Valuing stocks of commercial joint stock banks - The case of Sacombank = Định giá cổ phiếu ngân hàng thương mại qua trường hợp ngân hàng Sacombank

With the objective to contribute to finding a suitable stock valuation methods for stock valuation of listed commercial banks, and from that some methods for enhancing stock valuation in

VIETNAM NATIONAL UNIVERSITY, HANOI

SCHOOL OF BUSINESS

DANG QUOC HIEP

VALUING STOCKS OF COMMERCIAL JOINT STOCK BANKS

– THE CASE OF SACOMBANK

MASTER OF BUSINESS ADMINISTRATION THESIS

Hanoi – 2010

VIETNAM NATIONAL UNIVERSITY, HANOI

SCHOOL OF BUSINESS

DANG QUOC HIEP

VALUING STOCKS OF COMMERCIAL JOINT STOCK BANKS

– THE CASE OF SACOMBANK

Major: Business Administration Code: 60 34 05

MASTER OF BUSINESS ADMINISTRATION THESIS

Supervisor: Dr Chu Thanh

Ph.D Candidate Ha Nguyen

Hanoi – 2010

TABLE OF CONTENTS

ACKNOWLEDGEMENTS i

ABSTRACT ii

TÓM TẮT iv

List of tables viii

List of figures viii

List of abbreviations ix

INTRODUCTION 1

CHAPTER 1: COMMERCIAL JOINT STOCK BANKS: INTRODUCTION TO VALUATION OF STOCK 5

1.1 The introduction of commercial joint stock banks 5

1.1.1 Commercial bank- an important intermediary financial institution 5

1.1.1.1 The definition of commercial banks 5

1.1.1.2 The financial intermediary role of commercial banks 5

1.1.2 The organization and operation of commercial banks 6

1.1.2.1 Organization and management of commercial banks 6

1.1.2.2 Capital of commercial joint stock banks 8

1.1.2.3 Some basic criteria for evaluating the operation efficiency of commercial joint stock banks 13

1.2 Legal bases and stock valuation methods 15

1.2.1 Concept of stocks and valuing stocks 15

1.2.1.1 Concept of stocks 15

1.2.1.2 The concept of valuing stocks 16

1.2.2 The legal bases for valuing stocks in Vietnam 16

1.2.2.1 Some regulations of stock valuation 18

1.2.2.2 Regulations of valuation methods 19

1.2.2.3 The regulations of land usage right 23

1.2.2.4 The regulations of specifying the advantage values 24

1.2.3 The stock valuation methods: 25

1.2.3.1 The method of dividend discount model (DDM model) 28

1.2.3.2 The discounted cash flow method (DCF) 36

1.2.3.3 The valuation method based on P/E 39

1.2.3.4 The assessment method based on the value of net assets 41

1.2.3.5 The valuation method based on P/B 42

1.2.3.6 Methods to assess banking stock 43

CHAPTER 2: ANALYSIS OF COMMERCIAL BANK STOCK VALUATION – THE CASE OF SACOMBANK 45

2.1 The establishment and development of commercial joint stock banks in Vietnam 45

2.2 General introduction of Sacombank: 46

2.2.1 Sacombank stock: 46

2.2.2 Some general features of Sacombank: 48

2.2.2.1 Operational cirteria of Sacombank during 2005-2009 49

2.2.3 Asia banking sector overview and forecast: 51

2.3 Valuation analysis on the stock STB 53

2.3.1 Valuing the stock STB with DDM method 53

2.3.2 Valuing the stock STB with the method of P/E coefficient: 56

2.3.3 Valuing STB with the method of net value of assets: 57

2.3.4 Analyzing the P/B coefficient of STB as of year end 2009: 58

2.4 Evaluating the results of valuing the stock STB 59

2.6 Advantages and difficulties in valuing stocks of Vietnamese commercial joint stock banks 60

2.6.1 Advantages in valuing stocks: 60

2.6.2 Difficulties in valuing stocks 61

2.6.2.1 Difficulties from commercial banks themselves 61

2.6.2.2 Difficulties from the business environment 62

2.6.2.3 The lack of understanding of investors 66

2.7 Major lessons taken out of Sacombank 67

CHAPTER 3: SOLUTIONS & RECOMMENDATIONS TO ENHANCE/ IMPROVE STOCK VALUATION OF COMMERCIAL BANKS IN VIETNAM 71 3.1 Implications for other banks 71

3.2 Recommendations to enhance the quality of banking stock valuation 74

3.2.1 Recommendations to commercial banks: 74

3.2.1.1 Developing business strategies and long term financial plans 74

3.2.1.2 Complying with rules and accounting standards 75

3.2.1.3 Setting up expertise departments for valuing stocks 75

3.2.1.4 Performing the information announcement 75

3.2.2 Recommendations to the government 76

3.2.2.1 Improving the legal framework for valuation and system of related legal documents 76

3.2.2.2 Methods related to the market information 80

3.2.3 Recommendations to investors 83

CONCLUSION 85

LIST OF REFERENCES 87

Appendix 1: Country Default Spreads and Risk Premiums 90

Appendix 2: Asia banking sector peer comparison 94

List of tables

2.1 Operation criteria of Sacombank in the period of 2005-2009 49 2.2 Income Statement of Sacombank throughout the years 49 2.3 Key financial ratios of Sacombank throughout the years 50 2.4 Dividend payout history of Sacombank in recent years 66 2.5 ROE of Sacombank in the period of 2005-2009 66 2.6 Balance sheet of Sacombank in the quarter 4/2009 70

List of figures

2.1 The price movement of stock STB from the quotation day to

25/04/2009

47

List of abbreviations

VN-Index Vietnam Index GDP Gross Domestic Products WTO World Trade Organization IPO Initial public offering

