11 Multiples I.pdf - FINA 3403 Corporate Valuation HKUST...

Unformatted text preview: FINA 3403 Corporate Valuation HKUST Spring 2017-2018 Valuation Using Multiples Gina Kao Corporate Valuation Why use multiples • There are limitations of DCF DCF: Assume WACC based on targeted capital structure ▫ Many unknown items – unknown history, growth projection ▫ May need adjust many accounting treatments, e.g., R&D, depreciation method. • It is another approach for valuation ▫ It assumes the comparable transactions are truly comparable to the investment being evaluated ▫ Pervasive, easy to communicate check, find out ▫ Help to find the weak spots of DCF cross the problem in DCF/ Multiples assumptions Corporate Valuation 2 Why use multiples Multiples can assist in: • Testing the plausibility of forecasted cash flows. • Identifying disparities between a company’s performance and those of its competitors. • Identifying which companies the market believes are strategically positioned to create more value than other industry players. Corporate Valuation 3 What are multiples What you are paying for the asset (MV of Equity, EV) Multiple = What you are getting in return (Earning, EBIT, EBITDA, BV) EV (market approach) = MVE +(MV of Debt – Excess cash) = MVE + Net Debt Corporate Valuation 4 How do the multiples work? • Multiples (ratios) are calculated by scaling price or value by some observable variable or characteristic • We can value a security by multiplying the appropriate multiple (usually obtained from “comparable” firms) with the observable characteristic to get an estimated price Corporate Valuation 5 Advantages of using multiples • Easy to understand and communicate • Less assumptions needed and easy to calculate • Help to make value judgments – relative value • Reflects current market pricing information for comparable firms Corporate Valuation 6 The downside of multiples • Simplistic: combining many value drivers in a point estimate, it is difficult to disaggregate the effects of different drivers on value. • Measure value at a single point in time, not fully capture the dynamic nature of business and competition • Difficult to compare (e.g. different accounting policies, taxes, capital structure etc.) price and earnings --> no capital structure can be seen Corporate Valuation big company has big debt, so that they have higher interest 7 Types of multiples Multiples will be seen at the exam but not all Enterprise Multiples Multiples based on EV Value Multiples EV/EBITDA EV/EBIT EV/Sales Enterprise Value (EV) Non-operating assets (Excess Cash) Debt Equity Equity Multiples Multiples based on Equity Value (Price) P/E P/B P/S Price Multiples Corporate Valuation 8 EV multiples vs Equity multiples Lots of Assumptions Enterprise Value Multiples Equity Multiples More relevant to Enterprise DCF looks at operating value More relevant to Equity Value Less affected by accounting policy differences Affected by accounting policy DIV, share repurchases, no differences need to focus on WACC In accounting, there are some write-off, nonoperating expenses Less affected by capital structure More familiar to investors Enables the user to exclude non- Include the value of non-core core assets assets and thus less subjective assumptions needed Corporate Valuation 9 Industry specific multiples practical use of multiples in different industries Corporate Valuation e.g. the company will give rent instead of DIV to large shareholder (to convince the shareholder that they can secure the stable income) every year 10 Why multiples vary • Difference in the quality of business ▫ different value drivers - e.g. quality of management, branding, strategies • Accounting differences ▫ Not affect cash flow but affect profit, e.g. amortization, tax rules for some PE • Fluctuations in cash flow or profits ▫ Exceptional items • Mispricing e.g. currency under-priced: buy; overpriced: sell ▫ Distinguish the difference arising from the fundamentals or mispricing Corporate Valuation 11 Price to Earnings (P/E) Ratio P/E = ℎ ℎ which kind of industry you will use p/e to evaluate? - the CF is more stable, or at least they have earnings - for start up they don't have earnings they cannot use P/E • Price ▫ is usually the most recent share price ▫ is sometimes the average price for the year • Earnings per share (EPS) EPS = NI / # of shares A: P=10; EPS = -1; p/e =-10 B: P=10; EPS=-2; p/e = -5 which one is better? From number, -5 is better than -10; but in reality sense: A lost less! **Think about the meaning behind the number ▫ Earnings per share in most recent four quarters or 12 months (TTM: Trailing Twelve Months or LTM: Last Twelve Months) ▫ Earnings per share in most recent financial year Forward P/E: use future earnings per share (e.g. next year) Corporate Valuation 12 Price to Earnings (P/E) Ratio Is higher P/E better than lower P/E? e.g. P/E of Company A = 10; B = 15; given the same EPS, the market is willing to pay more for B (maybe because the growth prospect is better) Low P/E --> cheaper --> maybe because the prospect is declining (doesn't mean it's good) • Measure how much investors are willing to pay for a dollar of a company’s current or future earnings. • Companies with higher P/E ratios than their peers tends to have higher earnings growth expectations • Usually high growth firms will have a higher P/E than that of mature firms • Different industries or markets will have different P/E ratios higher p/e higher g higher growth --> higher P/E Zero Beta Strategy, assume A and B are in similar sector Beta(P) = Wa*beta(a) + Wb*beta(b) E(rp) = Wa E(ra) + Wb E(rb) Buy underprice and sell overprice --> gain with zero risk (arbitrage) Corporate Valuation 13 World Market P/E Source: Corporate Valuation 14 SIMILAR with the EXAM Example: paper products company in reality, you have to consider which comparable you use (average/medium?) i.e. outliers should be filtered / it's valuable? OC Company Symbol Price EPS P/E Kimberly-Clark Corp KMB 63.41 3.55 17.88 International Paper Co IP 39.89 0.71 56.18 Stora Enso Oyi SEO 13.85 0.68 20.22 UPM-Kymmene Oyj UPM 19.38 1.24 15.65 Georgia-Pacific Corp GP 34.68 2.30 15.07 Meadwestvaco Corp MWV 31.47 0.61 51.42 Average Corporate Valuation 29.40 15 one qs on midterm Example: paper products company • Boise Cascade Corporate (BCC) is a multinational distributor of office supplies, paper and packaging products, office furniture, and building materials • Its latest earnings per share were $1.71 • If BCC is comparable to the “average” large paper and paper products company, what is its share value? => $1.71 x 29.4 = $50.27 Corporate Valuation 16 Limitations with P/E • P/E is not relevant for companies with little or no earnings. • P/E mix operating and non-operating (and extraordinary) income and expense items • Influenced by the company’s leverage • Influenced by the accounting discrepancies EV --> discounted by WACC, WACC will be affected by capital structure Corporate Valuation 17 if everything hold constant, risk higher, p/e will drop P/E Ratio for stable growth firm if company has constant payout, higher payout will lead to higher p/e •With dividend discount model (constant growth) •P/E ratio 0 (1+) 0 ×(1−)(1+) 0 = − = − 1-b = payout ratio b = retention ratio 0 × (1 − )(1 + ) 0 (1 − )(1 + ) − = = 0 0 − unless mentioned •Forward P/E b: retention ratio : cost of equity Corporate Valuation 0 × (1 − )(1 + ) 0 (1 − ) − = = 1 1 − g: long-term growth rate = b x ROE P: Price per share g = b* ROE even g is higher but risk is higher, not necessary have higher PE P/E Ratio and Fundamentals midterm we never know the current market p/e is correct or not, unless market is efficient (OC) To spot out which company is cheaper, then check DCF, any special items, then look at the chart (ST), --> meaning that in reality, you cannot rely on single measure to make decision due to the market inefficiency • Other things held equal, ▫ Higher growth firms have __higher___ P/E higher, cost of equity (ke) is ▫ Higher risk firms have _lower____ P/E