L6_Relative_Valuations

L6_Relative_Valuations - Relative Valuations Relative...

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Relative Valuations
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2 Relative Valuations Main Types: Price : Earnings Price : NAV or Price : Book PEG Price : Sales Price : Cash Flow EV : EBITDA
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3 Price Multiples share per stic characteri monetary price share multiple Price e.g. , Share per Earnings Price Share Ratio Earnings : Price
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4 Example: Price Multiple The following applies to Deep Down Mining: Net earnings for 2010/11 were R 30,000,000 12,000,000 shares are outstanding Latest trade on the JSE was at R17.45 Therefore: EPS = R 30,000,000 / 12,000,000 shares = R2.50 / share P/E = R17.45 / R2.50 = 6.98
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5 Using Comparables Compare the market multiple of the share to one or more of: Its history Shares of similar listed companies A benchmark containing similar companies or the share's industry An average multiple of similar companies Not quite as simple as this - several adjustments may be required in order to arrive at a realistic valuation
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6 Assumptions of Multiple Valuations Share prices are mean-reverting Equities market is correctly valuing the prospects of profitability and growth of comparable /competitor firms The same prospects apply to firm of interest this assumption can be relaxed by adjusting the multiple upwards or downwards i.e, incorporating prospects into the multiple being used
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7 The P/E Ratio There are 2 types – always first determine which one is being used! Trailing (Historical) P/E Ratio Uses earnings of most recently available 12-month period in the denominator Leading (Forward) P/E Ratio Uses forecasted earnings for the next 12-month period in the denominator Share per Earnings Price Share Ratio Earnings : Price
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8 Interpretation: Historical P/E Ratios Market price of share divided by annual (last 12 months) earnings per share Approximate number of years of earnings per share an investor is paying for today (assuming constant future earnings) Low P/E generally means an investor is paying for fewer years of earnings months) 12 (last Share per Earnings Price Share PE
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9 What if a historical P/E is low? The share could be cheap – Buy! But , on the other hand: The market could expect future earnings to be lower (historical P/E is overstated). Earnings are volatile and uncertain. For some reason, the firm is of a lesser quality and therefore does not justify a high P/E. Always remember that the denominator (earnings) also plays a role Share per Earnings Price Share Ratio Earnings : Price
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10 P/E Ratios: Advantages P/E ratios are widely used in investments Earnings power is a key determinant of firm / share value There is a strong relationship between P/E differences and long-term share returns
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11 P/E Ratios: Disadvantages When earnings are negative , P/E ratios are meaningless Accounting earnings can be manipulated by management, reducing the usefulness of P/E ratios unless adjusted
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12 PE’s on the ALSI
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L6_Relative_Valuations - Relative Valuations Relative...

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