EPS Earning per share SML Security Market Line WACC Weighted average cost of capital CAPM Capital Asset Pricing Model HOSE Hochiminh Stock Exchange HASTC Hanoi Stock Trading Center OTC Over the counter

INTRODUCTION

The emergency and objectives of the research

The reform of Vietnam has been taking place totally and deeply in many fields The event that Vietnam became the official member of the World Trade Organization (WTO) put an important mark in the integrating process into the world economy Vietnam’s economy has grown fast, in the last five years GDP of Vietnam increased

by nearly 7.5% on average

In that situation, the process of economic monetarilization will also take place deeper and larger, demands for financial and banking services of enterprises and especially of inhabitants will increase dramatically In recent years, the average growth rate of banking sector is 22%, 3 times faster than the growth of GDP Besides, there is a market share transition among groups of banks, in which the market shares of commercial banks group will increase substantially

After 8 years in operation, Vietnam’s securities market has gained certain remarkable achievements; the highest VN-index reached 1070 points, then fell to the trough of 235 points The development of the securities market has made the stock valuation become necessary

The stock valuation has helped small investors in Vietnam become more active, avoid the phenomenon of transacting with the “gregarious” psychology and avoid bearing risks

For enterprises who conduct the initial public offering (IPO), the valuation of referential stocks for the first transaction day of the IPO firms is a necessary and extremely sensitive work This valuation may lead to success or failure of this public offering

In the banking sector, a number of state-owned banks are preparing for the equatization and offering securities to the public In the mean time, there are only

two joint stock banks listing their stocks in the centered securities market, those are ACB and Sacombank

With the objective to contribute to finding a suitable stock valuation methods for stock valuation of listed commercial banks, and from that some methods for enhancing stock valuation in the Vietnamese securities market can be recommended, I have chosen the topic “Valuing stocks of commercial joint stock banks- the case of Sacombank”

The objectives of the research are to:

- Present an overview of the commercial bank operations & stock evaluation methods

- Provide an analysis of the STB stock with various methods

- Recommend improvement plans to enhance the valuation of bank stocks

Subject and scope

The thesis concentrates on the valuation methods for stocks of commercial joint stock banks In which, it will specifically value the stock of Saigon commercial joint stock bank -Sacombank, one of the two banks which are listing their stocks in the listed securities market

Research methodology:

The author adopts both primary and secondary research methods to domestic and foreign material sources to find out basic theories about stock valuation methods, meanwhile collecting data through prospectus, financial statement, analysis reports

of Sacombank…Using the systematical, statistical, analytical methods to analyze all collected data

Combining studied theories, domestic legal bases with all collected results to give judgments on the application capability of valuation methods for stocks of the

banking sector, and to recommend some methods to enhance the stock valuation in the Vietnamese securities market at the same time

The structure of the thesis

The thesis is presented in three chapters in which the first chapter will give basic definitions and most general theories about the researched problem of this thesis The second chapter will apply each method presented in the first chapter one after the other to conduct the valuation of Sacombank’s stocks and give judgments about the application capability of the stock valuation methods The third chapter will give some recommendations about applying some valuation methods to evaluate stocks

of the banking sector, besides, give some recommendations to enhance the quality

of stock valuation in the Vietnamese securities market

Chapter 1: Commercial joint stock banks: Introduction to Valuation of Stock

The content of this chapter is to concentrate on giving a general overview about the system of commercial banks, legality of commercial joint stock banks in Vietnam and basic theories about stock valuation

Chapter 2: Valuing stock of commercial banks – the case of Sacombank

This chapter concentrates on introducing the establishment, development and operation of Vietnamese commercial joint stock banks in general and Sacombank in particular This chapter also collects preliminarily the price changes of the two banking stocks which are now being listed and then conduct applying the valuation methods in the first chapter to value the stock STB Finally, chapter 2 will evaluate the application capability of above valuation methods in valuing stocks of banks and give out some advantages and difficulties in valuing stocks of commercial joint stock banks currently

Chapter 3: Some recommendations and solutions to assessing stocks of Vietnamese commercial joint stock banks

This chapter concentrates on recommendations and solutions to assessing stocks of Vietnamese commercial joint stock banks

CHAPTER 1: COMMERCIAL JOINT STOCK BANKS: INTRODUCTION TO

VALUATION OF STOCK

1.1 The introduction of commercial joint stock banks 1.1.1 Commercial bank- an important intermediary financial institution

1.1.1.1 The definition of commercial banks

Commercial bank is one of the most important financial organizations of any economy In the world, there are many different definitions of commercial banks, most of which are presented through functions a commercial bank

According to website www.investorwords.com, a commercial bank is defined as:

“An institution which accepts deposits, makes business loans, and offers related services Commercial banks also allow for a variety of deposit accounts, such as checking, savings, and time deposit.”

Through the above definition we can see that the operations of banks today definitely have had changes, the scope of offering services of banks is enlarged Besides the main operations like credits, savings, payments, banks also target new fields like real estates, equity investment, insurance…

1.1.1.2 The financial intermediary role of commercial banks

A bank is a financial intermediary organization with the main operation of tranfering savings to investment, it requires the contact with two types of individuals and organizations in the economy: (1) individuals and organizations who temporarily have deficit in spendings, meaning that expenses for consumptions and investments are in excess of earnings, that is why they are the ones who need to supplement capital; and (2) individuals and organizations who are surplus in spendings, meaning that their current earnings are bigger than expenses for goods, services and hence they have money to save

Another contribution of banks is that they are willing to accept risky credits while issuing less risky stocks to depositors Indeed, banks take part in doing business on riskiness Banks also meet the liquidity demands of many customers

