Seminar 9 Flashcards
Relative valuation (13 cards)
Why use PE multiple?
1) commonly used
2) related to stock returns
3) EPS is driver of value
Limitations of PE multiple
1) 0, -ve or very small earnings
2) Permanent v Transitory earnings
3) Management discretion for earnings
Issues in using EPS
1) Diluted EPS: calculate dilutive impact of potential c/s
2) Difference in accounting methods
3) Negative EPS: use normalised EPS, or leading P/E if trailing P/E is negative
4) Cyclicality of biz and Volatility of PEs: low PEs at the top, high PEs at the bottom – does not reflect average / LT earning power of biz
What is normalised EPS
EPS after adjusting for 1-off occurrences, normalised for seasonality/biz cycles
4 types of benchmark values of multiple choices
- which should be used?
1) Industry peers
2) Industry/sector: eg. google
3) Broad market index
4) Firm’s historical: no comparable eg. new product
- choice of benchmark multiple is dependent on the company. consider sector, PLC, industry and company
4 types of benchmark values of multiple choices
- which should be used?
1) Industry peers
2) Industry/sector: eg. google
3) Broad market index
4) Firm’s historical: no comparable eg. new product ; BUT problematic when there are changes within and outside the firm (I/R, strategies, fin leverage, inflation)
- choice of benchmark multiple is dependent on the company. consider sector, PLC, industry and company
PEG limtations
- what is PEG
1) does not account for risk
2) does not account for growth duration (short v long durations): 5 years growth rate does not reflect long term growth prospects
3) assumes linear r/s: r/s between P/E ratios and g is not linear
- PEG: P/E growth ratio = P/E ÷ g –> impact of earnings growth on P/E
- lower PEGs more attractive than stocks with high PEGs
Pros & Cons of Price/Book equity multiple
Pros:
Book usually > 0, more stable than EPS
- suitable for financial firms and firms that will terminate
Cons:
Does not recognise nonphysical assets
Pros and Cons of Price/Sales multiple
Pros: Sales usually positive when EPS is 0/negative, sales less subject to distortion or manipulation than other fundamentals eg. EPS, more stable than EPS –> P/S more stable
- suitable for mature, cyclical and 0 income companies
Cons: To have value as going concern, biz must generate earnings and cash – company may have high sales growth but no profit, does not reflect different cost structures across companies
Pros and Cons of Price/CF multiple
Pros: CF less easily manipulated, more stable than P/E, address quality of earnings, explain stock returns
Cons: can be distorted, FCFE more volatile and more frequently negative
Leading and Trailing Dividend Yield
1) Trailing DY = (4 x most recent Q per share dividend (div rate) ÷ current market price per share
2) Leading DY = forecasted div per share over next year ÷ current market price per share
Pros and Cons of DY approach
Pros:
- DY is a component of total return
- Div is less risky of total return as compared to capital appreciation
Cons:
- just 1 component of total return – not to use all information related to expected return is not optimal
- dividend displacement of earnings – investors trade off future earnings growth to receive higher current divs
EV formula
EV = MVequity + MVpreferred + MV debt - C&CE (cash + ST inv)
- from POV of acquirer – buy out equity and pay off debt
