Market-Based Valuation (Price and EV Multiples) Flashcards
Uses
Price Multiples = value equity
EV Multiples = value firm
P/E Ratio
trailing P/E = market price per share / EPS over PREVIOUS 12 months
leading P/E = market price per share / EPS forecast over NEXT 12 months
P/B Ratio
P/B = MV(equity) / BV(equity)
P/B = market price per share / book value per share
Book Value of Equity
Book Value of Equity = Common Shareholders Equity
Book Value of Equity = ( Total Assets - Total Liabilities ) - Preferred Stock
P/S Ratio
P/S = MV(equity) / Total Sales
P/S = market price per share / sales per share
Dividend Yield (D/P)
Trailing D/P = 4 * most recent quarterly dividend / market price per share
Leading D/P = 4 * forecasted dividends over next 4 quarters / market price per share
Underlying Earnings
Underlying Earnings = Earnings adjusted for and non-recurring components including:
(a) gains and losses from sales of assets
(b) asset write-downs
(c) provision for future losses
(d) changes in acctg estimates
Normalized Earnings
Normalized Earnings = earnings adjusted for cyclicality. Two methods:
(1) historical average EPS
(2) average return on equity ( ROE * BVPS )
Earnings Yield (E/P)
High E/P = cheap security
Low E/P = expensive security
Justified Trailing P/E Multiple
Trailing P/E = P0/E0 = [ D0 * (1+g) / E0 ] / (r - g) = (1 - b) * (1 + g) / (r - g)
Justified Leading P/E Multiple
Leading P/E = P0/E1 = D1/E1 / (r - g) = (1-b) / (r-g)
Why will Trailing P/E be LARGER than Leading P/E?
Earnings are assumed to be growing, which means LEADING P/E will have a LARGER denominator (and thus a smaller ratio)
Justified P/B Multiple
P/B = ( ROE - g ) / ( r - g )
Justified P/S Multiple
P/S = P0/S0 = [ (E0/S0) * (1-b) * (1+g) ] / (r - g)
What is E0/S0?
Net Profit Margin
How does Net Profit Margin influence P/S?
Two ways:
(1) directly
(2) indirectly through its effect on g:
g = retention ratio * net profit margin * (S/A) * (A/E)
P/S as a function of TRAILING P/E
P0/S0 = (E0/S0) * Trailing PE
P0/S0 = (E0/S0) * [ (1-b)*(1+g) / (r-g) ]
Justified P/CF Multiple
V0 = FCFE0 * (1+g) / ( r-g )
Increases if:
- r decreases
- g increases
Justified EV/EBITDA Multiple
Increases if:
* g increases
Decreases if:
- risk level increases
- WACC increases
Justified Dividend Yield
D0/P0 = (r - g) / (1 + g)
PEG Ratio
PEG ratio = P/E ratio / g
Lower is better
PEG “standardizes” P/E for stocks with different expected growth rates
Calculating Terminal Value using Multiples and DCF
Terminal Value in year n = leading PE * forecasted earnings in year n+1
Terminal Value in year n = trailing PE * forecasted earnings in year n
Four definitions of cash flow for use in P/CF
(a) earnings + non-cash charges
(b) adjusted cash flow (adjusted CFO)
(c) free cash flow to equity (FCFE)
(d) EBITDA
CF (Earnings + non-cash charges)
CF = NI + Dep + Amort
CF (Adjusted CFO)
CF = adjusted CFO = CFO + [ net cash interest outflow * (1-tax) ]
CF (FCFE)
CF = FCFE = CFO - FcInv + net borrowing
Enterprise Value (EV)
EV = MV(common stock) + MV(pfd equity) + MV(debt) + MI - Cash and Investments
EV/EBITDA Ratio
EV/EBITDA = enterprise value / EBITDA
Total Invested Capital (TIC)
An alternate measure of a company’s overall value.
TCI = MV(equity) + MV(debt)
Includes cash and short-term investments, unlike EV
When to use EV/S instead of P/S
When comparing companies with significantly different capital structures.
Earnings Surprise
Earning surprise = reported EPS - expected EPS
Standardized Earnings Surprise (SUE)
SUE = earnings suprise / stddev(analyst earnings surprise estimates)
Analysts disagree –> higher stdev –> lower SUE.
Analysts agree –> lower stdev –> higher SUE
When to use Harmonic Mean
Useful for calculating P/Es of a portfolio or index
Weighted Harmonic Mean
weighted harmonic mean = 1 / [ SUM(wi/Xi) ]
where:
Xi = P/E
wi = weight of i
Weighted Harmonic Mean
Divide X into weight, take sum for all X, divide into 1.