Another reason for making banks develop and prosper is the ability to assess the information The unequal distribution of information and capacity of analysing the information called the state of “disproportionate information” have lessened the efficiency of market but created a profitability for banks which have expertise knowledge and experiences in evaluating financial tools and have abilities to choose tools with the most attracting factors of riskness and profits

1.1.2 The organization and operation of commercial banks

1.1.2.1 Organization and management of commercial banks

Figure 1.1: The organization of a small bank

(Source: the material of “Commercial banks: management and operations”)

PhD Phan Thi Thu Ha-PhD Nguyen Thi Thu Thao)

Investment and development Information technology

Transaction department Branches

The system organization of large commercial joint stock banks often contains more departments and rooms than small and medium banks

Figure 1.2: The organization of a large bank

(Source: the material of “Commercial banks: management and operations”)

PhD Phan Thi Thu Ha-PhD Nguyen Thi Thu Thao)

Foreign business

Planning and market

Domestic business

Acct and finance

Member units

Independent posting units:

- Jewelry companies

- Leasing companies 1 & 2

- Securities companies

Career posting units:

-Centers of trainings jobs -Informatics center

- Information center of preventing risk

Dependent posting units:

- General business branch

- Specialized business branch

- Transaction headquarter

- Provincial banking branch

- District banking branch

- Commune banking branch

Big banks often have a lot of branches, own many companies, operate in various fields, markets and may have different branches abroad Large banks are the wholesale ones having big customers (corporations, economic groups, ) Hence, the syteorganization of these banks must have a high specialization In specialized deparments, there are a lot of experts in consulting, researching market, analysing finance of companies, sectors and nation; and experts in lending, securities, laws, human resources, technology,…

1.1.2.2 Capital of commercial joint stock banks

- The foundation of capital of commercial joint stock banks:

Banks do business by mobilizing capital, lending, investing and providing other services Mobilizing capital – the activity to create capital source of the banks – plays an important role and affects the quality of operations of banks Hereby lists the different sources of money transferred to banks due to different channels:

Owners’ equities: to begin banking operations (allowed by laws), the owners of

banks must have a specific amount of money This is the kind of capital banks can use for long term, forming equipments, houses for banks The sources and operations creating this kind of capital are various depending on the ownerships, financial capacity of bank owners, demands and the development of the market

Initial capital: formed by the contributions of shareholders through buying shares or

stocks

Additional capital during operation process: during the operation process, banks

increase owners’ equities with many different methods depending on specific

conditions Retained earnings: in the situation when net income is bigger than zero,

the bank owners have the trend to increase their equities by transferring a part of net income into investment capital The proportion for accumulating depends on the consideration of bank owners about accumulation and spendings For long established banks, with big net income, they have higher capital sources

accumulated from profits than initial equities Additional source from issuing stocks, additional contributions: to expand the operation scale or to improve

equipments, or to meet the demands of increasing owners’ equities declared by the State Bank… The feature of this capital mobilization type is the infrequency, but it helps banks have a big amount of equities when necessary

Funds: banks have a lot of funds Each fund has its own objective First is the

Damage standby Fund This fund is set up annually and accumulated in order to make up all occurred damages The capital preserving fund is to make up depreciation of capital under the effect of inflation The surplus fund is a reevaluated part of assets of banks and difference between market price and face value of stocks when issuing new stocks Due to regulations of each country, banks also can have welfare fund, reward fund, directors’ fund,…

Convertible debt: long and medium term debts of commercial banks which are

likely to be changed to shares can be considered a part of equity of banks (additional source) since this source has some features such as long term usage, being able to invest into houses, real estates and being likely not to be repaid at maturity

Deposit source and operations of mobilizing deposits: deposits of customers are

the most important source of commercial banks When a bank begins to operate, the first operation is to open deposit accounts to keep money and perfom payment for customers, by this way, banks can mobilize money from enterprises, organizations and inhabitants

Payment deposits: (transaction deposits or payment deposits): this is money of

enterprises or individuals putting into banks so that banks can keep and perform payment for them within the allowed balance All the demands of paying and spending of enterprises and individuals are conducted by banks

Termed deposits of enterprises, social organizations: a lot of receipts in cash of

enterprises and social organizations will be paid after a specific period of time

Savings deposits of inhabitants: all levels of inhabitants have earnings items which

are not being used temporarily (savings items)

Sources in payment: all the payment activities without using cash can form a source

in payment (cheques during paying process, money as security to open L/C )

Other sources: other debt items like unpaid taxes, unpaid salaries…

- The usage of capital of commercial banks (asset structure of commercial joint stock banks)

The main activity of commercial joint stock banks is to find capitals (mobilizing capital) in order to gain profits The usage of capital is exactly the process of creating different types of assets of banks, in which lending and investing are the two important and huge assets

commercial Joint stock banks are enterprises who do business on money Because

of this feature, most of assets of banks are financial assets including lending contracts, hiring-purchasing contracts, securities, deposits… A small part of banks’ assets is fixed assets like houses, equipments… Each asset is formed due to its own way for its own objective which is to assure the safety and profitability for banks

Budget: Budget of a commercial banks often contains:

Cash in the safe: it can be domestic currency or foreign currencies (in abroad,

foreign currencies are used in circulation, or accepting foreign deposits) Some banks also have gold, other precious metals and stones Cash is used for quick payments However, cash does not bring profits and from the side of safety, it is usually the subject of robbery, fakery Cash sticks to some generating costs like preservation, counting, transportation,…

Deposit at banks: it contains deposits at the State Bank, at other banks and credit

organizations Commercial banks must perfom obligatory reserves The forms of obligatory reserves may be different in countries A lot of State Banks require commercial banks to maintain obligatory reserves under the form of deposits at the

Central Banks Besides, commercial banks keep these deposits for the aim of convenient payment method Many payment items among banks are performed through State banks (Central banks), or through agency banks (payment through different countries) This deposit can bring profits but very low

