Introduction
The most important thing in deciding whether or not to buy a company’s stock is to decide on whether that company is under, or overvalued. There are six steps used to get an accurate picture of the value of a company. The first step to valuing a company is to identify economic characteristics and competitive dynamics of the industry. Identifying the economic characteristics and competitive dynamics allows for a better understanding of the financial statement relationships the analyst should expect to observe. The second step to valuing any company is to analyze the company strategy. This strategy gives the analyst an idea about the competitiveness of the company and how that company will increase value in the future. The third step is to assess the quality of the financial statements. The use of the financial statements and notes provides an extensive set of information about the firm’s financial position, performance, and cash flows while giving great insight into the firm’s profitability, risk, and growth. The fourth step is to analyze the profitability and risk of the company.
Analyzing these two things will give the analyst more information about the return and risk associated with the company. An analyst will use commonsize financial statements and various financial statement ratios to address the return and risk associated with the firm and utilize this knowledge to decide the required rate of return based on the risk assumed. The fifth step is to prepare forecasted financial statements.
This is one of the most important parts of the valuation process because even a slight variation between the forecast and actual can have huge implications for the valuation
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and any financial decisions in the future. The sixth and final step is to value the firm.
This step will determine whether the analyst feels that the company is a good investment. There are many different ways to value a company and each has their own benefits and negatives. The most common are the dividendbased approach and the future free cash flow method which we will be using for our valuation.
In this project we will be valuing two companies within the fortune 500. We
chose to value Chesapeake Energy and Anadarko Petroleum. These two companies are a part of the mining sector, primarily for crudeoil and petroleum. In the following paper we will be following the sixstep process to value both of these companies.
Economic Characteristics and
Competitive Dynamics
Industry
The oil & gas exploration & production industry has an emphasis oil and liquids production which grew 21% in 2012. Natural gas production has grown at a lower rate of 3% and that number is seen as dropping in the future. The past year has seen falling energy prices which has caused a strain on both revenue and cashflow. The overall picture for natural gas is not great as there are significant funding and cash flow problems. The U.S Energy Information Administration forecasts that global supply growth, mainly stemming from North America, is expected to outpace higher global demand in 2013 and 2014. (Standard & Poors, Michael Kay)
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Using Porter’ Five Forces model to address the level of competition we found that the threat of new entrants is quite low. There currently are thousands of oil companies throughout the world, but the barriers to enter keep all but the most serious away. For example, some types of pumping trucks can cost more than $1 million each.
This creates a high cost to enter the market. The power of suppliers is quite powerful as the margins are controlled by a small handful of companies. The power of the buyer is shifting more and more to the buyer because they are not able to differentiate and often go for the lowest price. The availability for substitutes is quite low as oil and natural gas are used in more than just running our vehicles. As the world turns toward
