MARKET-BASED VALUATION: PRICE AND ENTERPRISE … · MARKET-BASED VALUATION: PRICE AND ENTERPRISE...
Transcript of MARKET-BASED VALUATION: PRICE AND ENTERPRISE … · MARKET-BASED VALUATION: PRICE AND ENTERPRISE...
MARKET-BASEDVALUATION:
PRICE AND ENTERPRISE VALUE MULTIPLES
VALUATION INDICATORS
Price Multiples
Enterprise Value
Multiples
Momentum Indicators
METHODS FOR PRICE & ENTERPRISE VALUE MULTIPLES
1) Method of Comparables• Economic rationale is the law of one price
2) Method Based on Forecasted Fundamentals• Reflects firm fundamentals and future cash flows
Justified Price Multiples• Can be determined using either method
PRICE-TO-EARNINGS MULTIPLERATIONALES & DRAWBACKS
RationalesEPS is driver of value
Widely used
Related to stock returns
DrawbacksZero, negative, or very
small earnings
Permanent vs. transitory earnings
Management discretion for earnings
PRICE-TO-EARNINGS MULTIPLEDEFINITIONS
Trailing P/E
Uses last year’s
earnings
Preferred when
forecasted earnings are not available
Forward P/E
Uses next year’s
earnings
Preferred when trailing earnings are not reflective
of future
EXAMPLE: FORWARD P/E
Stock price $20 .002011:Q1 EPS $0 .182011:Q2 EPS $0 .252011:Q3 EPS $0 .322011:Q4 EPS $0 .352011 Fiscal year forecast $1 .10
2012:Q1 EPS $0 .432012:Q2 EPS $0 .482012:Q3 EPS $0 .502012:Q4 EPS $0 .592012 Fiscal year forecast $2 .00
EXAMPLE: FORWARD P/E EXAMPLE: FORWARD P/E
ISSUES IN CALCULATING EPS
EPS Dilution Underlying Earnings
Normalized Earnings
Differences in Accounting
Methods
EXAMPLE: UNDERLYING EARNINGS
Reported EPS from previous four quarters $4.00
Restructuring charges $0.10
Amortization of intangibles $0.15
Impairment charge $0.20
Stock price $50.00
EXAMPLE: UNDERLYING EARNINGSEXAMPLE: NORMALIZED EARNINGS
Year EPS BVPS ROE
2010 $0.66 $4.11 16.1%
2009 $0.55 $3.67 15.0%
2008 $0.81 $2.98 27.2%
2007 $0.73 $2.12 34.4%
2006 $0.34 $1.61 21.1%
2011 stock price $24.00
EXAMPLE: NORMALIZED EARNINGSEXAMPLE: NORMALIZED EARNINGS
JUSTIFIED FORWARD P/E FROM FUNDAMENTALS
JUSTIFIED TRAILING P/E FROM FUNDAMENTALS
EXAMPLE: JUSTIFIED FORWARD P/E FROM FUNDAMENTALS
Retention ratio 0 .36
Dividend growth rate 4.0%
Required return on stock 10.0%
EXAMPLE: JUSTIFIED FORWARD P/E FROM FUNDAMENTALS
EXAMPLE: JUSTIFIED P/E FROM REGRESSION ON FUNDAMENTALS
Values for subject firm
Dividend payout ratio 0.40Beta 1 .20 Earnings growth rate 6.00%Actual P/E 15 .0
EXAMPLE: JUSTIFIED P/E FROM REGRESSION ON FUNDAMENTALS
METHOD OF COMPARABLES
Benchmark Value of the Multiple Choices
Industry peers
Industry or sector
index
Broad market index
Firm’s historical values
METHOD OF COMPARABLESUSING PEER COMPANY MULTIPLES
Law of one priceRisk and earnings growth adjustmentsPEG limitations:Assumes linear relationship Does not account for risk Does not account for growth duration
EXAMPLE: METHOD OF COMPARABLESUSING P/E AND PEG
Values for subject firmFive-year EPS growth rate 8.0%Consensus EPS forecast $4.50Current stock price $28.00
Values for peer groupMedian P/E 9 .00Median PEG 1 .60
EXAMPLE: METHOD OF COMPARABLESUSING P/E AND PEG
METHOD OF COMPARABLESUSING INDUSTRY AND MARKET MULTIPLES
Industry or Sector Index Mean vs. median Check industry valuation against market
Broad Market Index Adjust for differences in fundamentals & size Use relative values on a historical basis
METHOD OF COMPARABLESVALUING THE MARKET
Fed Model: Earnings Yield vs. T-Bond Yield Does not account for inflation correctly Relationship between earnings yield &
interest rates is nonlinear Small rate s → large s in P/E
Yardeni Model
METHOD OF COMPARABLESUSING OWN HISTORICAL MULTIPLES
Rationale: Regression to the MeanApproaches:Average of four middle values over past 10 yearsFive-year average trailing P/E
Potential Problems from Changes inFirm businessFirm financial leverageInterest rate environmentEconomic fundamentalsInflationary environment