Securities: commercial banks keep securities with the aim of liquidity and

diversifying assets Banks keep a lot of types of securities which can be classified

by many criteria such as liquidity, issuing subjects, objectives of keeping,…

Government securities (Central or provincial) are issued by the State Treasury

including: short, medium, and long term securities

Securities of other banks, financial companies: it includes stocks and other

debentures which are issued or accepted to pay by banks or financial companies

Securities of other companies: banks keep securities because they can bring profits

to them and can be sold to increase budget when necessary Banks often divide

securities into liquid and less liquid securities Normally, securities which are safe, can be easily sold, not reduce in price frequently, have low profitability rate; in converse, securities which are less liquid (investment securities) having high risks often have high profitability rate

Credits: credit is a type of assets accounting for the largest proportion in most of

commercial banks, which reflects the typical operation of banks This asset is classified by many different criteria

Short, medium, long term credits: short term credits – the period of less than 12

months Medium term credits – the period from 1 to 5 years Long term credits – over 5 years Specifying the credit periods is comparative only because a lot of credits do not determine in advance exactly the time Classifying credits due to time

is significant to banks since time is related to the safety and profitability of assests The proportion of short term credits at commercial banks is usually higher than medium and long term credits Banks mainly finance mobile assets of customers

Medium and long term credits often have lower proportions due to higher risk and more costly and scarce sources of capital There are a lot of factors affecting this proportion such as period, stability of capital source, the ability to manage the liquidity of banks, the ability to forecast and provide for risks in medium and long term

Other assets:

Mandated assets: assets are formed according to the mandates of customers Banks

offer lending mandate services for other banks, Government organizations and non Government organizations

Pooled capital (united): banks can take part in contributing capitals with other

organizations (not under the way of keeping securities) For example, pooling capital into joint venture banks, companies,…

Other assets: houses and equipments of banks serve the business process of banks

and are used for rent The buildings are the largest fixed assetsof banks In spite of accounting for small proportion in the total assets, these assets can affect the position, productivity of banks In addition, there are also advancing items to purchase small devices which are not allocated totally during the term, advancing items for banks’ staff Some banks put slice loans into other assets

Off-balance sheet assets: banks give commitments to customers, which forms a

type of asset that is commitment contract For example, guarantee contracts, management mandate contracts (customers mandate assets to banks to manage), financial contracts Although they are not used to calculate many important

financial targets related to total assets (total assets - Asset – only on-balance sheet

assets), off-balance sheet assets also affect operation capacity of banks, can create earnings and cause risks to banks

1.1.2.3 Some basic criteria for evaluating the operation efficiency of commercial

joint stock banks

Group of profitability criteria:

ROA = net income after tax /total assets (return on assets – ROA) ROA is calculated by letting net income be divided by average total assets in a period

The increasing trend of ROA is generally positive with the condition that banks do not perform the business policy of accepting a lot of risks

ROE = net income after tax / shareholder’s equity (return on equity – ROE)

ROE is a measurement of the profitability of banks, often combined with ROA ROE

of banks is usually calculated by letting net income be divided by average equity in one period With the aim to maximize the profits of owners, ROE is a profitability criterion cared most by bankers

ROE = net incomet after tax /average equity = (ROA x total assets)/average equity

= (ROA x total sources/average equity) = ROA x (1+Debts)/ average equity

The above relationship shows that the correlation between main profitability ratio of ROE and other basic ratios of banks If other factors do not change, the bigger the ratio of Debt/Equity is, the higher the profitability of the bank gets

Interest spread = interest receipts – interest expenses Interest spread reflects the profitable scale from the basic operations of banks:

mobilizing capitals to lend and invest The more the difference is, the higher the net income of banks get Difference of other receipts and expenses plays a more and more important role to banks when the difference of receipts and expenses from interests tends to decrease The after tax net income is the result criterion reflecting most the profitability of banks

Net income after tax = Interest receipts – Interest expenses + Other receipts – Other expenses – Income tax

The factors affecting interest receipts - expenses and other receipts - expenses clearly affect the before tax net income The tax rate and taxed subjects continue to affect the after tax net income It means that income of tax free securities is substracted from the before tax income to calculate tax, then it is added to calculate after tax income The higher the income from securities is, the lower the tax is and the higher the after tax income becomes The degree of decreasing tax depends on the way of calculating the input costs of tax free securities In general, banks want

to reduce this costs as low as possible The tax office will calculate the average cost for the whole cash source Then, it depends on the degree of encouraging to keep securities to calculate capital cost for securities due to a ratio of average cost (first it

is 15%, then 25%, and can be reached to 100%) With different ratios, the profitabilities of tax free securities is different

Group of risk criteria:

Bad debts/total debt balances

Outstanding debts/owner’s equities Budget/short term sources

Sensitive assets/sensitive sources

The above criteria reflect risks (credit risk, liquidity risk, interest risk, exchange rate risk, ) supplementing the profitability criteria in order to reflect fully the business results of a bank in a period If a bank pursues risky investments, the profitability ratio will be higher However, if the damage happens (normally after a specific time), the profitability of that bank will be reduced, even that this bank may get bankruptcy Hence, in this stage, high risk can cause damages to the next period reducing the profitability of the following period The higher the ratio of Debts/owners’ equities, the higher the ratio of ROE becomes, but the lower the

ability to resist damages of banks is The ratio of Sensitive assets/sensitive sources reflects interest risk when the interest changes in the negative direction for the banks However, when interest changes in positive direction or keeps unchanged, the income of banks will increase

