rank correlation of the trading signal X and the subsequent returns Y More specifically, let Xi, Yi, i = n be the sample returns and signal series and n be the number of observations, then the sample Spearman’s ρ is estimated by ∑ ( Rank ( X ) − Rank (Y )) 1− n i =1 i ( i ) n n2 − Information coefficient can be related to the alpha of a strategy via the Fundamental Law of Active Management: IR = IC × BR , where IR is the manager’s information ratio and BR is the strategy’s breadth, or number of independent forecasts For details, see Grinold and Kahn (1999) 10 We may alternatively define Free Cash Flow =Δ Net Operating Cash Flow—CapEx to account for this pitfall Tải thêm nhiều sách : www.topfxvn.com prie_z03brefs.qxd 11/30/06 2:58 PM Page 163 REFERENCES Arzac, E R 2004 Valuations for Mergers, Buyouts, and Restructuring Hoboken, NJ: John Wiley & Sons Duffie, D., and K Singleton 1999 “Modeling Term Structures of Defaultable Bonds.” Review of Financial Studies 12, 687–720 Grinold, R C., and R N Kahn 1999 Active Portfolio Management: A Quantitative Approach for Producing Superior Returns and Controlling Risk New York: McGraw-Hill Ho, T., and S Lee 2004 The Oxford Guide to Financial Modeling: Applications for Capital Markets, Corporate Finance, Risk Management and Financial Institutions New York: Oxford University Press Merton, R C 1974 On the Pricing of Corporate Debt: The Risk Structure of Interest Rates Journal of Finance 29(2), 449–470 Modigliani, F., and M Miller 1958 “The Cost of Capital, Corporation Finance and the Theory of Investment.” American Economic Review 48, 267–297 Modigliani, F., and M Miller 1963 “Corporate Income Taxes and the Cost of Capital: A Correction.” American Economic Review 53(3), 433– 443 Musiela, M., and M Rutkowski 2005 Martingale Methods in Financial Modeling New York: Springer-Verlag Rebonato, R 2002 Modern Pricing of Interest-Rate Derivatives: The LIBOR Market Model and Beyond Princeton, NJ: Princeton University Press Schönbucher, P 2003 Credit Derivatives Pricing Models: Model, Pricing and Implementation Hoboken, NJ: John Wiley & Sons 163 Tải thêm nhiều sách : www.topfxvn.com prie_z03brefs.qxd 11/30/06 2:58 PM Page 164 Tải thêm nhiều sách : www.topfxvn.com prie_z04bindex.qxd 11/30/06 2:59 PM Page 165 INDEX A Accounting, definition of, Airplanes, as assets, 13 Amalgamated Iceman’s Pension Fund (case study), 11–13 Apple Computer, 25 Arnott, Robert D., 46 Arzac, Enrique, 8–9, 19 Asness, Clifford S., 46 Asset, value and longevity, 14–15 B Book value, concept of, 15 Brown, Rob, 109 C Capital, cost of, 15–16 Capital markets, investing in, 133–142 Cash, importance of, 7–8 Cash dividends, 42–48 history of, 42–43 Cash flow: definition of, 4–5 uses of, 20–21 valuation methodology and, Chambers, Ray, 5–7 China: role in global marketplace, 80–87 United States and, 84–87 workforce composition, 83 World Trade Organization, 85 Christy, George, 9, 18 Citicorp, options and, 62 Cliggott, Doug, 120 Combined effects, 28 Comparative advantage, law of, 68–76 Corporate compensation plans, 62 Corporate profit bubble, 119–128 165 Tải thêm nhiều sách : www.topfxvn.com prie_z04bindex.qxd 11/30/06 2:59 PM Page 166 166 Index Corporate profits, as a percentage of gross domestic product, 77–78 Cost of capital, 15–16 Credit risk transfer markets (CRT), 115–116 D Davita, 55–56 Debt repayment, 54–58 De facto dollar zone, 87–90 Demographic changes, 69–70 Depreciation, accountings view of, 13 