Valuations - Market Based

MARKET-BASED
VALUATION:
PRICE AND ENTERPRISE
VALUE MULTIPLES
Presenter
Venue
Date
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 MULTIPLE
RATIONALES & DRAWBACKS
Rationale
s
EPS is driver of value
Drawback
s
Zero, negative, or very
small earnings
Widely used
Permanent vs.
transitory earnings
Related to stock
returns
Management
discretion for earnings
PRICE-TO-EARNINGS MULTIPLE
DEFINITIONS
Trailing
P/E
Uses last
years
earnings
Preferred
when
forecasted
earnings are
not available
Forward
P/E
Uses next
years
earnings
Preferred
when trailing
earnings are
not reflective
of future
EXAMPLE: FORWARD P/E

Stock price
$20
2011:Q1 EPS
$0
2011:Q2 EPS
$0
2011:Q3 EPS
$0
2011:Q4 EPS
$0
2011 Fiscal year forecast
$1
2012:Q1 EPS
2012:Q2 EPS
.
00
.
18
.
25
.
32
.
35
.
10
.
$0 43
.
$0 48
.

1) Forward P/E based on EPS for the next 4 quarters:
EPS for the next 4 quarters = $0.35 $0.43 $0.48 $0.50 $1.76
Forward P/E based on EPS for the next 4 quarters $20 $1.76 11.4
2) Forward P/E based on EPS for the NTM (next 12 months):
EPS for the NTM 1 $1.10 11 $2.00 $1.925

12
12
Forward P/E based on EPS for the NTM $20 $1.925 10.4

3) Forward P/E based on the current fiscal year's EPS:
EPS for the current fiscal year $1.10
Forward P/E based on EPS for the current fiscal year $20 $1.10 18.2
4) Forward P/E based on the next fiscal year's EPS:

EPS for the next fiscal year $2.00
Forward P/E based on EPS for the next fiscal year $20 $2.00 10.0
ISSUES IN CALCULATING EPS
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 EARNINGS

P/E based on reported earnings $50 $4.00 12.5
Reported core earnings $4.00 $0.10 $0.15 $0.20 $4.45
P/E based on reported core earnings $50 $4.45 11.2
Underlying earnings $4.00 $0.20 $4.20
P/E based on underlying earnings $50 $4.20 11.9
EXAMPLE: 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
1) Method of historical average EPS
($0.66 $0.55 $0.81 $0.73 $0.34)

Average (normalized) EPS
$0.618
5
P/E $24.00 $0.618 38.8

2) Method of average ROE
Average ROE
(16.1% 15.0% 27.2% 34.4% 21.1%)

22.8%
5
Average (normalized) EPS Average ROE Current equity book value per share
Average (normalized) EPS 22.8% $4.11 $0.937
P E $24.00 $0.937 25.6
JUSTIFIED FORWARD P/E FROM

FUNDAMENTALS
D1
V0
r g
P0
D1 E1
E1
r g
P0
1 b
E1
r g
JUSTIFIED TRAILING P/E FROM

FUNDAMENTALS
D 0 (1 g )
V0
rg
P0
D 0 (1 g ) E0
E0
rg
P0
(1 b)(1 g )
E0
rg
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
P0
1 b
=
E1
rg
P0
1 0.36
=
=10.7
E1
0.10 0.04
EXAMPLE: JUSTIFIED P/E FROM

REGRESSION ON FUNDAMENTALS
Predicted P/E
11.5 2.2 DPR + 0.03 Beta + 16.2 EGR
Values for subject firm
Dividend payout ratio
Beta
0.40
1 .20
Earnings growth rate
6.00%
Actual P/E
15 .0
EXAMPLE: JUSTIFIED P/E FROM

REGRESSION ON FUNDAMENTALS
Predicted P/E
11.5 2.2 DPR 0.03 Beta 16.2 EGR
11.5 2.2 0.4 + 0.03 1.2 16.2 0.06
13.3
METHOD OF COMPARABLES
USING PEER COMPANY MULTIPLES
Law of one price