USING P/ES FOR TERMINAL VALUE
Justified P/E
P/E =(D/E)/(r – g)
Sensitive to required inputs
P/E Based on Comparables
Grounded in market data
If comp is mispriced, terminal value will
be mispriced
EXAMPLE: USING P/ES FOR TERMINAL VALUE
Values for subject firmRequired rate of return 11.0%EPS forecast for year 3 $2.50
Values for peer groupMean dividend payout ratio 0 .40Mean ROE 8.0%Median P/E 9 .00
EXAMPLE: USING P/ES FOR TERMINAL VALUEUSING GORDON GROWTH MODEL
EXAMPLE: USING P/ES FOR TERMINAL VALUEUSING COMPARABLES
PRICE-TO-BOOK VALUE MULTIPLERATIONALES
Book Value Is Usually Positive
More Stable than EPS
Appropriate for Financial Firms
Appropriate for Firms that Will Terminate
Can explain stock returns
PRICE-TO-BOOK VALUE MULTIPLEDRAWBACKS
Does Not Recognize Nonphysical Assets
Misleading when Asset Levels Vary
Can Be Misleading Due to Accounting Practices
Less Useful when Asset Age Differs
Can Be Distorted Historically by Repurchases
ADJUSTMENTS TO BOOK VALUE
Intangible Assets
Inventory Accounting
Off-Balance-Sheet Items Fair Value
JUSTIFIED P/BPRICE-TO-SALES
MULTIPLE RATIONALES
Sales Less Easily Manipulated
Sales Are Always Positive
P/S Appropriate For Mature, Cyclical, & Distressed Firms
P/S More Stable Than P/E
Can Explain Stock Returns
PRICE-TO-SALES MULTIPLE DRAWBACKS
Sales ≠ Earnings & Cash Flow
Numerator & Denominator Not Consistent
P/S Does Not Reflect Cost Differences
P/S Can Be Misleading Due to Accounting Practices
JUSTIFIED P/S
EXAMPLE: CALCULATING THE ACTUAL & JUSTIFIED P/E, P/B, & P/S
Stock price $50 .00EPS $2 .00Dividends per share $1 .20Book value of equity per share $6 .25Sales per share $15 .00ROE 22.5%Required return on stock 12.0%
EXAMPLE: CALCULATING THE ACTUALP/E, P/B, & P/S
EXAMPLE: CALCULATING THE INPUTS FOR THE JUSTIFIEDP/E, P/B, & P/S
EXAMPLE: CALCULATING THE JUSTIFIEDP/E, P/B, & P/S
PRICE-TO-CASH-FLOW MULTIPLE RATIONALES
Cash Flow Less Easily Manipulated
Ratio More Stable Than P/E
Ratio Addresses Quality of Earnings Issue with P/E
Ratio Can Explain Stock Returns
PRICE-TO-CASH-FLOW MULTIPLE DRAWBACKS
Cash Flow Can Be Distorted
FCFE More Volatile and More Frequently
Negative
Cash Flow Increasingly Managed by Firms
DEFINITIONS OF CASH FLOW
• Earnings + Depreciation + Amortization + DepletionCF
• From statement of cash flowsCFO
• Most valid but volatileFCFE• Best used with enterprise
valueEBITDA
JUSTIFIED PRICE-TO-CASH-FLOW RATIO
DIVIDEND YIELDRATIONALES & DRAWBACKS
RationalesComponent of return
Dividends less risky than future capital
gains
DrawbacksOnly one component of
return
Dividends may displace future earnings
Market may not favor dividends
JUSTIFIED DIVIDEND YIELD
INVERSE PRICE RATIOS
Price Ratio Inverse Price Ratio
Price-to-earnings (P/E) Earnings yield (E/P)
Price-to-book (P/B) Book-to-market (B/P)
Price-to-sales (P/S) Sales-to-price (S/P)
Price-to-cash-flow (P/CF) Cash flow yield (C/P)
Price-to-dividends (P/D) Dividend yield (D/P)
ENTERPRISE VALUE/EBITDA MULTIPLERATIONALES & DRAWBACKS
RationalesUseful for comparing firms
of different leverage
Useful for comparing firms of different capital utilization
Usually positive
DrawbacksExaggerates cash flow
FCFF more strongly grounded
ISSUES IN USING ENTERPRISE VALUE MULTIPLES
EV = Market Value of Stock + Debt – Cash – Investments
Justified EV/EBITDA• Positively related to FCFF growth• Positively related to ROIC• Negatively related to WACC
Comparables May Utilize TIC
Other EV Multiples• EV/FCFF• EV/EBITA• EV/EBIT• EV/S
CROSS-COUNTRY COMPARISONS
• Net income higher under IFRS• Shareholder's equity lower under IFRS• ROE higher under IFRS
US GAAP vs. IFRS
• P/CFO & P/FCFE most comparable• P/B, P/E, & EBITDA multiples least
comparable
Valuation Multiples
• Higher inflation Lower justified price multiples
• Higher pass-through rates Higher justified price multiples
Inflation
MOMENTUM INDICATORS:EARNINGS SURPRISES
