Document

Report
Equity
Valuation
13
Bodie, Kane and Marcus
Essentials of Investments
9th Global Edition
13.1 EQUITY VALUATION
Book

Value
Net worth of common equity according to
a firm’s balance sheet
Limitations

of Book Value
Liquidation value: Net amount realized by
selling assets of firm and paying off debt

Replacement cost: Cost to replace firm’s
assets

Tobin’s q: Ratio of firm’s market value to
replacement cost
TABLE 13.1 MICROSOFT FINANCIAL
HIGHLIGHTS, JAN 2012
Price per share
Common shares outstanding (billion)
Market capitalization ($ billion)
Latest 12 Months
Sales ($ billion)
EBITDA ($ billion)
Net income ($ billion)
Earnings per share
Valuation
P/E ratio
Price/Book
Price/Sales
Price/Cash flow
PEG
Profitability
ROE (%)
ROA (%)
Operating profit margin (%)
Net profit margin (%)
$28.25
8.41
237.6
71.12
30.15
23.48
$2.75
Microsoft
10.3
4.0
3.3
13.9
1.1
44.16
17.33
38.78
33.01
Industry
Avg
17.5
10.5
2.7
20.5
1.2
24.9
8.58
23.2
13.2 INTRINSIC VALUE VERSUS
MARKET PRICE



= expected dividend per share
= current share price
= expected end-of-year price
13.2 INTRINSIC VALUE VERSUS
MARKET PRICE

Intrinsic Value


Present value of firm’s expected future net cash flows
discounted by required RoR
Market Capitalization Rate

Market-consensus estimate of appropriate discount rate for
firm’s cash flows
13.2 INTRINSIC VALUE VERSUS
MARKET PRICE
•
13.3 DIVIDEND DISCOUNT MODELS
•
13.3 DIVIDEND DISCOUNT MODELS
•
13.3 DIVIDEND DISCOUNT MODELS
•
13.3 DIVIDEND DISCOUNT MODELS
13.3 DIVIDEND DISCOUNT MODELS

Life Cycles and Multistage Growth Models

Two-stage DDM
DDM in which dividend growth assumed to
level off only at future date


Multistage Growth Models

Allow dividends per share to grow at several different rates
as firm matures
13.4 PRICE-EARNINGS RATIOS
•
13.4 PRICE-EARNINGS RATIOS
P/E Ratios
25
20
15
NBK
KFH
10
Zain
5
0
1998
2000
2002
2004
2006
2008
13.4 PRICE-EARNINGS RATIOS
Growth Rate
40%
35%
30%
25%
20%
NBK
15%
KFH
10%
Zain
5%
0%
2000
-5%
-10%
-15%
2001
2002
2003
2004
2005
2006
2007
13.4 PRICE-EARNINGS RATIOS
•
TABLE 13.3 EFFECT OF ROE AND PLOWBACK
ON GROWTH AND P/E RATIO
13.4 PRICE-EARNINGS RATIOS
The P/E ratio of any company that’s fairly priced
will equal its growth rate. I’m talking here about
growth rate of earnings…if the the P/E ratio of
Coca-Cola is 15, you’d expect the company to be
growing at about 15% per year, etc. But if
the P/E ratio is less than the growth rate,
you may have found yourself a bargain.
13.4 PRICE-EARNINGS RATIOS
•
FIGURE 13.3 P/E RATIO OF S&P 500
AND INFLATION
60
P/E ratio
Inflation rate
50
40
30
20
10
0
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
13.4 PRICE-EARNINGS RATIOS

Pitfalls in P/E Analysis

Earnings Management
Practice of using flexibility in accounting
rules to improve apparent profitability of
firm
Large amount of discretion in managing
earnings

FIGURE 13.6 P/E RATIOS
Aerospace/defense
Integrated oil & gas
Money center banks
Health care plans
Computer systems
Telecom services
Industrial metals
Electric utilities
Home improvement
Pharmaceuticals
Chemical products
Application software
Asset management
Food products
Restaurants
Auto manufacturers
Trucking
Heavy construction
Business software
Biotech
8.5
10.2
11.0
11.8
13.2
14.7
14.9
15.6
16.5
17.2
17.4
17.5
17.5
21.1
21.4
25.3
28.0
32.4
34.7
57.8
0
10
20
30
P/E ratio
40
50
60
P/E as of end of 2012
30
25
20
15
10
5
0
13.4 PRICE-EARNINGS RATIOS

Combining P/E Analysis and the DDM


Estimates stock price at horizon date
Other Comparative Valuation Ratios
Price-to-book: Indicates how aggressively market values
firm
 Price-to-cash-flow: Cash flow less affected by accounting
decisions than earnings
 Price-to-sales: For start-ups with no earnings
 Creative ratios

FIGURE 13.7 VALUATION RATIOS FOR S&P
500
13.5 FREE CASH FLOW VALUATION
APPROACHES
•
13.5 FREE CASH FLOW VALUATION
APPROACHES
•
13.5 FREE CASH FLOW VALUATION
APPROACHES
•
13.5 FREE CASH FLOW VALUATION
APPROACHES
•
13.5 FREE CASH FLOW VALUATION
APPROACHES

Comparing Valuation Models



Model values differ in practice
Differences stem from simplifying assumptions
Problems with DCF Models
DCF estimates are always somewhat imprecise
 Investors employ hierarchy of valuation

Real estate, plant, equipment
Economic profit on assets in place
Growth opportunities

13.6 THE AGGREGATE STOCK MARKET

Forecasting Aggregate Stock Market

Earnings multiplier applied at aggregate level
Forecast corporate profits for period
Derive estimate of aggregate P/E ratio
based on long-term interest rates


Some analysts use aggregate DDM
FIGURE 13.8 EARNINGS YIELD OF S&P 500
VERSUS 10-YEAR TREASURY BOND YIELD
16%
Treasury yield
Earnings yield
14%
12%
10%
8%
6%
4%
2%
0%
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
TABLE 13.4 S&P 500 FORECASTS
Pessimistic Most Likely
Scenario
Scenario
Optimistic
Scenario
Treasury bond yield
3.6%
3.1%
2.6%
Earnings yield
6.5%
6.0%
5.5%
Resulting P/E ratio
15.4
16.7
18.2
93
93
93
1431
1550
1691
EPS forecast
Forecast for S&P 500

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