Market Based Valuation: Price & Enterprise Value Multiples Flashcards
What is the difference between price multiples and enterprise value multiples?
- price multiples: stock market price to some measure of fundamental value
- enterprise value multiples: market value of company to a fundamental value
What are the two methods for price multiples and enterprise value multiples valuation, describe them.
- method of comparables: values an asset based on multiples of similar assets or relative to a similar asset
- method based on forecasted fundamentals: values an asset based on company personal fundamental values
What is the method of comparables based on?
- based on law of one price: which states identical assets should trade at the same price
What are 3 drawbacks of using P/E multiples?
- EPS can be zero, negative, or very small.
- difficult to determine if earnings are sustainable.
- reported EPS may be distorted due to differences in accounting standards.
What are 5 considerations when calculating trailing EPS?
- potential dilution of EPS
- non recurring items (one time events should be removed because focus is on future cash flows)
- business cycle influences
- comparability with other companies
- extremely low, zero, or negative earnings (undefined or meaningless P/E ratios )
What is formula for justified forward P/E ratio?
justified forward P/E ratio = P0/E1 = (D1/E1)/ (r-g) = (1-b) / (r-g)
P0 = share price
E1 = earnings in 1 year
D1 = dividend in 1 year
r = required rate of return
g = dividend growth rate
b = retention ratio
What is formula for justified trailing P/E ratio?
justified trailing P/E ratio = P0/E0 = (D0* (1+g)/E0) / (r-g) = ((1-b)* (1+g))/ (r-g)
P0 = share price
E0 = earnings per share now
D0 = dividend now
r = required rate of return
g = dividend growth rate
b = retention ratio
What is the formula for PEG’s ratio? Is a lower PEG or higher PEG more attractive?
PEG = (P/E) / expected earnings growth rate
lower PEG is more attractive than higher PEG, all else equal
What is the FED model? When is it overvalued and what does overvalued mean?
- compares S&P 500 earnings yield to the 10-year treasury yield
- market is considered overvalued if the earnings yield is less than the T-bond yield, means market P/E ratio is too high
What is the yardeni model and formula?
- Yardeni model is a valuation model used to determine whether the overall stock market is overvalued or not
CEY = CBY - b *LTEG + residual
CEY = current earnings yield on market index
CBY = current moody’s investor service A - rated corporate bond yield
LTEG = consensus 5 year earnings growth rate
b = weight investors give earnings
What is the P/E ratio based on the yardeni model?
justified P/E ratio = 1/ (CBY - b * LTEG)
CBY = current Moody’s Investors Service A-rated corporate bond yield
LTEG = is the consensus five-year earnings growth rate
b = represents the weight that investors give to earnings, which is normally between 0.10 and 0.25
What is formula for justified P/E with inflation?
P0/E1 = 1/ (p + (1- inflation pass) * I)
p = real rate of return for a company’s shares
inflation pass = amount of inflation that can be passed through to consumer
I = cost of inflation
What is book value per share formula?
BV per share = common shareholders equity - preferred stock period / common shares outstanding
What is formula for justified price to book ratio?
P0/B0 = (ROE - g) / (r - g)
ROE = return on equity
g = growth
r = required rate of return
Using the residual income model, what is the justified P/B formula?
P0/B0 = 1 + (present value of expected future residual earnings/B0)
B0 = book value now
P0 = price now