Devaluation, of dollar, 91–92 Dividend payout ratios, 43–44 Dividends, as predictors for corporate behavior, 59–64 Dodd, David, 4, 47 Dooley, Michael, 86 E Earnings: accounting definition, 11 calculation of, 3–4 definition of, focus on, free cash flow versus, 10–20 Epoch core model, 143–146 Equity market performance, drivers of, 26–29 Equity return, sources of, 23–37 Expansionary policies, effects of, 36 Exxon, options and, 62 F Fair value, accountant’s view of, 13 Feathered Feast, The (Treynor, Jack), 11–13, 16–17 Firm growth, concept of, 25 Floating dollar, 90–91 Folkerts-landau, David, 86 Free cash flow: definition of, 8–10 earnings versus, 10–20 forecasting model, 146–153 Free Cash Flow: A Two-Hour Primer for Management and the Board (Christy, George), 9, 18 Freeman, Richard, 76 Friedman, Thomas, 67 Full Employment Act, 34–35 Fundamental analysis, Tải thêm nhiều sách : www.topfxvn.com prie_z04bindex.qxd 11/30/06 2:59 PM Page 167 167 Index G I GAMBRO, 56 Garber, Peter, 86 Generally accepted accounting principles, usefulness of, 10–11 Gibson Greeting Cards, 5–7, 18, 103 Globalization, effects on capital markets, 67–94 Gould, Stephen Jay, 96–97 Graham, Benjamin, 4, 47 Greenspan, Allen, and the housing bubble, 102–103 Gross domestic product, 31–32 global wealth and, 70–71 Ikenberry, David L., 53 Inflation, effects of, 35 Integrating China into the Global Economy (Lardy, Nicholas), 89–90 Intercontinental, 26 Interest rates: history of, 34–37 price earnings ratios, 33–34 J Jobs and Growth Tax Relief Reconciliation Act, 43 K KFI Industries, 54–55 H Household debt and disposable personal income, 34 Housing bubble, 100–110 birth of, 101–105 Greenspan and, 102–103 magnitude of, 105 popping the, 105–107 post-popping of, 107–109 L Labor as it relates to capital, 76–80 Lardy, Nicholas, 89–90 Liquidity bubble, 110–119 global financial imbalances and, 110–114 hedge funds and, 114–119 Tải thêm nhiều sách : www.topfxvn.com prie_z04bindex.qxd 11/30/06 2:59 PM Page 168 168 Index M Marriott, 26 Miller, Merton, 54 Modigliani, Franco, 54 Mutually assured destruction policy, 84–87 P Period-to-period performance, 11 Political changes, 69–70 Present value, definition of, Prestowitz, Clyde, 80, 90–91 Price earnings ratios, 29–34 free cash flow and, 10–20 Public corporate debt, 57 Punctuated equilibriums, 95–130 definition of, 96–97 R RCA, Real and financial economies, linking, 29–34 Restricted stock units (RSUs), 62–63 Ricardo, David, 69 S Security Analysis: Principles and Techniques (Graham and Dodd), Security selection, approach to, Shareholder value, generation of, 20–21 Shareholder Yield: case for, 134–135 components of, 23–26 as driving force in the market, 39–58 Share repurchases, 48–53 Simon, Bill, 5–7 Starwood, 26 T Theory of Investment Value, The ( John Burr Williams), Three Billion New Capitalists (Prestowitz, Clyde), 80, 90–91 Treynor, Jack, 11 Tải thêm nhiều sách : www.topfxvn.com prie_z04bindex.qxd 11/30/06 2:59 PM Page 169 169 Index V W Valuation for Mergers, Buyouts, and Restructuring (Arzac, Enrique), 9, 19 Valuation methodology, cash flow and, Valuation ratios, 16 Value and longevity of assets, 14–15 Value versus growth companies, 17 Volcker, Paul, 35 Washington Mutual and the housing bubble, 106–107 W.E.S.Ray, 5–7, 103 Williams, John Burr, 4, 14 Witter, Lon, 103, 106 World Is Flat, The (Friedman, Thomas), 67 World Trade Organization (WTO), and China, 85 Tải thêm nhiều sách : www.topfxvn.com