risk higher, p/e lower ▫ Firms with lower reinvestment needs (therefore higher reinvest --> payout ratio) will have _higher____ P/E lower higher payout --> higher p/e e.g. Well-positioned firms with competitive advantages, intellectual property, patents, and managerial expertise are able to generate both higher rates of return on new investment, as well as opportunities to reinvest more of their earnings. Corporate Valuation 19 Example • Deutsche Bank had earnings per share of 46.38 DM in current year, and paid out 16.50 DM as dividends. • The growth rate in earnings and dividends, in the long term, is expected to be 6%. • The cost of equity is assumed to be 11.64% • What are Deutsche Bank’s P/E and forward P/E? Corporate Valuation 20 Example--Answer Firstly, find out the DIV payout ratio b= (46.38-16.50)/46.38 =29.88/46.38=0.64 P/E 0 0 = (1−)(1+) (1−0.64)(1+0.06) = − 0.1164−0.06 =6.766 P/E * EPS = Price Implied P0=6.766x $46.38=313.81 Forward P/E 0 1 = (1−) (1−0.64) = − 0.1164−0.06 =6.383 Implied P0=6.383x $46.38x 1.06=313.81 Corporate Valuation 21 Case in Practice • Facebook was traded at P/E of 91 , which the sector P/E was around 15.38. • What are the reasons that Facebook’s P/E is so high comparing to the same sector P/E? => 1. longer length of high growth period 2. maintain low dividend payout ratio (close to zero) 3. be able to maintain the return of the reinvested earning Corporate Valuation 22 Case in Practice Corporate Valuation Last Year Data (16 Fall) Facebook has higher p/e than industry, as: 1. higher growth 2. the non-constant period will be longer than others (because of the C.A.) 23 ROE can been inflated by capital structure In Finance, we should take look of ROIC and WACC BIDU has higher P/E than IBM, but in ROE; IBM > BIDU; Why? BIDU give investor lower return g = ROE * b --> (1-payout)*ROE IBM: Lower beta, Lower discount rate, Higher ROE, Higher growth BIDU is not as mature as IBM, BIDU has higher growth opportunity and they don't pay DIV Strange--> look at some fundamental! Case in Practice Sep 30 2015 Price EPS P/E ratio Mkt Cap (B) Div. GOOGL 622.61 19.89 31.31 428.03 0.00 BIDU 136.68 5.21 26.24 48.51 YNDX 10.77 0.68 15.74 3.56 YHOO 28.26 6.89 4.10 28.08 MSFT 43.44 1.46 29.77 352.65 IBM 142.47 15.01 FB 86.67 AAPL TWTR ROE Beta Revenue Net Income EBITDA 14.57 0.90 66,001.00 13,928.00 21,476.00 29.20 1.84 7,702.33 1,922.49 2,634.48 33.26 2.71 766.70 257.04 299.13 29.03 1.32 4,618.13 6,474.28 843.94 1.24 14.36 0.90 93,580.00 12,193.00 34,129.00 9.49 142.39 4.25 90.89 0.71 92,793.00 15,752.00 25,350.00 0.95 91.02 253.94 0.00 11.34 0.76 12,466.00 109.06 8.66 12.60 634.49 1.82 33.61 0.81 25.59 -0.95 17.34 0.00 -17.57 0.00 2,940.00 6,237.00 182,795.0 39,510.00 60,503.00 0 1,403.00 -577.82 -330.70 Compare to Google, FB has a lower ROE but higher P/E => This could be due to a lower risk of FB (lower beta) or a higher growth rate of FB. Compare to Microsoft, Google has lower dividend (zero) payout and a similar beta => Google could have a higher growth rate (higher ROE and b) Corporate Valuation 24 An under valued company … • An undervalued asset would be one ▫ With a low PE (it is cheap) ▫ With high expected growth in earnings ▫ With low risk (and a low cost of equity) ▫ With high ROE • When there is a cheap stock, ask the key questions: ▫ What is the expected growth in earnings? ▫ What is the risk in the stock? ▫ How efficiently does this company generate it growth? Corporate Valuation 25 Another approach to get PE ratio: A regression approach • In contrast to the “comparable firm” approach, the information in the entire cross-section of firms can be used to predict PE ratios • Multiple regression = + 1 + 2 + 3 ▫ π: Dividend Payout Ratio ▫ Beta: Beta of the stock, proxy for risk (r) ▫ EGR: Earnings growth rate over the previous five years Corporate Valuation 26 Example using regression • Regression result for stocks listed on the Value Line Database: P/E = 18.69 - 0.4262 PAYOUT- 0.5082 BETA+ 0.0695 EGR • You are attempting to value the