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VALUATION:
PRICE AND ENTERPRISE
VALUE MULTIPLES
Presenter
Venue
Date
VALUATION INDICATORS
Enterprise
Price
Value
Multiples
Multiples
Momentum
Indicators
METHODS FOR PRICE AND ENTERPRISE
VALUE MULTIPLES
1. Method of Comparables
• Economic rationale is the law of one price
Rationales Drawbacks
Zero, negative, or very
EPS is driver of value
small earnings
Permanent versus
Widely used
transitory earnings
Trailing Forward
P/E P/E
Preferred Preferred
Uses last when Uses next when trailing
year’s forecasted year’s earnings are
earnings earnings are earnings not reflective
not available of future
EXAMPLE: FORWARD P/E
Stock price* $20 .00
2016:Q1 EPS $0 .18
2016:Q2 EPS $0 .25
2016:Q3 EPS $0 .32
2016:Q4 EPS $0 .35
2016 Fiscal year forecast $1 .10
EPS for the NTM 1 $1.10 11 $2.00 $1.925
12 12
Forward P/E based on EPS for the NTM $20 $1.925 10.4
EXAMPLE: FORWARD P/E
Underlying
EPS Dilution
Earnings
Differences
Normalized
in Accounting
Earnings
Methods
EXAMPLE: UNDERLYING EARNINGS
Average (normalized) EPS Average ROE Current equity book value per share
Average (normalized) EPS 22.8% $4.11 $0.937
D1
V0
rg
P0 D1 E1
E1 rg
P0 1 b
E1 rg
JUSTIFIED TRAILING P/E FROM
FUNDAMENTALS
D 0 (1 g )
V0
rg
P0 D 0 (1 g ) E0
E0 rg
P0 (1 b)(1 g )
E0 rg
EXAMPLE: JUSTIFIED FORWARD P/E
FROM FUNDAMENTALS
P0 1 b
=
E1 rg
P0 1 0.36
= =10.7
E1 0.10 0.04
EXAMPLE: JUSTIFIED P/E FROM
REGRESSION ON FUNDAMENTALS
Predicted P/E
11.5 2.2 DPR + 0.03 Beta + 16.2 EGR
Predicted P/E
13.3
METHOD OF COMPARABLES
Yardeni Model
METHOD OF COMPARABLES
USING OWN HISTORICAL MULTIPLES
Rationale: Regression to the Mean
Approaches:
Average of four middle values over past 10 years
Five-year average trailing P/E
Potential Problems from Changes in
firm business
firm financial leverage
interest rate environment
economic fundamentals
inflationary environment
USING P/ES FOR TERMINAL VALUE
P/E Based on
Justified P/E
Comparables
If comp is mispriced,
Sensitive to required
terminal value will
inputs
be mispriced
EXAMPLE: USING P/ES FOR TERMINAL VALUE
D3 1 g $1.00 1 0.048
V3 $16.90
rg 0.11 0.048
EXAMPLE: USING P/ES FOR TERMINAL VALUE
USING COMPARABLES
V3 P/E EPS3
Intangible Inventory
Assets Accounting
Off-Balance-
Fair Value
Sheet Items
JUSTIFIED P/B
P0 ROE g
B0 rg
g b ROE
P0 $50
Actual 25.0
E0 $2
P0 $50
Actual 8.0
B0 $6.25
P0 $50
Actual 3.3
S0 $15
EXAMPLE: CALCULATING THE INPUTS FOR
THE JUSTIFIED
P/E, P/B, AND P/S
• Earnings + Depreciation +
CF Amortization + Depletion
FCFE 0 (1 g )
V0
rg
DIVIDEND YIELD
RATIONALES AND DRAWBACKS
Rationales Drawbacks
It is only one
Component of return component of return
D0 rg
P0 1 g
INVERSE PRICE RATIOS
Rationales Drawbacks
Useful for comparing firms
of different leverage Exaggerates cash flow
Justified EV/EBITDA
• Positively related to FCFF growth
• Positively related to ROIC
• Negatively related to WACC
Comparables May Use Total Invested Capital
Other EV Multiples
• EV/FCFF
• EV/EBITA
• EV/EBIT
• EV/S
CROSS-COUNTRY COMPARISONS
Past Performance
Relative to an Index
Inherently Self-
Destructing
VALUATION INDICATORS IN PRACTICE:
AVERAGING MULTIPLES
Arithmetic
Mean and • Overestimate of index P/E
Weighted Mean
Weighted
Harmonic Mean
• Equal to index P/E
VALUATION INDICATORS IN PRACTICE:
STOCK SCREENS
Database Limitations
• Variables are predetermined
• Does not contain qualitative data
Look-Ahead Bias
• Assumes investor has info not yet available
Sector Rotation
SUMMARY
• Method of comparables
• Method based on forecasted fundamentals
Method of Comparables
• Industry peers
• Industry or sector index
• Broad market index
• Own historical values
SUMMARY
Price-to-Book Rationales and Drawbacks
• Rationales: Book value usually > zero, more stable than EPS,
appropriate for financial firms and firms that will terminate, and
explains stock returns
• Drawbacks: Doesn’t recognize nonphysical assets, misleading
if asset levels vary or differ from accounting practices, less
useful when asset age differs, and can be distorted by
repurchases
• Intangible assets
• Inventory accounting
• Off-balance-sheet items
• Fair value
SUMMARY
Price-to-Sales Rationales and Drawbacks
• Rationales: Sales less easily distorted, sales always
positive, P/S more stable than P/E, appropriate for many
firms, and explains stock returns
• Drawbacks: Sales ≠ Earnings and Cash flow, numerator
and denominator not consistent, does not reflect cost
differences, and can be distorted
Justified Multiples
Cross-Country Comparisons
Momentum Indicators
Stock Screens
• Database limitations
• Potential look-ahead bias
• Used in sector rotation