Risk and earnings growth adjustments
PEG limitations:
Assumes linear relationship
Does not account for risk
Does not account for growth duration
EXAMPLE: METHOD OF COMPARABLES

USING P/E AND PEG

Five-year EPS growth rate
Consensus EPS forecast
Current stock price
Values for peer group
Median P/E
Median PEG
8.0%
$4.50
$28.00
9 .00
1 .60
EXAMPLE: METHOD OF COMPARABLES

USING P/E AND PEG
P/E $28.00 $4.50 6.2

PEG 6.2 8.0 0.78
Intrinsic value 9.0 $4.50 $40.50
USING 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
VALUING 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
USING OWN HISTORICAL MULTIPLES
Rationale: Regression to the Mean
Approaches:
Average of four middle values over past 10 years
Five-year average trailing P/E
Potential Problems from Changes in
Firm business
Firm financial leverage
Interest rate environment
Economic fundamentals
Inflationary environment
USING P/ES FOR TERMINAL VALUE
EXAMPLE: USING P/ES FOR TERMINAL VALUE

Required rate of
return
EPS forecast for year
3
Values for peer group
Mean dividend payout
ratio
Mean ROE
Median P/E
11.0%
$2.50
0 .40
8.0%
9 .00

USING GORDON GROWTH MODEL
D3 EPS3 Dividend payout ratio
D3 $2.50 0.40 $1.00
Retention ratio 1 Dividend payout ratio
Retention ratio 1 0.40 0.60
g Retention ratio ROE
g 0.60 8% 4.8%
D3 1 g
$1.00 1 0.048
V3
$16.90
rg
0.11 0.048

USING COMPARABLES
V3 P/E EPS3
9.0 $2.50 $22.50
PRICE-TO-BOOK VALUE MULTIPLE

RATIONALES
PRICE-TO-BOOK VALUE MULTIPLE

DRAWBACKS
ADJUSTMENTS TO BOOK VALUE
JUSTIFIED P/B
P0
ROE g
B0
r g
PV Expected future residual earnings
P0
1
B0
B0
PRICE-TO-SALES
MULTIPLE RATIONALES
PRICE-TO-SALES
MULTIPLE DRAWBACKS
JUSTIFIED P/S
P0
(E0 / S0 )(1 b)(1 g )
S0
rg
g b ROE
Sales
Total assets
g b PM0

Total assets Shareholders equity
EXAMPLE: CALCULATING THE ACTUAL & JUSTIFIED

P/E, P/B, & P/S
Stock price
EPS
Dividends per share
Book value of equity per
share
Sales per share
ROE
Required return on stock
$50 .00
$2 .00
$1 .20
$6 .25
$15 .00
22.5%
12.0%
EXAMPLE: CALCULATING THE ACTUAL

P/E, P/B, & P/S
P0
$50
Actual
25.0
E0
$2
P0
$50
Actual
8.0
B0
$6.25
P0
$50
Actual
3.3
S0
$15
EXAMPLE: CALCULATING THE INPUTS FOR THE

JUSTIFIED
P/E, P/B, & P/S
Dividend payout ratio $1.20 $2.00 0.60
Retention ratio (b) 1 0.60 0.40
Growth rate in dividends (g ) 0.40 22.5% 9.0%
EXAMPLE: CALCULATING THE JUSTIFIED

P/E, P/B, & P/S
P0
(1 b)(1 g )
(1 0.60)(1 0.09)
21.8
E0
rg
0.12 0.09
P0 ROE g 0.225 0.09
4.5
B0
rg
0.12 0.09
P0 (E0 S0 )(1 b)(1 g ) ($2 $15)(0.6)(1.09)
2.9
S0
rg
0.12 0.09
PRICE-TO-CASH-FLOW
MULTIPLE RATIONALES
PRICE-TO-CASH-FLOW
MULTIPLE DRAWBACKS
DEFINITIONS OF CASH FLOW
JUSTIFIED PRICE-TO-CASH-FLOW RATIO
FCFE 0 (1 g )
V0
rg
DIVIDEND YIELD
JUSTIFIED DIVIDEND YIELD
D0
rg
P0
1 g
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 MULTIPLE

