Relative Valuation

Question 0

Define the P/E ratio

Answer 0

P is usually current price sometimes average price in M&A cases.

EPS
based on trailing 12 months EPS(0)
IBs and corporate finance people would use this ratio an it perfectly makes sense because their job isn’t the valuation that particular stock

From our perspective or from valuation perspective it should be EPS(1) forecasted next years earnings per share

P(0)= Div(1)/(r-g)=Div(0)•(1+g)/(r-g)
=EPS(0)•(1-b)•(1+g)/(r-g) =>

P(0)/EPS(0)=(1-b)•(1+g)/(r-g)
Or
P(0)/EPS(1)=(1-b)/(r-g)

This formula pretty much sums up our comprehensive analysis why?
b is reinvestment ratio in other words what we put into the NWC and NFA

r is our risk and g is the growth

Question 1

What is a relative valuation?

Answer 1

It is estimating the value of any asset by looking at how the market prices “similar” or “comparable” assets

Highly important rule is always ask as soon as you see relative or PE valuation what are the comp groups or are they really comp?

It is relatively easy to understand and easy to use while being theoretically sound, however it can be abused depending on the user’s understanding or intention.

Question 2

Do you know 2-stage PE ratio

Answer 2

g high phase and low phase

High phase part uses growing annuity

Question 3

Is PEG ratio fundamentally correct?

Answer 3

Firstly by simply dividing PE ratio by g doesn’t neutralize the growth effect in fact it makes much more complex g function

However it is frequently used on The Street. The logic to compare companies that are in different industries which are growing at totally different rate by normalizing through growth