L7 - Fundamental Principles and Earnings Multiple_2001s2

The larger multiple and look deceivingly dearer than

This preview shows page 5 - 8 out of 20 pages.

the larger multiple and look deceivingly dearer than firms with less debt? ii) the multiples are uniformly measured, especially for the EPS and BVPS variables. Take EPS for example For a sample of firms with different financial year end dates – While trailing PE multiple is uniform with respect to the period in which earnings are measured , current PE isn’t and has this undesired impact: a high growth firm with an earlier YE date could have a larger current PE and look deceivingly dearer than another high growth firm with a later YE date. All expense items should be classified uniformly according to the taxation rulings into operational or CAPEX to eliminate the difference in EPS caused by reporting flexibility. Otherwise, firms that expense items will have higher PE and look dearer than firms that capitalize and amortize the same items.
Image of page 5

Subscribe to view the full document.

FINS3641 SAV Week 8: Fundamental Principles and Earnings Multiples 6 Usage of Relative Valuation – 2 nd Quality Control Test – Descriptive Test It is also critical that we know (or have a sense of) for each sector, the cross sectional and time series distribution of multiples among the firms the cross sectional and time series distribution of the average multiples in one sector relative to those of the other sector and the entire market in order to pass judgment on whether the multiple of a given firm or a sector is too high or low Hence we need to, for each and every sector and the entire universe of stocks, i) For a normally distributed sample of multiples, compute the mean and standard deviation. ii) For a sample of multiples that is skewed by the outliers (i.e., excessively large values), compute the median and percentile values in the sample iii) Do not rely on any biased sample of multiples that have firms removed / constrained due to excessively large multiples firms removed due to negative multiples that do not make sense Ensure that all firms are used in the set of (unbiased) sample descriptive statistics. For firms with meaningless multiples , take a firm with negative earnings or a negative PE multiple, instead of dropping the firm and having biased sample descriptive statistics, we may Divide the aggregate market value by the aggregate net income/loss of the sample Compute the earnings yield (the reciprocal of PE ratio) for each and every firm instead
Image of page 6