1.2 Legal bases and stock valuation methods 1.2.1 Concept of stocks and valuing stocks

1.2.1.1 Concept of stocks

Stock is understood as a proof of comfirming the enterprise ownership of investors who invest in joint stock companies According to Securities Law 2006 of Vietnam,

stock is defined as following: “Stock is a kind of securities comfirming the rights

and legal benefits of owners towards a part of joint stock capitals of the issuing organizations”

Stock can exist under the form of certificates, book entries, electronic data When buying stocks, the investors will become stockholders, the owners of companies The degree of that ownership depends on the proportions of stocks the stockholders keep Being the owners, the stockholders will together share the results and damages during the operation process of the companies In the worst case when the company must liquidate its assets because of bankruptcy, stockholders only receive the rest after the company pays all other liabilities (such as tax, bank debts, bonds,… Stocks are untermed tools According to the benefits stocks can bring to stockholders, there are two basic types of stocks which are common and preferred stocks

Common stock is the most typical stock If a company is allowed to issue only one type of stock, it will issue common stocks The common stock holders will get the following rights: right of receiving devidends, right of buying new stocks and right

of voting

Preferred stock is divided into three types according to Enterprise Law 2005: Voting preferred stock, devidend preferred stock and returnable preferred stock Within the scope of this thesis, all stock valuation methods will only concentrate on assessing common stocks of Saigon Thuong Tin commercial joint stock bank

1.2.1.2 The concept of valuing stocks

All investors who have the intention of keeping stocks in long run want to know that whether the price people offer is reasonable or not They want to know the internal value of stocks This value is defined as the present value of all receipts that investors want to gain in the future

Valuing stocks will help investors give decisions of whether to invest in a type of stock or not If after calculating, the real value of stock is higher than the market price of that stock, meaning that this stock is being sold at the price lower than its internal value, and it is advised to buy this stock because its price will increase to its real value On the contrary, it is better not to invest in stocks that are being sold at the prices higher than their real values, since in the next time, the prices will decrease to come back their real values

1.2.2 The legal bases for valuing stocks in Vietnam

In reality, in Vietnam, there is no legal document directly mentioning valuing stocks However, we can base on legal documents on the issues of equitizing state-owned enterprises (in which enterprise valuation methods are mentioned) to have legal bases for valuing stocks in Vietnam

The year of 1992 was the beginning one of the program of equitizing state-owned enterprises Since that time, enterprise valuation has been cared much more From

1992 to present, the Government and Ministry of Finance have issued some legal documents regulating the transfer of state owned enterprises to the form of joint stock companies Each document was issued with the aim to replace the previous

one and be more suitable to the reality of country’s development We can divide these documents due to the following periods:

The first period, from 1996-1998: includes the decree 28/1996/ND-CP issued on 07/05/1996 about transferring some state owned enterprises to joint stock companies, and the circular 50/1996/TT-BTC of the Ministry of Finance issued on 30/08/1996 instructing to perform the decree 28

The second period, from 1998-2002: includes the decree 44/1998/ND-CP (replacing the decree 28) issued on 29/06/1998 about transferring some state owned enterprises

to joint stock companies, and the circular 104/1998/TT-BTC of Ministry of Finance issued on 14/07/1996 instructing to perform the decree 44

The third period, from 2002-2004: includes the decree 64/2002/ND-CP (replacing the decree 44) issued on 19/06/2002 about transferring some state owned enterprises

to joint stock companies, and the circular 79/2003/TT-BTC of Ministry of Finance issued on 12/09/2003 instructing to perform the decree 64

The fourth period, from 2004 to June of 2007: includes the decree 187/2004/ND-CP issued on 16/11/2004 about transferring some state owned enterprises to joint stock companies, the circular 126/2004/TT-BTC of Ministry of Finance issued on 24/12/2004, and then the circular 95/2006/TT-BTC revising and supplementing the circular 126/2004/TT-BTC instructing to perform the decree 187

The fifth period, from June of 2007 to present: The decree 109/2007/ND-CP issued

on 26/06/2007 about transferring some state owned enterprises to joint stock companies, and the circular 146/2007/TT-BTC of Ministry of Finance issued on 06/12/2007 instructing to perform the decree 109

Due to the real demands during the development process, especially since the establishment of Ho Chi Minh Stock Exchange (HOSE), the legal documents regulating enterprise valuation and stock valuation have been more and more improved so that they can be more suitable to the reality of the economy We can

consider the aspect: the regulations of valuation, regulations of valuation methods, regulations of land using right and regulations of comparative advantages

1.2.2.1 Some regulations of stock valuation

From 2002 to previous, this was the beginning period of equitization process; enterprise valuation and stock valuation were performed by the enterprise management agency through the Committee of valuing enterprises The members of this committee included representatives of financial agency, sector management agency, enterprises’ representatives and financial experts The inadequate point of this model is the lack of objectiveness, lack of marketability, and it does not have staffs that specialize in valuing enterprises and stocks as well

The period of 2002-2004, the activities of valuing enterprises and stocks received the contributions of financial intermediaries when the decree 64/2002/ND-CP allowed to maintain two valuation methods which are through valuation committee and through intermediary institutions like auditing companies or companies specializing in valuing

The decree 187 which was issued in 2004 partly solved the above existing problems This decree eliminated the valuation method through the committee in order to enhance the clearness and professionalism in valuing enterprises and stocks This decree regulated: “All enterprises having the total value of accounting assets up to over 30 billion VND must conduct the valuation through the valuation agencies like: auditing companies, securities companies, price assessing companies and domestic and foreign investment banks which have the function of assessing prices Enterprises with the value of total assets less than 30 billions VND do not need to hire the professional organizations to value enterprises In the case that enterprises do not hire the valuation organizations, the results must be reported to the authorized agencies about decisions on values of enterprises

