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VALUATION:
PRICE AND ENTERPRISE
VALUE MULTIPLES
Presenter
Venue
Date
VALUATION INDICATORS
Price
Multiples
Enterprise
Value
Multiples
Momentum
Indicators
1) Method of Comparables
Economic rationale is the law of one price
PRICE-TO-EARNINGS MULTIPLE
RATIONALES & DRAWBACKS
Rationales
Drawbacks
Widely used
Permanent vs.
transitory earnings
Related to stock
returns
Management
discretion for earnings
PRICE-TO-EARNINGS MULTIPLE
DEFINITIONS
Trailing
P/E
Uses last
years
earnings
Preferred
when
forecasted
earnings are
not available
Forward
P/E
Uses next
years
earnings
Preferred
when trailing
earnings are
not reflective
of future
$20 .00
2011:Q1 EPS
$0 .18
2011:Q2 EPS
$0 .25
2011:Q3 EPS
$0 .32
2011:Q4 EPS
$0 .35
$1 .10
2012:Q1 EPS
$0 .43
2012:Q2 EPS
$0 .48
2012:Q3 EPS
$0 .50
2012:Q4 EPS
$0 .59
$2 .00
EPS Dilution
Underlying
Earnings
Normalized
Earnings
Differences
in Accounting
Methods
$4 .00
Restructuring charges
$0 .10
Amortization of intangibles
$0 .15
Impairment charge
$0 .20
Stock price
$50 .00
EPS
BVPS
ROE
2010
$0.66
$4.11
16.1%
2009
$0.55
$3.67
15.0%
2008
$0.81
$2.98
27.2%
2007
$0.73
$2.12
34.4%
2006
$0.34
$1.61
21.1%
$24.00
Average ROE
Average (normalized) EPS Average ROE Current equity book value per share
Average (normalized) EPS 22.8% $4.11 $0.937
D1
V0
r g
P0
D1 E1
E1
r g
P0
1 b
E1
r g
D 0 (1 g )
V0
rg
P0
D 0 (1 g ) E0
E0
rg
P0
(1 b )(1 g )
E0
rg
Retention ratio
0 .36
4 .0%
10 .0%
P0
1 b
=
E1
rg
P0
1 0.36
=
=10.7
E1
0.10 0.04
0 .40
1 .20
6 .00%
15 .0
METHOD OF COMPARABLES
Industry
or sector
index
Broad
market
index
Firms
historical
values
METHOD OF COMPARABLES
USING PEER COMPANY MULTIPLES
8 .0%
$4 .50
$28 .00
9 .00
1 .60
METHOD OF COMPARABLES
USING INDUSTRY AND MARKET MULTIPLES
Industry or Sector Index
Mean vs. median
Check industry valuation against market
METHOD OF COMPARABLES
VALUING THE MARKET
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
Justified P/E
P/E Based on
Comparables
P/E =
(D/E)/(r g)
Grounded in market
data
Sensitive to required
inputs
If comp is mispriced,
terminal value will
be mispriced
11 .0%
$2 .50
0 .40
8 .0%
9 .00
$16.90
rg
0.11 0.048
V3 P/E EPS3
9.0 $2.50 $22.50
Intangible
Assets
Inventory
Accounting
Off-BalanceSheet Items
Fair Value
JUSTIFIED P/B
P0
ROE g
B0
r g
PV Expected future residual earnings
P0
1
B0
B0
PRICE-TO-SALES
MULTIPLE RATIONALES
PRICE-TO-SALES
MULTIPLE DRAWBACKS
Sales Earnings & Cash Flow
Numerator & Denominator Not Consistent
JUSTIFIED P/S
P0
(E0 / S0 )(1 b)(1 g )
S0
rg
g b ROE
Sales
Total assets
g b PM0
Total assets Shareholders equity
$50 .00
$2 .00
$1 .20
$6 .25
$15 .00
22 .5%
12 .0%
25.0
E0
$2
P0
$50
Actual
8.0
B0
$6.25
P0
$50
Actual
3.3
S0
$15
21.8
E0
rg
0.12 0.09
4.5
B0
rg
0.12 0.09
P0 (E0 S0 )(1 b)(1 g ) ($2 $15)(0.6)(1.09)
2.9
S0
rg
0.12 0.09
PRICE-TO-CASH-FLOW
MULTIPLE RATIONALES
PRICE-TO-CASH-FLOW
MULTIPLE DRAWBACKS
CF
CFO
FCFE
EBITDA
Earnings + Depreciation +
Amortization + Depletion
From statement of cash flows
Most valid but volatile
