Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Valuation with Multiples Handout: Market-Base Valuation, Price and enterprise value multiples. In this approach a price multiple is compared to a benchmark value to decide

image text in transcribed
image text in transcribed
Valuation with Multiples Handout: Market-Base Valuation, Price and enterprise value multiples. In this approach a price multiple is compared to a benchmark value to decide if an asset is relatively undervas overvalued or fairly valued. Price multiples are ratios of a stock's price to some measure of value per thare. The benchmark value may be multiple of a similar company, average value of the multiples of several similtar compintig. or an industry. Firm's historical multiples may also be used as a benchmark. One important price multiple is P/E ratio. The idea behind the multiples approach is law of one price. The main factors that affect P/E are the expected earnings growth rate and the required rate of return. There are two alternative definitions of P/E. Trailing P/E is based on the most recent four quarters of EPS. Forward looking P/E is based on next year's expected earnings. The EPS is frequently subject to distortions, volatility and negative. We can address cyclicality in EPS by normalizing it. L.e, we can remove the impact of business cycles on EPS by normalizing it: One way to normalize EPS is to calculate historical average of EPS of the most recent full cycle. Normalized EPS is defined as EPS firm can achieve under midcyclical conditions. When stock has zero or negative EPS, a ranking by P/E is not meaningful but a ranking by earnings yield is meaningful (E/P). We can estimate the terminal value (horizon value) in multistage discounted cash flow model using price multiples based on comparables. TerminalValue,=(BenchmarkvalueofEn)Earningst. Examble 1: Based on given information, how an analyst might use the relative valuation in this case. Using the given information estimate Betazi's intrinsic value per share. Betari's N=( Benchmark value of P/E)( Betazi's EPS ) Example 2: The Umbrella corp, and Tyron corp. are competitive firms. The Umbrella has a current market price of 515 , 25 million shares outstanding, annual sales of $2 bilion, and a 10% profit margin. The Tyron corp. has a market price of $25,36 million shares outstanding, annual sales of $1.5 billion, and a profit margin of 5%. a) Which firm has a more attractive valuation based on P/S multiples? b) Identify one advantage of P/S and P/CF over P/E as a valuation toot. Eliminating impact of capital structure on multiples (comparables) approach. Value of operations or Enterprise Value (EV) is the total value of firm (the market value of debt, common equity, and preferred equity) minus the value of short-term investments. Using ratio of EV to sales enable us to compare firms with different capital structures. Free cash flows, EBIT, and EBrTOA are other important cash flows that can be used hi multiples approach. E.g., EV/FCF, EV/EBIT, EV/EBITDA. Example 3: You have a client who wants to know method best suited for comparing companies in an industry with following characteristics: - (1) Principal companies within the industry are located in the US, France, Japan and Brazil. - (2) The industry is currently operating at a cyclical low, with many companies reporting losses. Determine which one of the following valuation ratios is most appropriate for comparing companies and support your answer. - P/E - P/B - EV/S Solution. (1) Indicates international markets. These firms have different accounting/reporting practices. These may affect book value per share and B/P. (2) Indicates negative eamings. So, P/E is useless. We do not report a negative P/E. So, EV/S seems to be the best method. It is free from copital structure issues and manipulation irwiex

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Contemporary Financial Management Fundamentals

Authors: R. Charles Moyer, James R. McGuigan, Ramesh P. Rao

1st Edition

0324015771, 9780324015775

More Books

Students also viewed these Finance questions