Abstract：By analyzing actual cash flows in comparison with enterprise values (market capitalization plus debt minus cash) we document that the market dramaticall undervalues firms. The findings suggest that the equity market appears to have an extraordinarily high discount rate which negates future earnings in the calculus of firm value. That is, the discount rate is so high that the vast majority of future cash flows are virtually ignored.
Our research finds that stock prices do not reflect future corporate earnings. This finding contrasts with the well known statement in finance textbooks that “the value of a firm equals the present discounted value of future cash flows.” In fact, we find that enterprise values are substantially less than the present discounted value of future cash flows. A one-dollar increase in future cash flows produces only a 75 cent increase in a firm’s enterprise value.
The implication of our work is clear: companies are worth far more than the market believes. This provides strong support to the idea behind the private equity industry. We realize that of late private equity firms have overpaid for acquisitions and may lose their entire investment during the current phase of deleveraging. Yet, if private equity firms acquire companies at reasonable prices using less debt, they are likely to create substantial value as a consequence of the fact that companies are so undervalued by the market relative to their cash flows.
There are no previous research efforts following our methodological design based on actual cash flows. Rather, .prior research studies have focused on the relationship between forecasted cash flows (by market analysts) and enterprise value. Our approach focuses on a different question – the relationship between discounted future cash flows and the current market value as posited by financial theory. 沙盘模拟经营大赛总结
Keywords: Enterprise Value, Actual Cash Flow, Cash Flow, Valuation
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The common explanation provided in finance textbooks for the value of the firm
is that it equals the present discounted value of future free cash flows (FCF). Few
analysts or market observers disagree with this statement. Despite its universal
acceptance, there are few studies of the basic FCF proposition and the theory that
underlies the science of valuation. In this paper, we explore the question of whether the value of the firm is related to its future cash flows. Existent literature on this subject includes a few studies conceptually similar to ours and a large body of work on questions peripheral to the basic issue addressed in this paper. Those related works use the FCF valuation theory to address issues of market efficiency. Our work is directed at valuation and not the market efficiency question.
Obviously actual future cash flows are unknown when analysts estimate value.
Lacking actual future cash flow data, analysts create careful projections of annual cash flows for several years, usually less than 10, and then estimate cash flows in additional years with a terminal value. Public companies have value forecasts prepared for them by many unrelated individuals and organizations. Some forecasts are too optimistic while others are too pessimistic. Presumably optimistic forecasters are buyers of securities while pessimistic forecasters are sellers. A security’s market price would then be the share value that clears the market of optimists and pessimists.
The specific projections of all individual forecasters are unavailable. What is 暑期夏令营社会实践活动总结
known, at a point in time, is the actual market capitalization and enterprise value (EV)
that results from the interactions of these many forecasts. Some researchers have tested the relationship between the value of the firm and cash flow forecasts by obtaining a sample of analyst’s forecasts or forecasts from other published sources. We instead substitute actual cash flows for forecasted cash flows. Our null hypothesis assumes that the market-clearing forecast of future free cash flows is correct for every company. In that case, actual cash flows can be substituted for cash flow forecasts. If the market clearing forecast is too optimistic (pessimistic) then the observed EV exceeds (is less than) the present discounted value of actual free cash flows. Our first empirical test examines how closely EV compare with the present discounted value of actual subsequent cash flows. Finding the theory to be less than complete, our second empirical exercise considers additional explanatory factors to explain EV. This portion of the paper tests whether the accepted FCF theory fully explains EVs.2386