MOMENTUM INDICATORS:RELATIVE STRENGTH
Past Performance
Relative to an Index
Inherently Self-Destructing
VALUATION INDICATORS IN PRACTICE: AVERAGING MULTIPLES
• Overestimate of index P/EArithmetic Mean &
Weighted Mean
• Closer to index P/E but is influenced by small outliersHarmonic Mean
• Equal to index P/EWeighted Harmonic Mean
VALUATION INDICATORS IN PRACTICE: STOCK SCREENS
Database Limitations• Variables are predetermined• Does not contain qualitative data
Look-Ahead Bias• Assumes investor has info not yet available
Sector Rotation
SUMMARY
• Method of comparables• Method based on forecasted fundamentals
Price & Enterprise Value Multiples
• Rationales: EPS Driver of value; widely used; related to stock returns
• Drawbacks: Zero, negative, or very small earnings; transitory components; management discretion for earnings
• Trailing and forward P/Es
Price-to-Earnings Rationales & Drawbacks
SUMMARY
• EPS dilution• Underlying earnings• Normalized earnings• Differences in accounting methods
Issues in Calculating EPS
• Industry peers• Industry or sector index• Broad market index• Own historical values
Method of Comparables
SUMMARY
• Rationales: Book value usually > 0, more stable than EPS, appropriate for financial firms & firms that will terminate, explains stock returns
• Drawbacks: Doesn’t recognize nonphysical assets, misleading if asset levels vary or differ from accounting practices, less useful when asset age differs, can be distorted by repurchases
Price-to-Book Rationales & Drawbacks
• Intangible assets• Inventory accounting• Off-balance-sheet items• Fair value
Issues in Calculating Book Value
SUMMARY
• Rationales: Sales less easily distorted, sales always positive, P/S more stable than P/E, appropriate for many firms, explains stock returns
• Drawbacks: Sales ≠ Earnings & Cash flow, numerator & denominator not consistent, does not reflect cost differences, can be distorted
Price-to-Sales Rationales & Drawbacks
• Rationales: CF less easily manipulated, more stable than P/E, addresses quality of earnings issue, explains stock returns
• Drawbacks: can be distorted, FCFE more volatile and more frequently negative, increasingly managed by firms
Price-to-Cash-Flow Rationales & Drawbacks
SUMMARY
• CF: Earnings + Depreciation + Amortization + Depletion• CFO: From statement of cash flows • FCFE: Most valid but volatile• EBITDA: Best used with enterprise value
Measures of Cash Flow
• Rationales: A component of return, dividends less risky than future capital gains
• Drawbacks: Only one component of return, dividends may displace future earnings, market may not favor dividends
Dividend Yield Rationales & Drawbacks
SUMMARY
• Useful when denominators are small, low, or negative (e.g., earnings)
• Earnings yield, book-to-market, sales-to-price, cash flow yield, and dividend yield
Inverse Price Ratios
• EV = Market value of stock + Debt – Cash –Investments
• Rationales: Useful for comparing firms of different leverage & capital utilization, usually positive
• Drawbacks: Exaggerates cash flow, FCFF more strongly grounded
Enterprise Value Multiples
SUMMARY
• P/E: + related to g, – related to r• P/B: + related to ROE, – related to r• P/S: + related to g & PM, – related to r• P/CF: + related to g, – related to r• D/P: - related to g, + related to r• EV/EBITDA: + related to g and PM, –
related to WACC
Justified Multiples
SUMMARY
• IFRS ROE higher than GAAP ROE• P/CFO & P/FCFE most comparable• P/B, P/E, & EBITDA multiples least
comparable• Higher inflation Lower justified price
multiples• Higher pass-through rates Higher
justified price multiples
Cross-Country Comparisons
SUMMARY
• Unexpected earnings (UE)• Standardized unexpected earnings (SUE)• Relative strength
Momentum Indicators
• Database limitations• Potential look-ahead bias• Used in sector rotation
Stock Screens