POPULAR METHOD Less Time and Resource Intens nsive as Compared to - PowerPoint PPT Presentation

POPULAR METHOD • Less Time and Resource Intens nsive as Compared to DCF. • Easy to Understand and Comm municate to Clients. • Can be Defended Easily • Reflects the Current Market M Mood.

PITFALLS • Inconsistent estimates of value w where key variables (risk,growth and cash flow potential ial) are ignored • Values move with market mood ods • Lack of transparency in Underl rlying Assumptions • Vulnerable to manipulation and nd biases

ASIC STEPS USING MULTIPLES Define consistently and clearly ( Example:- Different variations of P.E Ratio) Logical choice of numerator and denominat inator( Example :-Equity Value with quity Value) Uniform application across firms. (Example: Uniform application across firms. (Example: ple:- Different Accounting Standards ple:- Different Accounting Standards Rules /Closing Year) Description Tests • Outliers and Averages • Biases due to elimination

nalytical Tests hat are the fundamentals that affect t ct the multiple ow will the multiple react to changes es in these fundamentals eterminants of the multiples arethe sa same as before – risk, growth and cash flow potential

lative Valuations vis-à-vis DCF CF assumes markets may be wrong – – at overall level and at firm level elative Valuation assumes markets are are right are overall level and could wrong at firm level wrong at firm level hus, you could find a stock overvalue ued on DCF basis, but undervalued relative basis if the sector is overvalu lued

ICE EARNING RATIO (P.E RATIO) O) P.E = Market Price Per Share/ Earning ing per Share Most Widely Used Tool due to Easy A Availability and Understanding Logically Defined – both relate to an n Equity Share In Common Parlance Low P.E = Unde dervaluation and Vice Versa P. E – Tool to Estimate Simple Payba back Period

LOGICAL STEPS IN DERIVING P P.E Adjusting for Diluted Earnings w.r.t E t ESOPS Judging the probabilities of Future C Conversions. Removing The effect of Extraordinary ary Adjustments/One Offs. Using Similar Earnings for Comparis rison – like Trailing, Forward, Current, Basic or Diluted

SOME EXAMPLES /CASE STUD UDIES IN P.E ADJUSTMENT LOSS MAKING COMPANIES/ / CYCLICAL COMPANIES Loss is due to one off Factors OR du due to Cyclical Nature of the Busines Taking Average of last 5 years OR th Taking Average of last 5 years OR th the Entire Cycle. the Entire Cycle. Also using other ratios to come to a a logical conclusion Above Steps to enable a Measured D Decision

K CEMENT SANGH HVI MOVERS A Domestic Cyclical Company) ( A Dom omestic Cyclical Company) YEAR EPS YEAR EPS 2014 13.4 2014 -3.4 2013 32.3 2013 9.3 2012 24.5 2012 23 2011 8.8 2011 19.5 2010 31.3 2010 20.4 VERAGE EPS VERAGE EPS 22.06 22.06 AVERA AVERA AGE EPS AGE EPS 13.8 13.8 RICE 640 PRICE 180 ATEST P.E 47.8 LATEST ST P.E N.A .E BASED ON AVERAGE EPS 29.0 P.E BAS ASED ON AVERAGE EPS 13.1 ECTOR P.E 32.0 SECTOR OR P.E 26.0 URCE:- CAPITALINE SOURCE: E:- CAPITALINE

BANKING AND FINANCIAL L COMPANIES Unique Nature of Business makes s at times using P.E misleading As all Assets are priced at Current nt Value, P/BV a more apt measure More Detailed Discussion at time o e of P/BV discussion.

COMPANIES WITH HIGH FINANCIAL L LEVERAGE arnings depressed due to high leverage . .E ratio is at elevated levels igh Financial Leverage may be due to Faulty lty Capital Structure or Prevailing High Intere igh Financial Leverage correction may happ ppen via New equity issuance or Debt Refina V/EBIDTA is a better tool in such a scenario io

DCF Perspective with regards to PE • PE Multiples derivation from DCF Formul mulae • PE Multiple is positively impacted by grow by growth (both in high growth period and stable period) • PE Multiple is negatively impacted by ris by risk • PE Multiple is positively impacted by retur eturn on equity

E Multiples across time Comparison of current multiples with history is very ery common However, if underlying fundamentals have changed, ed, such historical comparison may not be valid An increase in interest rates should result in higher c r cost of equity and a lower PE multiple A greater propensity to take risks will result in a low wer risk premium expectation and thus lower cost equity and increase PE multiples An increase in expected growth rates will increase P PE multiples An increase in return on equity will increase PE mul ultiples