The decree 109 basically did not change any point about this issue

1.2.2.2 Regulations of valuation methods

Before 2002, the method used to evaluate the prices of equitized enterprises and then to specify the value of shares which are presented by stocks was the method of asset’s value Because each enterprise had specific features, operated in different fields, especially there were a lot of limitations in the valuation method of assets’ value, with only this method itself could not bring the exact valuation results It can

be seen that banking sector does trading on money and provides related services, so banks are very different from manufacturing enterprises in terms of value of assets, but in reality, the value of banks is very big and may be much higher than other manufacturing enterprises

The decree 64 combined the two methods in valuing enterprises From that valuing stocks could be:

- Net asset method: enterprise valuation based on assessing assets which they are possessing and using

- Discounted cash flow method: enterprise valuation based on the profitability

of them in the future

However, the discounted cash flow method just applied limitedly to enterprises which operated in the fields of trade service had the ratio of after tax profits over average owner’s equities in 5 consecutive years from the valuation point of time The decree 187 not only regulated the two methods similar to the decree 164, but it also allowed enterprises to apply other valuation methods after negotiating with Ministry of Finance

The decree 109 basically did not change any point about this issue In detail, the two valuation methods mentioned in the decree 109/2007/ND-CP are:

a The asset method:

According to the asset method, the value of an enterprise is the value of all assets that enterprise currently possesses, including the profitability of the enterprise which can be accepted by the stock sellers and buyers The real value of the State’s capital in the equitized enterprises is the real value of the enterprises after subtracting liabilities, the balance of reward fund, welfare fund and the balance of career expense source (if any)

The value of an enterprise (adjusted net asset value):

= Total sources – Liabilities – Funds – Expenses

= Owner’s equity – Funds - Expenses The real value of an enterprise is the real value of all assets that enterprise currently has at the time point of valuation, including the profitability of the enterprise According to the decree 109/2007/ND-CP there are four basements to determine the real value of enterprises:

o Data in the accounting book of the enterprises at the time point of valuation

o Documents of inventory, classification and evaluation of assets’ quality

of the enterprises at the point time of valuation

o The market value of assets at the time point of valuation

o The values of rights of using the delivered, rent lands and the value of business advantage of the enterprises

The assets which are objects:

a Only reevaluate the assets that joint stock companies continue to use

b The real value of assets = The original price being calculated based on the market price x The rest quality of assets at the time point of valuation

c The fixed assets depreciated to collect the full capital; labor devices, management tools allocated absolutely to business expenses but the joint stock companies still continue to use must be reevaluated to add to the value of the enterprises

The assets in cash, deposits and other valuable papers (treasury bills, bonds,…)

of the enterprises can be calculated as following:

a Cash is specified according to the budget inventory report

b Deposits are specified according to the balance confirmed by banks

c Valuable papers are specified according to the market transaction prices If there is no transaction, they are specified based on the face values of them

Accounts receivables: which are added to the values of enterprise are specified

according to the real balance in accounting books after being handled

Incomplete expenses: construction investment, business manufacturing, career

business are specified according to the arisen facts posted in the accounting books

The values of guaranteed, long and short term security assets are specified

according to the real balances in the confirmed accounting books

The value of intangible assets (if any) is specified according to the rest value

which is being post in the accounting book

Particularly, the value of land using right is specified subject to the item 30 of

decree 109/2007/ND-CP:

o In the case that the enterprise has land usage right, the value of land usage right is added to the value of enterprise based on the land prices regulated and declared by people’s committees of central provinces and cities

o In the case that equitized enterprises choose the way of renting lands:

For the enterprises which pay the rental annually, do not add the rental money to the value of enterprises

For the enterprises which pay the rental once for the whole time they rent, the money for rental will be added to the value of enterprises subject to the market prices which are regulated and declared by People’s committees of central provinces and cities at the time point of valuation

According to the item 31 of the decree 109/2007/ND-CP:

The value of business advantages of enterprises consists of the geographical

advantage, the value of brand and the development potential The value of business advantages of equitized enterprises is determined by the authorized agencies, but not less then the value of business advantage specified by the instructions of Finance Ministry

b The discounted cash flow method:

According to the item 33 of the decree 109/2007/ND-CP:

The real value of equitized enterprises specified with the discounted cash flow method is based on the profitability of enterprises in the future The basements for specifying the value of enterprises subject to the discounted cash flow method consist of:

o The financial report of enterprises in the 5 consecutive years before the time point of valuation

o The operation and manufacture plans of enterprises within 3 to 5 years after changing into joint stock companies

o Interests of government bonds with over 5 year term at the nearest time point, before the time point of organizing the enterprise valuation and the cash flow discount coefficient of assessed enterprises

The real value of enterprises at the time point of valuation subject to the discounted cash flow method is specified as following:

After calculating the value of enterprises according to each method, the prices of stocks will be calculated as shown in the formula:

Po = the value of net assets of enterprises/the number of outstanding stocks

1.2.2.3 The regulations of land usage right

The documents before 2002 did not declare to add the land usage right to the value

of enterprises, hence, a lot of enterprises which had the advantage of land usage right were depreciated many times in comparison with their real values, and their stocks, for that, were depreciated as well

The decree 64 of 2002 was an important step when mentioning the land usage right

in the value of enterprises The decree distinguished the two cases:

For the area of land the enterprises are renting to use for offices, places for manufacturing and trading, the enterprises are still allowed to rent after carrying out the equitization process

For the area of land delivered by the state to do infrastructure business, the value of land usage must be added to the value of equitized enterprises

However, the decree 64 had some limitations when it did not mention the land area delivered by the state to enterprises in order to manufacture and do business There were some more suitable improvements in the decree 187 when it had the following regulations:

o The land asset used by enterprises, enterprises must choose and rent lands

or deliver lands subject to the Land Law

o In the case that enterprises rent lands, do not add the value of using land right to the value of enterprises Joint stock companies continue to sign contracts to rent lands subject to the regulations of the law and manage, use the lands with right objectives and are not allowed to sell or transfer the lands

