Summary of basis of valuation and methodology used in proprietary models

Types of methodology
The following three methodologies are typically used in the valuation of financial instruments by research analysts:

Absolute – This method generates a present value of an asset’s expected future cash flow. Absolute methods include multi-period models, e.g. discounted cash flow, or single-period models.

Relative – This method determines the current value of an asset based on the current price, acquisition cost or trading multiples (e.g. price: earnings ratio) of similar assets.

Option pricing – which uses mathematic models such as Black-Scholes-Merton to generate a present value for instruments such as warrants and options.

Valuation may be via a single method or a combination of multiple methods.

In generating a valuation for an instrument it is usually necessary to make assumptions as to the future performance of the instrument, and to select relevant economic parameters. These assumptions will be based on numerous internal and external factors which may include:

• Past performance

• Stated business targets and management guidance

• Relevant industry and market trends

• Cost and availability of debt and equity capital

• Relevant economic inputs, e.g. exchange rates, inflation rates, tax rates

• Duration of activity

Typically the historical trading data (e.g. company accounts) and the forecast future performance of the instrument, based on the assumptions made, will be combined into a theoretical financial model.

A valuation can then be calculated using the selected methodology (e.g. absolute or relative) and the forecast future earnings/cash flow (or other relevant metric) within the model. A target price, i.e. the perceived “appropriate” value of the instrument, can then be calculated based on this valuation subject to any adjustments from external factors deemed appropriate. Models, and the data associated with model production and maintenance, are held on a secure, shared server which is accessible to CFE research departmental staff only to safeguard their integrity.

Valuation methodology, underlying assumptions and target prices are frequently reviewed. Changes to assumptions, financial estimates and target prices can be made at any time in light of information specific to the instrument concerned, such as annual financial results, or based on changes to relevant market or industry conditions.

The valuation methodology, underlying assumptions and target price for each instrument is detailed in research notes along with all information relevant to the specific investment case.

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