ISSUES IN USING ENTERPRISE VALUE

MULTIPLES
CROSS-COUNTRY COMPARISONS
MOMENTUM INDICATORS:
EARNINGS SURPRISES
UEt EPSt E EPSt
SUEt
EPSt E EPSt
EPSt E EPSt
UEt
UEt
MOMENTUM INDICATORS:
RELATIVE STRENGTH
VALUATION INDICATORS IN PRACTICE:

AVERAGING MULTIPLES
VALUATION INDICATORS IN PRACTICE:

STOCK SCREENS
SUMMARY
SUMMARY
SUMMARY
SUMMARY
SUMMARY
SUMMARY
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MARKET-BASED

METHODS FOR PRICE & ENTERPRISE VALUE

2) Method Based on Forecasted Fundamentals

Justified Price Multiples

EXAMPLE: FORWARD P/E

2011 Fiscal year forecast

EXAMPLE: FORWARD P/E

2) Forward P/E based on EPS for the NTM (next 12 months):

EPS for the NTM 1 $1.10 11 $2.00 $1.925

EXAMPLE: FORWARD P/E

4) Forward P/E based on the next fiscal year's EPS:

ISSUES IN CALCULATING EPS

EXAMPLE: UNDERLYING EARNINGS

EXAMPLE: UNDERLYING EARNINGS

EXAMPLE: NORMALIZED EARNINGS

2011 stock price

EXAMPLE: NORMALIZED EARNINGS

1) Method of historical average EPS

($0.66 $0.55 $0.81 $0.73 $0.34)

P/E $24.00 $0.618 38.8

EXAMPLE: NORMALIZED EARNINGS

(16.1% 15.0% 27.2% 34.4% 21.1%)

P E $24.00 $0.937 25.6

JUSTIFIED FORWARD P/E FROM

JUSTIFIED TRAILING P/E FROM

EXAMPLE: JUSTIFIED FORWARD P/E

Dividend growth rate

Required return on stock

EXAMPLE: JUSTIFIED FORWARD P/E

EXAMPLE: JUSTIFIED P/E FROM

Earnings growth rate

EXAMPLE: JUSTIFIED P/E FROM

Law of one price

EXAMPLE: METHOD OF COMPARABLES

Values for subject firm

EXAMPLE: METHOD OF COMPARABLES

P/E $28.00 $4.50 6.2

USING P/ES FOR TERMINAL VALUE

EXAMPLE: USING P/ES FOR TERMINAL VALUE

EXAMPLE: USING P/ES FOR TERMINAL VALUE

EXAMPLE: USING P/ES FOR TERMINAL VALUE

PRICE-TO-BOOK VALUE MULTIPLE

PRICE-TO-BOOK VALUE MULTIPLE

ADJUSTMENTS TO BOOK VALUE

EXAMPLE: CALCULATING THE ACTUAL & JUSTIFIED

EXAMPLE: CALCULATING THE ACTUAL

EXAMPLE: CALCULATING THE INPUTS FOR THE

EXAMPLE: CALCULATING THE JUSTIFIED

P0 ROE g 0.225 0.09

DEFINITIONS OF CASH FLOW

JUSTIFIED PRICE-TO-CASH-FLOW RATIO

JUSTIFIED DIVIDEND YIELD

INVERSE PRICE RATIOS

Inverse Price Ratio

Earnings yield (E/P)

Cash flow yield (C/P)

Dividend yield (D/P)

ENTERPRISE VALUE/EBITDA MULTIPLE

ISSUES IN USING ENTERPRISE VALUE