FCFE0 (1 g )
V0
rg
DIVIDEND YIELD
RATIONALES & DRAWBACKS
Rationales
Drawbacks
Component of return
D0
rg
P0
1 g
Price-to-earnings (P/E)
Price-to-book (P/B)
Book-to-market (B/P)
Price-to-sales (P/S)
Sales-to-price (S/P)
Price-to-cash-flow (P/CF)
Price-to-dividends (P/D)
Rationales
Drawbacks
Usually positive
EV/FCFF
EV/EBITA
EV/EBIT
EV/S
CROSS-COUNTRY COMPARISONS
US GAAP
vs. IFRS
Valuation
Multiples
Inflation
MOMENTUM INDICATORS:
EARNINGS SURPRISES
UEt EPSt E EPSt
SUEt
EPSt E EPSt
EPSt E EPSt
UEt
UEt
MOMENTUM INDICATORS:
RELATIVE STRENGTH
Past Performance
Relative to an Index
Inherently SelfDestructing
Harmonic Mean
Weighted
Equal
to
index
P/E
Harmonic Mean
Database Limitations
Variables are predetermined
Does not contain qualitative data
Look-Ahead Bias
Assumes investor has info not yet available
Sector Rotation
SUMMARY
Price & Enterprise Value Multiples
Method of comparables
Method based on forecasted fundamentals
SUMMARY
Issues in Calculating EPS
EPS dilution
Underlying earnings
Normalized earnings
Differences in accounting methods
Method of Comparables
Industry peers
Industry or sector index
Broad market index
Own historical values
SUMMARY
Price-to-Book Rationales & Drawbacks
Rationales: Book value usually > 0, more stable than EPS,
appropriate for financial firms & firms that will terminate,
explains stock returns
Drawbacks: Doesnt recognize nonphysical assets, misleading
if asset levels vary or differ from accounting practices, less
useful when asset age differs, can be distorted by repurchases
Issues in Calculating Book Value
Intangible assets
Inventory accounting
Off-balance-sheet items
Fair value
SUMMARY
Price-to-Sales Rationales & Drawbacks
Rationales: Sales less easily distorted, sales always positive,
P/S more stable than P/E, appropriate for many firms,
explains stock returns
Drawbacks: Sales Earnings & Cash flow, numerator &
denominator not consistent, does not reflect cost differences,
can be distorted
Price-to-Cash-Flow Rationales & Drawbacks
Rationales: CF less easily manipulated, more stable than
P/E, addresses quality of earnings issue, explains stock
returns
Drawbacks: can be distorted, FCFE more volatile and more
frequently negative, increasingly managed by firms
SUMMARY
Measures of Cash Flow
SUMMARY
Inverse Price Ratios
Useful when denominators are small, low, or negative
(e.g., earnings)
Earnings yield, book-to-market, sales-to-price, cash
flow yield, and dividend yield
Enterprise Value Multiples
EV = Market value of stock + Debt Cash
Investments
Rationales: Useful for comparing firms of different
leverage & capital utilization, usually positive
Drawbacks: Exaggerates cash flow, FCFF more
strongly grounded
SUMMARY
Justified Multiples
SUMMARY
Cross-Country Comparisons
IFRS ROE higher than GAAP ROE
P/CFO & P/FCFE most comparable
P/B, P/E, & EBITDA multiples least
comparable
Higher inflation Lower justified price
multiples
Higher pass-through rates Higher
justified price multiples
SUMMARY
Momentum Indicators