Equity Valuation: Market Based Valuation

Question 1

Law of One Price

Answer 1

Two identical assets should have the same price

Question 2

Normalized EPS (two methods)

Answer 2

1. Historical Average: Average EPS over a full business cycle
2. Average ROE: Average ROE X Current BV per share

Question 3

Earnings Yield

Answer 3

EY = EPS/Price

Allows for calcuating multiples across companies with negative EPS because price cannot be negative.

Question 4

Justified Price

Answer 4

JP = (Benchmark value of own historical PE) X (Most recent EPS)

Question 5

Common Shareholder’s Equity (for BV)

Answer 5

CSE = (Shareholder EQ) - (Value of Equity Claims Senior to Common)

Question 6

Justified P/B ratio based on Fundamentals

Answer 6

Po/Bo = ROE-G / r-G

Question 7

Justfied P/B Ratio from Residual Income

Answer 7

Po/Bo = 1 + (PV of Expected Future Residual Earnings)/Bo

Question 8

P/S based on Forecasted Fundamentals

Answer 8

Po/So = [(Eo/So)(1-b)(1+G)] / r-G

Question 9

Justified P/CF based on Forcasted Fundamentals

Answer 9

Vo = [(1+G)FCFEo] / r-G

Question 10

Trailing Dividend Yield (two methods)

Answer 10

1. Consistent quarterly payor = (Most recent Qtrly Div X 4) / Po
2. Semiannual payor (inconsistent) = (Dividends over last 12 months) / Po

Question 11

Enterprise Value vs. Total Invested Capital (TIC)

Answer 11

EV = MVd + MVe +MVpe - Cash - STInv

TIC = EV + Cash + STInv

Cash and ST Investments are considered nonearning assets

Question 12

Standardized Unexpected Earnings

Answer 12

SUE = (EPSt - eEPSt) / σ(EPSt - eEPSt)

• 1. σ(EPSt - eEPSt): SDev of suprises over some period*
• 2. The more common surprises are the less the impact.*

Question 13

Harmonic Mean (for multiples and everything else)

Answer 13

Xh = n / ∑(1/Xi)

Question 14

Justified Price/Sales Ratio

Answer 14

Po/So = [(Eo/So)(1-b)(1+G)] / r-G

Question 15

Underlying Earnings

Answer 15

EPS + Extraordinary items (one time charges and such)

- Core, continuing or persistent earnings

Question 16

When to use relative strength indicators

Answer 16

Patterns of persistence and reversals exist in stock returns that may be shown to depend on the investor’s time horizon