The decree 109 added the following regulations: For enterprises which pay the rental once for the whole time they rent the lands, add the amount of money for rental to the value of the enterprises subject to the market prices which are regulated and declared by People’s committees of central provinces and cities at the time point of valuation

1.2.2.4 The regulations of specifying the advantage values

Advantage is a term used to indicate the intangible value creating the profitable value in the future of enterprises thanks to some factors like invention licenses, patents, brand prestige, rights of exploiting and using

In the theory, the asset valuation method in the decrees of Government in the previous time was the method of assessing adjusted net assets including the value of tangible assets plus the advantage value (if any) However, this method of evaluating the advantage value was not consistently regulated in each period; it also lacked some basements as well Up to the decree 64, the way of calculating the value of advantages was clearly improved in comparison with the previous ones: The advantage value = The value of State’s capital based on the accounting book x (The ratio of after tax profits over average State’s capital in 3 years – the interest of Government’s 10 year bonds at the nearest time point)

This formula was continually used in the decree 197 to calculate the advantage value in the equitized enterprises

However, the decree 109 regulated: “The business advantage of an equitized enterprise is considered by the authorized agencies, but this decision result can not

be less than the business advantage value which is determined according to the instructions of the Ministry of Finance”

Above are the legal documents related to the enterprise valuation, from that the stock valuation of those enterprises can be applied in our country today Nowadays,

in the world, there are a lot of ways of assessing enterprises and stocks as well But

in general, these methods base on the three basic methods: the discounted cash flow method, the valuation method based on the market criteria, the valuation method based on the enterprises’ assets

1.2.3 The stock valuation methods:

Assessing stocks is a very important work towards enterprises, investors and the whole society In practice, people use many ways of assessing stocks These methods are divided into 4 groups (Asset based valuation, discounted cash flow, relative valuation, contigent claim models):

Figure 1.3: Valuation Models

Source: Aswath Damodaran,

Relative Valuation Contingent Claim

Firm Valuation Models

Cost of capital approach

APV approach

Excess Return Models

Option to expand

Option to liquidate

Patent Undeveloped

Reserves

Young firms

Undeveloped land

Equity in troubled firm

Dividends

Free Cashflow

to Firm

The valuation models can be categorized as:

- Asset based valuation

 Asset based valuation comprises of:

• Liquidation value

• Replacement cost

• Mixed

 Asset based valuation is most appropriate when:

• Businesses are mature

• Assets are separable and marketable

• Asset market & financial market diverge

- Discounted cash flow valuation

 Discounted cash flow valuation comprises of:

• Dividend discount model (DDM)

• Free cash flow to equity (FCFE)

• Free cash flow to the firm (FCFF)

• Residual income

 DDM is appropriate when:

• The company has a history of dividend payment

• The dividend policy is clear and related to the earning of the firm

• The asset is being valued from the position of a minority shareholder

 Free cash flow is appropriate when:

• The company does not have a history of dividend payment or the dividend policy is not clear nor related to the earning of the firm

• The asset is being valued from the position of a controlling shareholder

• The free cash flow is positive in foreseeable future

 Residual income is appropriate when:

• The company do not have a history of dividend payment or the dividend policy is not clear nor related to the earning of the firm

• Free cash flow is negative for the foreseeable future

• Company has transperent financial reporting and high-quality earning

- Multiple-based valuation

 Multiple-based valuation is based on the law of one price:

• This method is used when there is a bunch of similar assets

• To cross-check other methods Basically, to value growth stocks, 5 popular methods are often used:

o The method of dividend discount model (DDM model)

o The method of discounted cash flow (DCF model)

o The valuation method based on the coefficient of price over earning (P/E)

o The valuation method based on the coefficient of price over book value (P/B)

o The valuation method based on the value of net assets DDM & DCF belong to discounted cash flow group P/E & P/B belong to relative valuation group Net asset value (liquidation value) belong to Asset based valuation group

1.2.3.1 The method of dividend discount model (DDM model)

The dividend discount method is built on the idea that the value of stocks is specified equally the present value of all the income flows in the future Supposing that there is a stock which is being held at the nth year, the dividends paid from the first year to the nth one are D1, D2, , Dn respectively Knowing that the price of

that stock in the nth year is Pn and the required discount rate of investors is constant

r, we have the following formula to calculate the value of stocks according to the

dividend discount method:

P 0 =

Where:

P0 is the value of stock at present point of time

Dt is the dividend of the t year

r is the required rate of return ( it is also called discount rate)

If the stock is held by investors perpetually, meaning that n reaches infinite (normally, the existing time of stock is unlimited because it has no maturity time), the value of the initial capital Pn/ (1+r)n will approach 0 and the above formula will become:

r

D P

1 ( 1 )

t n n

D

) 1 ( ) 1 (





In the case that a company does not grow, the dividend which is paid annually will

be fixed, meaning that D 0 = D 1 = D 2 = = D n. At this time, the value of stocks will

be calculated as in this formula:

t

r

D r

r

D r

D P

1

0

) 1 (

1 1

) 1

b The case of single stage growth

When a company grows regularly, it means that the dividend will be grown

annually at a fixed growth rate g

We have: D1= D0 (1+g), D2=D1(1+g)=D0 (1+g)2

Dt = D0 (1+g)tWith the supposal that r>g>0, the value of stocks will be calculated as following:

g r

D g

r

g D

r

g D

1

0 0

) 1 ( )