equity of a firm. It has the payout ratio is 30%, the current earning per share is $0.5. The earnings in the past 5 years had grown 25% per year and are expected to maintain the same growth rate. It has beta of 1.15. What should the price per share be for this firm? If you know P/E, you will know the next year earnings so as the price Corporate Valuation 27 Example -- Answer • P/E = 18.69 - 0.4262 PAYOUT- 0.5082 BETA+ 0.0695 EGR • P/E = 18.69 – 0.4264x0.30.5082x1.15+0.0695x0.25=17.99 • P =17.99 x $0.5 = $9.00 Corporate Valuation 28 Problems with the regression methodology • Independent variables are correlated with each other • The assumption that a liner relationship between P/E and fundamentals may not be appropriate • The basic relationship between P/E and the financial variables itself is not stable Corporate Valuation 29 PEG Ratio for high growth company • The PEG ratio is the ratio of PE to expected growth in earnings per share. • = P/EPS P0 = D1/(ke-g), if we look at PE we can find the implied g in the formula / ℎ this is estimated g high-growth company --> higher PE but higher risk PEG: high growth industry is more preferred than mature industry • The calculation of annual growth rate should be consistent among comparable firms. • If P/E < g or PEG is lower means the stock is more likely to be undervalued (i.e. P/E changes lower than the growth rate changes). • PEG is more suitable to be used for high growth industry. implied g< estimated g Corporate Valuation 30 PEG Ratios and Fundamentals multiple is another tool (easier and faster tool) than DCF Lazy analysts: do multiples only lol • Factors affect P/E ratios will affect PEG ratios. • Other thing held equal, ▫ High risk companies will have lower PEG ratios (with the same growth rate-- Higher risk, lower PE) ▫ Companies that can attain growth more efficiently by investing less in better return projects will have _higher PEG ratios that grow at the same rate ▫ Companies with very low or very high growth rates will tend to have _higher_ PEG ratios than firms with average growth denominator is rates. This bias is worse for low growth stocks. when very high/small --> the change will have huge effect Corporate Valuation 31 if the company is not frequently traded in the market, you don't know the rate, how can you find the value of the bond? Price to Book Ratio (P/B) If you don't have MV, look at the BV as proxy • = = ℎ ℎ ▫ Use for companies’ balance sheets are reasonable reflections of the market value of their asset, e.g. financial institutions, banks (more capital intensive industry) Corporate Valuation 32 P/B Ratio: Stable Growth Firm higher risk, lower book value × 1 − = = − − • The Price-book equity ratio of a stable firm is determined by difference between _the return on equity and the required rate of return on its equity : 1 = Corporate Valuation 1 0 33 Proof: P/B Ratio: Stable Growth Firm 1 1 = 0 0 = 1 1 = − − 1 1 × × 0 − 0 1 = = = 0 0 − − 0 1 − = 0 − the company which has higher ROE, will have higher BV Corporate Valuation g = 1 − 1 = 1 − 1 = > 1 x Payout = 1 - g 34 P/B and Fundamentals you expect in the future, you will have the gain • A Firm with P/B> 1 means its ROE > . • Firms have high ROE tends to sell above book value • Should draw attentions when a firm with low PB but high ROE or high PB with low ROE • Compare” with the median for the sector in to decide the “high” or “low. Corporate Valuation 35 e.g. Amazon has lower ROE but higher P/B than Alibaba possible reason: higher beta (higher risk!), higher discount rate Case in Practice Company name Goldman Sachs Gro... JPMorgan Chase & Co. Morgan Stanley Sumitomo Mitsui F... Societe Generale ... Virtu Financial Inc Evercore Partners... Interactive Broke... p/b = (ROE-g)/(ke-g) p/b can be higher because higher ke g = b*ROE (ROE higher, g is higher) Price Earnings per share P/E ratio Price-tobook ratio Return on avg equity 170.52 10.57 16.13 0.95 7.47 67.52 5.9 11.44 1.12 10.35 32.07 6.47 7.27 13.87 52.08 35.92 2.18 1.08 1.03 1.06 1.29 1.52 