Module 41.3: Relative Valuation Measures

Question 1

what is the price multiple approach of valuation?

Answer 1

analyst compares a stocks price multiple to a benchmark value based on an index, industry group of firms, or a peer group.

Question 2

What is the main critique of price multiples?

Answer 2

They only reflect the past historical data.

Question 3

What is the price to earning ratio?

Answer 3

a firm stock price divided by earnings per share

Question 4

what is the price to sales ratio?

Answer 4

firms stock divided by sales per share

Question 5

price to book value ratio?

Answer 5

firms stock price divided by book value of equity per share

Question 6

what is the price cash flow ratio?

Answer 6

the stock price divided by cash flow per share.

Question 7

What is justified leading P/E ratio?

Answer 7

justified because we have the correct inputs for D1, E1, ke, and g.

formula = (D1 / E1) / ( k - g )

D1 / E1 = expected dividend payout ratio

Question 8

What is the P/E ratio a function of?

Answer 8

1) D1 / E1 = expected dividend payout ratio
2) k = required rate of return on the stock
3) g = expected constant growth rate of dividends

Question 9

What are the three drivers that can increase the leading P/E ratio?

Answer 9

1) a higher dividend payout rate
2) a higher growth rate
3) a lower required rate of return

Question 10

What is the dividend displacement of earnings?

Answer 10

higher dividends increase firm value, but reduce the growth rate of the firm which will decrease value.

Question 11

What is the law of one price?

Answer 11

two identical assets should sell at the same price.

Question 12

What are three limitations of using price multiples based on comparables?

Answer 12

1) a stock may appear overvalued by the comparable method but undervalued by the fundamental method
2) different accounting methods can result in price multiples that are not comparable across firms
3) price multiples for cyclical firms may be greatly affected by economic conditions at a given point in time.

Question 13

What is the formula for enterprise value?

Answer 13

EV = market value of common and preferred stock + market value of debt - cash and short term investments.

Question 14

When is it problematic to use the asset-based model? When is it most reliable?

Answer 14

when a firm has a large amount of intangible assets, on or off balance sheet.

Most reliable when the firm has primarily tangible short-term assets, assets with ready market values.