Multiples across countries ountries with higher real interest rates es would have lower PE Multiples ountries with higher expected real gro rowth rates will have higher PE Multi ountries which are viewed to be high r h risk and would hence require higher miums would carry lower PE Multiple ples. ountries which are more efficient and d hence earn higher ROE will have her PE Multiples

EG Ratio PEG Ratio = PE Multiple / Expected G d Growth Rate If Growth is on current year’s earning ngs, PE should be Current PE If Growth is based on trailing earnings gs, PE should be Trailing PE Forward PE is never used as it will res result in double counting

terprise Value to EBIDTA One of the Most Theoratically strong multipl tiple. irm level multiple ewer firms with negative EBIDTA as compa pared to negative EPS – hence, fewer firm t in aggregation epreciation policy differences impact on EP on EPS eliminated in EBIDTA omparable across companies with different nt leverage levels Only Core Operating Earnings are concerne ned Widely used in Mergers and Acquisitions

/ EBIDTA / EBIDTA = (Market Value of Equity +MV of Deb ebt – Cash) / EBIDTA ash netted out of numerator terest Income netted out of EBIDTA ifficulties in case of investments in subsidiaries and d joint ventures as incomes ets ) are not fully recognized Book Value of Debt is normally taken ( as in India w a we don’t have a thriving Bond Market)

TATA MOTORS ( C ( CONSOLIDATED) (IN CRORES) (IN CRORES) (IN CRORES) R Market Price EPS P.E RATIO NET DEBT M MARKET CAP EV EBIDTA EV/ 31.6 -10.9 - 30853 8110 38963 2548 134.3 5.4 25.1 26365 38267 64632 9875 211.8 28.6 7.4 21401 67149 88550 17478 234.1 44.5 5.3 28910 74208 103118 22141 228.6 32.2 7.1 32601 72930 105531 24809 342.0 342.0 45.9 45.9 7.5 7.5 30931 30931 109106 109106 140037 140037 34681 34681 rce:- Capitaline

Multiple Perspectives irms with lower tax rates should comm mmand higher multiples igher depreciation and amortisation l levels should result in lower multiple igher reinvestment requirements shou ould depress the multiple irms with lower cost of capital should ld enjoy higher multiples irms with higher expected growth sho hould enjoy higher multiples

ice to Book (Adjustments) ook Value however affected by accounting ng policies omparisons across countries may be difficul icult ome firms especially tech may have low book va book values and hence very high ratios djustments for acquisition accounting may be ay be difficult and complex Technological changes may make Assets re redundant . (ex Camera Film Roll, Pagers) Good Will needs to be looked at in Detail. l. (Case Study)

TATA STEEL BOOK VALUE 2009 305 2010 257 2011 369 2012 439 2013 351 (Impairment Charge of Rs. 88 Per share) (Im 2014 2014 417 417 RUS ACQUISITION 200 ODWILL IMPAIRMENT CHARGE 201 pical Time Lag between Error and Admission seem ems to be about 5 years ( Source : ECONOMIST) urce :- pitaline

PBV Perspectives • PBV increases with higher ROE • PBV increases with a higher payou out ratio • PBV decreases with a higher Cost o st of Equity • PBV increases as growth rate incre reases

Applications – [part 1] ome investors use PBV as a screen to pick unde k undervalued stocks hers combine this with other fundamentals t s to pick undervalued stocks gh ROE combined with Low PBV is taken a n as a proxy for low risk igh Usage in Valuing Banks and Financial S l Stocks as no Historical Bias in their alance Sheet. ma and French concluded that firms in the L e Low PBV class earned 1.83% per month nst High PBV firms earning 0.30% during 1963 t ng 1963 to 1990

V Applications – [part – 2] enjamin Graham uses price to be less ss than 2/3rd of book value as a terion since 1934 amodaran tested low PBV portfolios amodaran tested low PBV portfolios s (with high ROE) and found they s (with high ROE) and found they rned 25.6% annually against S&P earn arning 17.49% during 1982-1991 he reverse portfolio (high PBV and lo low ROE) earned 10.61% in this riod

ICICI BANK A AXIS BANK HDFC BANK YES BANK PRICE 350 490 950 740 BV AS ON MARCH 14 127 163 181 197 P/BV 2.8 3.0 5.2 3.8 ROE 14% 17% 21% 25% P.E 21 19 28 17 Source :- Capitaline