the larger multiple and look deceivingly dearerthan firms with less debt?ii)the multiples areuniformlymeasured, especially for the EPS and BVPS variables. Take EPS for exampleFor a sample of firms with different financial year end dates – While trailing PE multiple is uniformwith respect to theperiod in which earnings are measured, current PE isn’t and has this undesired impact: a high growth firm with an earlierYE 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 uniformlyaccording to the taxation rulingsinto operational or CAPEX to eliminatethe difference in EPS caused by reporting flexibility. Otherwise, firms that expense items will have higher PE and lookdearer than firms that capitalize and amortize the same items.
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FINS3641 SAV Week 8: Fundamental Principles and Earnings Multiples 6 Usage of Relative Valuation – 2ndQuality Control Test – Descriptive TestIt 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 firmsthe cross sectional and time series distribution of the average multiples in one sector relative to those ofthe other sector and the entire marketin order topass judgment on whether the multiple of a given firm or a sector is too high or lowHence we need to, for each and every sector and the entire universe of stocks,i)For anormally distributedsample of multiples, compute the mean and standard deviation.ii)For a sample of multiples that isskewedby the outliers (i.e., excessively large values), compute the medianand percentile values in the sampleiii)Do not rely on anybiasedsample of multiples that havefirms removed / constrained due to excessively large multiplesfirms removed due to negative multiples that do not make senseEnsure that all firms are used in the set of (unbiased) sample descriptive statistics. For firms withmeaningless multiples, take a firm with negative earnings or a negative PE multiple, instead of droppingthe firm and having biased sample descriptive statistics, we mayDivide the aggregate market value by the aggregate net income/loss of the sampleCompute the earnings yield (the reciprocal of PE ratio) for each and every firm instead