4. Describe the multiple: 24
Examples:How asymmetric is the distribution and what is the effect of this asymmetry on the moments of the distribution? How large are the outliers to the distribution, and how do we deal with the outliers? o Are there cases where the multiple cannot be estimated (e.g. negative EPS, BV)? Will ignoring these cases lead to a biased estimate of the multiple? oHow has this multiple changed over time? Step 4: Describe the Multiple (cont’d)25
Characteristics of Multiples: Biased Samples US Market – January 2013 26
Markets have a lot in common PE Ratios: US, Europe, Japan and Emerging Markets January 2013 27
The 6 Steps to Understanding Multiples 1. Select comparable firms2.Define the multiple3.Consistency of the multiple4.Describe the multiple5.Analyze the multiple6.Determine valuation 28
Example:Consider again JB Hi Fi (ticker: JBH). You want to establish whether the firm is fairly priced relativeto its peer firms in the same sector/industry (SectorServices ; Industry: Specialty Retail).The P/E of JBH is 15(i.e., the market is paying $15 for each $1 of EPS). The average P/E in the same sector/industry is 20Can you conclude that JBH is undervalued? : . What are the fundamentals of JBH’s P/E? Step 5: Analyze the Multiple29
Equity Multiple or Firm Multiple Equity Multiple Firm Multiple 1. Start with an equity DCF model (a dividend or FCFE model) 2. Isolate the denominator of the multiple in the model 3. Do the algebra to arrive at the equation for the multiple 1. Start with a firm DCF model (a FCFF model) 2. Isolate the denominator of the multiple in the model 3. Do the algebra to arrive at the equation for the multiple 5. Analyse the multiple : It is critical that we understand the fundamentals that drive each multiple, and the nature of the relationship between the multiple and each variable. Step 5: Analyse the drivers of the multiple 30
To understand the fundamentals, start with a basic equity discounted cash flow model. With the dividend discount model, Dividing both sides by the current earnings per share, Fundamental Drivers of P/E ratios Apple Actual Payout ratio = 0 P 0 DPS 1 r g n P 0 EPS 0 PE= Payout Ratio*(1 g n ) r-g n 31
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