Market-Based Valuation (Price and EV Multiples)

Question 1

Uses

Answer 1

Price Multiples = value equity

EV Multiples = value firm

Question 2

P/E Ratio

Answer 2

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

Question 3

P/B Ratio

Answer 3

P/B = MV(equity) / BV(equity)

P/B = market price per share / book value per share

Question 4

Book Value of Equity

Answer 4

Book Value of Equity = Common Shareholders Equity

Book Value of Equity = ( Total Assets - Total Liabilities ) - Preferred Stock

Question 5

P/S Ratio

Answer 5

P/S = MV(equity) / Total Sales

P/S = market price per share / sales per share

Question 6

Dividend Yield (D/P)

Answer 6

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

Question 7

Underlying Earnings

Answer 7

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

Question 8

Normalized Earnings

Answer 8

Normalized Earnings = earnings adjusted for cyclicality. Two methods:

(1) historical average EPS
(2) average return on equity ( ROE * BVPS )

Question 9

Earnings Yield (E/P)

Answer 9

High E/P = cheap security

Low E/P = expensive security

Question 10

Justified Trailing P/E Multiple

Answer 10

Trailing P/E = P0/E0 = [ D0 * (1+g) / E0 ] / (r - g) = (1 - b) * (1 + g) / (r - g)

Question 11

Justified Leading P/E Multiple

Answer 11

Leading P/E = P0/E1 = D1/E1 / (r - g) = (1-b) / (r-g)

Question 12

Why will Trailing P/E be LARGER than Leading P/E?

Answer 12

Earnings are assumed to be growing, which means LEADING P/E will have a LARGER denominator (and thus a smaller ratio)

Question 13

Justified P/B Multiple

Answer 13

P/B = ( ROE - g ) / ( r - g )

Question 14

Justified P/S Multiple

Answer 14

P/S = P0/S0 = [ (E0/S0) * (1-b) * (1+g) ] / (r - g)

Question 15

What is E0/S0?

Answer 15

Net Profit Margin

Question 16

How does Net Profit Margin influence P/S?

Answer 16

Two ways:
(1) directly

(2) indirectly through its effect on g:

g = retention ratio * net profit margin * (S/A) * (A/E)

Question 17

P/S as a function of TRAILING P/E

Answer 17

P0/S0 = (E0/S0) * Trailing PE

P0/S0 = (E0/S0) * [ (1-b)*(1+g) / (r-g) ]

Question 18

Justified P/CF Multiple

Answer 18

V0 = FCFE0 * (1+g) / ( r-g )

Increases if:

• r decreases
• g increases

Question 19

Justified EV/EBITDA Multiple

Answer 19

Increases if:
* g increases

Decreases if:

• risk level increases
• WACC increases

Question 20

Justified Dividend Yield

Answer 20

D0/P0 = (r - g) / (1 + g)

Question 21

PEG Ratio

Answer 21

PEG ratio = P/E ratio / g

Lower is better
PEG “standardizes” P/E for stocks with different expected growth rates

Question 22

Calculating Terminal Value using Multiples and DCF

Answer 22

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

Question 23

Four definitions of cash flow for use in P/CF

Answer 23

(a) earnings + non-cash charges
(b) adjusted cash flow (adjusted CFO)
(c) free cash flow to equity (FCFE)
(d) EBITDA

Question 24

CF (Earnings + non-cash charges)

Answer 24

CF = NI + Dep + Amort

Question 25

CF (Adjusted CFO)

Answer 25

CF = adjusted CFO = CFO + [ net cash interest outflow * (1-tax) ]

Question 26

CF (FCFE)

Answer 26

CF = FCFE = CFO - FcInv + net borrowing

Question 27

Enterprise Value (EV)

Answer 27

EV = MV(common stock) + MV(pfd equity) + MV(debt) + MI - Cash and Investments

Question 28

EV/EBITDA Ratio

Answer 28

EV/EBITDA = enterprise value / EBITDA

Question 29

Total Invested Capital (TIC)

Answer 29

An alternate measure of a company’s overall value.

TCI = MV(equity) + MV(debt)

Includes cash and short-term investments, unlike EV

Question 30

When to use EV/S instead of P/S

Answer 30

When comparing companies with significantly different capital structures.

Question 31

Earnings Surprise

Answer 31

Earning surprise = reported EPS - expected EPS

Question 32

Standardized Earnings Surprise (SUE)

Answer 32

SUE = earnings suprise / stddev(analyst earnings surprise estimates)

Analysts disagree –> higher stdev –> lower SUE.
Analysts agree –> lower stdev –> higher SUE

Question 33

When to use Harmonic Mean

Answer 33

Useful for calculating P/Es of a portfolio or index

Question 34

Weighted Harmonic Mean

Answer 34

weighted harmonic mean = 1 / [ SUM(wi/Xi) ]

where:
Xi = P/E
wi = weight of i

Question 35

Weighted Harmonic Mean

Answer 35

Divide X into weight, take sum for all X, divide into 1.