Los 46.k

Question 1

List the price multiples

Answer 1

• Price-earnings (P/E) ratio: The P/E ratio is a firm’s stock price divided by earnings per share and is widely used by analysts and cited in the press.
• Price-sales (P/S) ratio: The P/S ratio is a firm’s stock price divided by sales per share.
• Price-book value (P/B) ratio: The P/B ratio is a firm’s stock price divided by book value of equity per share.
• Price-cash flow (P/CF) ratio: The P/CF ratio is a firm’s stock price divided by cash flow per share, where cash flow may be defined as operating cash flow or free cash flow.

Question 1

How to work out the P/E for a firm using the GGM

Answer 1

D1/Next Year Earnings / r-g

Question 2

Why is a PE based on fundamental called Justified?

Answer 2

It assumes the correct inputs for D1, E1 and R and G, so it’s based on present value of future cash flows

Question 3

What’s the difference between leading PE ratio and lagging/trailing PE Ratio

Answer 3

Leading = Based on expected earnings next period
Lagging = Based on earning for the previous period

Question 4

According to the constant growth DDM, what factors influence the P/E ratio?

Answer 4

Dividend payout ratio, growth rate, and required rate of return.

Question 5

How does the P/E ratio relate to the dividend payout ratio, growth rate, and required rate of return, assuming all other factors remain constant?

Answer 5

P/E increases with a higher dividend payout ratio, a higher growth rate, and a lower required rate of return.

Question 6

What is the dividend displacement of earnings?

Answer 6

A higher payout ratio may imply a slower growth rate as a result of the company retaining a lower proportion of earnings for reinvestment.

Question 7

What is the most common valuation approach using price multiples?

Answer 7

The method of comparables.

Question 8

What economic principle underlies the method of comparables?

Answer 8

The law of one price: Identical assets should sell for the same price.

Question 9

What are three benchmark choices for comparison in this method?

Answer 9

Multiple of a similar stock, average/median industry multiple, historical average multiple (trend analysis).

Question 10

What are key dimensions to consider when identifying comparable companies?

Answer 10

Overall size, product lines, growth rate (and other financial characteristics, geographic markets, stage in lifecycle).