PP Equity Valuation

If k g is constant then as 1 b increases pe increases

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Unformatted text preview: er. is As dividends increase, P/E increases, because b is lower. If k-g is constant, then as (1-b) increases, P/E increases P/E = 1-b / k-g P/E P/E = 1-b / k – (ROE x b) P/E Assuming all other factors remain unchanged, which variable would reduce the market P/E ratio? variable Remember: P/E = (1-b) / (k-g) Remember: For P / E to decrease either the numerator decreases, i.e. b increases. decreases, Or the denominator increases, i.e. k increases or g Or decreases. decreases. For g to decrease ROE has to decreases. Rationale for using P / E ratios: Rationale Earning power, as measured by EPS is the Earning primary determinant of investment value. primary Investment community uses P/ E ratio Empirical research shows that P/E differences Empirical are scientifically related to long-term average stock returns. stock Drawbacks to P/E analysis Drawbacks Earnings can be negative. Difficult to interpret as due to price volatility. Management can distort earnings, making it Management difficult to compare P/E among firms. difficult Rationale for using P / BV Rationale P/BV = market price per share / BV per share(1) BV per share = BV of the equity(1) / # of shares outstanding outstanding Book value is typically positive BV is more stable than EPS BV P/BV is good for valuing firms that may go out of P/BV business business P/BV linked to differences in L/R stock returns differences Drawback to P/BV Drawback Does not recognize non-physical assets May be misleading when there are significant differences in asset size differences Inflation and technology can lead to big Inflation differences in book & market values differences Rationale for using Price/sales Rationale P/S = Market price per share / Sales per share Meaningful even for distressed firms, since Meaningful sales is always positive sales Sales not easy to manipulate Not as volatile as EPS Drawbacks to P/Sales Drawbacks High sales growth does not necessarily High indicate high operating profit indicate Doesn’t capture different cost structures Distortion is still possible given different Distortion revenue recognition practices revenue Company Analysis and Stock Selection Company Steps in establishing the value of a company: Estimate EPS Find the P/E Put a value on the stock =( EPS) (P /E) Make an informed investment decision E(R) >K...
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This document was uploaded on 02/05/2014.

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