1 (

) 1 (

The above formula is true only when the growth rate g is smaller than the expected discount rate r In practice, people suppose that r > g because this is absolutely reasonable Since g is the growth speed in long term while r is the discount rate required in short term only and it is often changed

c The case of multi stage growth

In reality, there is no company which has a constant growth rate in the whole time

of existence In the life cycle, companies have different growth rates That is why this is the most practical case Normally it happens the case that the growth rate of dividend is not regular in some years before it can reach a stable period

In order to evaluate the price of stocks, we need to divide the growth process of a company into different growth stages, mainly into two stages The first stage is the inconstant growth one In this stage, investors need to base on the expected income and dividend policy to evaluate annual dividend The second stage is the long one and is supposed to have an unchanged growth rate

To calculate the price of stocks, we combine the formulas of the two above cases: supposing that in n first years the dividends are estimated at D1, D2, ., Dn From the (n+1)th year, the growth rate g is constant

At that time, the price of stocks is calculated as following:

n n

r

D P

) 1

( )

1 (

Through three formula of calculating the price of stocks in the three cases, we can

see that we need to estimate the following parameters: the future dividend (D), the expected discount rate (r), and the dividend growth rate (g) To calculate exactly

these parameters, it is necessary to analyze and specify the finance situation of the issuing organization to estimate the prospects of the enterprise

o The estimated dividend (D): the estimation of the dividend of the first year is based on the data about dividends in the past, the policy of allocating dividends in the future, the estimation of next year income From that, it can be estimated the value of dividend which can be gained

in the first year D1

Dividend = D = dividend payout ratio * EPS

g = ROE b

In this formula, the ratio of Earnings per share – EPS is calculated by letting net income subtract dividends on preferred stocks and then letting this difference be divided by average outstanding shares

o Calculating the growth rate g:

The calculation of the dividend growth rate of a company must be based on the evaluation of the development potential of that company in the long term, not only some next years, because the growth rate is supposed to be constant in the whole life of operation Hence, the data to calculate g must be the average estimations in long run

The dividend growth rate is evaluated based on the profit growth rate and profit rate for paying dividends In practice, the dividend growth rate is supposed to be equal

to the income growth rate and be calculated like in the formula:

Where:

b is the profit rate retained for reinvestment

EPS

D

b  1  = 1- dividend payout ratio

ROE = net income/shareholders’ equity

= Earnings per share (EPS)/the book value of a stock

o The required rate of return (r):

To calculate the discount rate required by investors, it is necessary to base on the risk degree of the issuing company If the company has high risk degree, the investors require a high discount rate to make up that risk To specify r, people have some different formulas depending on the capital structure of the issuing company

The most popular one to specify r is to apply the Capital Asset Pricing Model – CAPM)

(*)

Where:

rf : is the interest of treasury bill with the risk degree equaling to 0

rm : the interest of market portfolio

 : is the risk degree of the company

β (rm – rf ): the risk premium when investing in stocks

We can express the above formula through the security market line as following

Figure 1.4: SML – The Security Market Line

The Security Market Line SML is considered as a standard criterion to evaluate an investment project By accepting a specific risk of an investment project (being measured by the coefficient β, the line SML shows us how much the profit of the project must be so that it can make up the risk that investors have to bear

From the meaning of the line SML, if all types of stocks are measured exactly, they must lie on the line SML The points which lie above or under the line SML do express the situation that the prices do not reflect correctly the balance values in the market If they are the points lying above the line SML, those securities are being evaluated lower than their real values In this case, it is advised to buy those securities On the contrary, with the points lying under the line SML, it is better not

to buy those securities because their prices are higher than their real values

In the model CAPM, the coefficient β only considers the systematic risk of the company Through the above formula, we can see that the risk degree is in direct proportion with the required discount rate If a company has a high degree of risk, the required discount rate is high

To calculate r (the required discount rate), we will go in detail to understand deeper about the coefficient β and the method to calculate this coefficient:

- The investment in stocks is always associated with risks, in this situation, risks are defined as probabilities of happening the event that the discount rate of the investment is skew from the required interest (r) Some risks arise from the internal and the company can control at a comparative degree But some risks lie out of the control of the issuing company and can affect a lot of companies at one time In investment, the risks, which are generated by the internal factors can be controlled and only affect one sector or a company, are called unsystematic risks On the contrary, the risks which are caused by external factors can not be controlled and can affect widely the market and all types of securities are called systematic risks

Unsystematic risk: is a part of risks related to a company or a specific industry

sector, outside the risks associated with the whole market Those factors may be the management ability of the company, the consumption interest of customers, strikes

or some other factors causing the change in income from stocks of the company These risks belong to business risk and finance risk

Systematic risk consists of:

Market risk: is the risk arising from the judgments of stock investors and from the

fact that the stock prices can strongly fluctuate while the income of the company does not change This risk appears due to the reactions of investors towards visible

or invisible events Those are economic, financial, social,… events The judgment that the profit of a company may decrease may be the reason for the decrease in prices of most of stocks

Interest risk: this risk mentions the instability of market prices and the future

income The reason is due to the fluctuation of common interest rates

Purchasing power risk: this is exactly the effect of inflation on investments If we

consider an investment as an immediate consumption, we can see that when a person buys stocks, he loses the chances to buy goods and services during the time

he holds the stocks When the prices of goods, services increase due to inflation, the investors lose a part of purchasing power

So, in order to measure the risk degree of the profitability of a stock, we need to specify the total systematic and unsystematic risks However, the economists have proved that the unsystematic risk can be eliminated by diversifying portfolio Hence, when calculating the discount rate, we do not care about unsystematic risk since it is considered as a risk that will not be paid or not made up That is the reason for the foundation of the model CAPM, in which the required discount rate is calculated based on the coefficient β- the coefficient of evaluating the systematic risk degree of a stock

- How to calculate the coefficient β

The coefficient β is calculated based on the past data about the investment discount rate of a security and the discount rate of a market portfolio