Lent Term - Lecture 9 Flashcards
What are the key assumptions of comparable pricing?
1) You can identify other comparables
2) You can identify a value-related measure
3) The market values similar projects similarly (i.e. law of one price)
How is the P/E ratio normally calculated?
Price today/Forward looking earnings
What makes a good value-relevant attribute?
It has to have a strong positive correlation with firm value
What are the two key ingredients for successful valuation from comparables?
1) A good selection of comparable firms
2) An attribute that is closely attributed to firm value
What does a P/E ratio of 12 mean?
The market values every dollar of earning at 12
With constant earnings forever what should the P/E ration be? And with growth?
1/r
with growth it is 1/r-g
Why are share prices high when P/E ratios are high?
The market expects high future earnings.
A high P/E can also mean current E is low so firms close to bankruptcy can have high P/E.
P/E can also be high when price is too high indicates low future returns.
How do we calculate average P/Es for merged firms?
Sum of firm values/Sum of firm earnings. THIS IS NOT EQUAL TO THE EQUAL WEIGHTED AVERAGE P/E/
What is the 1/x domain problem?
This is where earnings are either 0 or negative. When earnings are 0 1/x is discontinuous and when earnings are negative the P/E ratio does not make sense.
What are some solutions to the 1/x domain problem?
1) Ignore nonpositive earnings firms
2) Use median not mean
3) Calculate average E/P and invert
4) Use P/S instead
What is multiples valuation?
Assuming the firm’s value is a multiple of its earnings
What are some other ratios that can be used for valuation?
- Price/employees ratio
- Price/patent ratio
- Price/customer, price/consumer, price/click ratio