14.71 6.01 7.05 13.1 40.5 23.68 0.91 0.63 0.45 14.73 4.09 2.66 8.58 11.15 6.23 6.55 8.12 6.01 3.08 1.41 16.58 13.91 3.19 1.04 8.06 7.80 mean median Higher ROE but low PB could be undervalued Corporate Valuation 36 Price to Sales Ratio P/S ratio = ▫ ▫ ▫ ▫ ▫ = ℎ ℎ Use when firms or their peers don’t have positive earning Useful for start-ups industries (no positive income) p/e cannot be used Yet, they can call the clients and check the It is relatively difficult to manipulate sales record It is not as volatile as price-earnings multiples Provides a convenient handle for examining the effects of changes in pricing policy and other corporate strategic to evaluate the marketing campaign decisions. tool if believing the marketing is LT +ve impact --> P/S increase (willing to pay more to buy your shares) (refers to next page bullet pt.) Corporate Valuation 37 P/S Ratio: Stable Growth Firm 0 0 = 1 − 0 = 1 0 − 0 ×(1+)/0 = − = × (1+) − • The key determinant of price-sales ratios is the profit margin. • Lower (expected) Profit Margin will lower the P/S directly • Lower growth rate will lower the P/S indirectly • Evaluate the branding (pricing strategy) Corporate Valuation 38 Case in Practice they are not stable companies, the risk varies Price Baidu has lower PM and lower P/S than baba GOOGL and EBay has similar operating Margin, but EBay has lower P/S (Ebay has higher beta = risk which reduced the price and Net PM Earnings Price-toper share sales ratio Return on investment Operating margin Alibaba Group Hol... 101.85 2.80 16.76 30.21 27.88 Amazon.Inc. 822.96 4.01 3.65 2.16 2.09 Apple Inc. 117.63 8.56 2.71 28.23 30.48 Baidu 175.51 13.49 6.17 33.49 17.58 31.89 1.67 4.19 9.04 25.57 57.42 2.10 5.24 12.96 23.28 75.29 0.00010 1.17 -1.24 6.06 0.00 1.25 -18.20 0.43 -20.25 53.08 0.21 23.63 5.78 7.85 41.44 -5.19 7.94 -9.37 -95.58 eBay Inc Microsoft Corpora... SINA Corp Subaye Inc Weibo Corp (ADR) Yahoo! Inc. Corporate Valuation 39 EV/ EBITDA price multiples you believe the market valuation + − ℎ = • EV = Price per share x shares outstanding plus interestbearing debt (ST and LT) less cash (excess cash) • The multiple can be computed even for firms that are reporting net losses, since EBITDA are usually positive. • For firms that have significant noncash expenses (i.e. depreciation). • It is less affected by any changes in capital structure. When the company swaps debt for equity, EBITDA is unchanged because it is pre-interest. (EV will changes due to tax shields, signaling MM1: buy back will etc.) affect the capital structure Corporate Valuation 40 EV/ EBITDA • EBITDA multiples provide a good valuation tool for businesses in which most of the value comes from a firm’s existing assets. • EBITDA multiples are used primarily for the valuation of stable, mature businesses. • EBITDA multiples are much less useful for evaluating businesses whose values come mainly from future growth opportunities. Corporate Valuation 41 EV/ EBITDA and stable growth • 0 = 1 − FCF1 = EBIT (1-t) - (Cex - Depr) - Δ Net Working Capital = (EBITDA - Depr) (1-t) - (Cex - Depr) - Δ Net Working Capital = EBITDA (1-t) + Depr (t) - Cex - Δ Net Working Capital EBITDA (1−t) + Depr (t) − CAPEX − Δ Working Capital 0 = − = Corporate Valuation (1−t) + Depr (t) Δ Working Capital − − − 42 EV/ EBITDA and Fundamentals Determinant 1. Tax Rate 2. Cost of Capital 3. Depreciation/EBITDA 4. Growth and Capital Expenditures/EBITDA Corporate Valuation Effect on Value/EBITDA multiple Implications FCF = 1-t --> tax rate •Firms with large net operating losses increase, value drop should sell for higher Value/EBITDA As tax rate increases, multiples. multiple decreases. •As tax rates increase, Value/EBITDA multiples should go down. •Firms which are riskier and use lower As cost of capital increases, leverage should have lower multiple will decrease. Value/EBITDA multiples. only if depr. is deductible As depreciation increases •For a given level of capital as a proportion of ...
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