Expected growth rate Retention ratio Return on Equity Retention Ratio Net

Expected growth rate retention ratio return on equity

This preview shows page 124 - 135 out of 202 pages.

Expected growth rate = Retention ratio * Return on Equity = Retention Ratio *(Net Profit / Sales) * ( Sales / BV of Equity) = Retention Ratio * Profit Margin * Sales/BV of Equity
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Aswath Damodaran 125 Price/Sales Ratio: An Example High Growth Phase Stable Growth Length of Period 5 years Forever after year 5 Net Margin 10% 6% Sales/BV of Equity 2.5 2.5 Beta 1.25 1.00 Payout Ratio 20% 60% Expected Growth (.1)(2.5)(.8)=20% (.06)(2.5)(.4)=.06 Riskless Rate =6% PS = 0.10 * 0.2 * (1.20) * 1 (1.20) 5 (1.12875) 5 " # $ % & (.12875 - .20) + 0.06 * 0.60 * (1.20) 5 * (1.06) (.115 -.06) (1.12875) 5 ' ( ) ) ) * + , , , = 1.06
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Aswath Damodaran 126 Effect of Margin Changes Price/Sales Ratios and Net Margins 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2% 4% 6% 8% 10% 12% 14% 16% Net Margin PS Ratio
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Aswath Damodaran 127 Price to Sales Multiples: Grocery Stores - US in January 2007 Net Margin 5 4 3 2 1 0 -1 -2 -3 PS_RATIO 1.6 1.4 1.2 1.0 .8 .6 .4 .2 0.0 -.2 Rsq = 0.5947 WFMI ARD RDK SWY WMK AHO OATS PTMK MARSA Whole Foods : In 2007: Net Margin was 3.41% and Price/ Sales ratio was 1.41 Predicted Price to Sales = 0.07 + 10.49 (0.0341) = 0.43
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Aswath Damodaran 128 Reversion to normalcy: Grocery Stores - US in January 2009 Whole Foods : In 2009, Net Margin had dropped to 2.77% and Price to Sales ratio was down to 0.31. Predicted Price to Sales = 0.07 + 10.49 (.0277) = 0.36
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Aswath Damodaran 129 And again in 2010.. Whole Foods : In 2010, Net Margin had dropped to 1.44% and Price to Sales ratio increased to 0.50. Predicted Price to Sales = 0.06 + 11.43 (.0144) = 0.22
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Aswath Damodaran 130 Here is 2011… PS Ratio= - 0.585 + 55.50 (Net Margin) R 2 = 48.2% PS Ratio for WFMI = -0.585 + 55.50 (.0273) = 0.93 At a PS ratio of 0.98, WFMI is slightly over valued.
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Aswath Damodaran 131 Current versus Predicted Margins One of the limitations of the analysis we did in these last few pages is the focus on current margins. Stocks are priced based upon expected margins rather than current margins. For most firms, current margins and predicted margins are highly correlated, making the analysis still relevant. For firms where current margins have little or no correlation with expected margins, regressions of price to sales ratios against current margins (or price to book against current return on equity) will not provide much explanatory power. In these cases, it makes more sense to run the regression using either predicted margins or some proxy for predicted margins.
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Aswath Damodaran 132 A Case Study: Internet Stocks in January 2000 ROWE PPOD TURF BUYX ELTX GEEK RMII FATB TMNT ONEM ABTL INFO ANET ITRA IIXL BIZZ EGRP ACOM ALOY BIDS SPLN EDGR PSIX ATHY AMZN CLKS PCLN APNT SONE NETO CBIS NTPA CSGP INTW RAMP DCLK CNET ATHM MQST FFIV SCNT MMXI INTM SPYG LCOS PKSI -0 10 20 30 -0.8 -0.6 -0.4 -0.2 AdjMargin A d j P S
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Aswath Damodaran 133 PS Ratios and Margins are not highly correlated Regressing PS ratios against current margins yields the following PS = 81.36 - 7.54(Net Margin) R 2 = 0.04 (0.49) This is not surprising. These firms are priced based upon expected margins, rather than current margins. Consequently, there is little relationship between current margins and market values.
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Aswath Damodaran 134 Solution 1: Use proxies for survival and growth: Amazon in early 2000 Hypothesizing that firms with higher revenue growth and higher cash balances should have a greater chance of surviving and becoming profitable, we ran the
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  • Spring '11
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  • P/E ratio, PEG ratio, Aswath Damodaran, Damodaran

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