Chapter 6 - Market Based Valuation

Calculating the forward P/E ratio based on 4 different specifications of forward EPS
Example for Slides 6-8

ASSUMPTIONS
Months from fiscal year end
Stock price
2011:Q1 EPS
2011:Q2 EPS
2011:Q3 EPS
2011:Q4 EPS
2011 Fiscal year forecast
2012:Q1 EPS
2012:Q2 EPS
2012:Q3 EPS
2012:Q4 EPS
2012 Fiscal year forecast

1
$20.00
$0.18
$0.25
$0.32
$0.35
$1.10
$0.43
$0.48
$0.50
$0.59
$2.00

Note this assumes that the forward P/E is calculated during 2011 and that the fiscal year end = calend
OUTPUT - P/E ratios and earnings
P/E and EPS based on next 4 quarters
EPS
$1.760
P/E
11.4
P/E and EPS based on NTM (next 12 months)
EPS
$1.925
P/E
10.4
P/E and EPS based on current fiscal year forecast
EPS
$1.100
P/E
18.2
P/E and EPS based on next fiscal year forecast
EPS
$2.000
P/E
10.0

of forward EPS

e fiscal year end = calendar year end

Chapter 6 - Market Based Valuation

Calculating the underlying earnings from a firm's reported earnings (underlying = the pers
Example for Slides 10-11

ASSUMPTIONS

Reported EPS from previous four quarters

Restructuring charges
Amortization of intangibles
Impairment charge
Stock price

$4.00
$0.10
$0.15
$0.20
$50.00

OUTPUT - P/E ratios, core and underlying earnings

P/E based on reported EPS

12.5

Reported core EPS from previous four quarters

P/E based on reported core EPS

$4.45
11.2

Underlying earnings (if only impairment is nonrecurring)

P/E based on underlying EPS

$4.20
11.9

gs (underlying = the persistent earnings expected to continue into the future)

Chapter 6 - Market Based Valuation

Calculating the normalized earnings to adjust for the business cycle
Example for Slides 12-14

ASSUMPTIONS
Year
2010
2009
2008
2007
2006

EPS
$0.66
$0.55
$0.81
$0.73
$0.34

2011 Stock Price

BVPS
$4.11
$3.67
$2.98
$2.12
$1.61

ROE
16.1%
15.0%
27.2%
34.4%
21.1%

$24.00

OUTPUT - P/E ratios and normalized earnings

Normalized earnings using historical average EPS
EPS
$0.62
P/E
38.8
Normalized earnings using average ROE
ROE
22.8%
EPS
$0.94
P/E
25.7

Growth in BVPS

155%

usiness cycle

Chapter 6 - Market Based Valuation

Calculating the justified forward P/E based on fundamentals using the Gordon growth mod
Example for Slides 17-18

ASSUMPTIONS
Retention ratio
Dividend growth rate
Required return on stock

0.36
4.0%
10.0%

OUTPUT - Calculating the justified forward P/E

Justified forward P/E
10.7

he Gordon growth model

Chapter 6 - Market Based Valuation

Calculating the justified P/E based on fundamentals and a regression model
Example for Slides 19-20

ASSUMPTIONS
Regression coefficients
Intercept
Dividend payout ratio
Beta
Earnings growth rate
Values for subject firm
Dividend payout ratio
Beta
Earnings growth rate
Actual P/E

11.50
2.20
-0.03
16.20
0.40
1.20
6.00%
15.0

OUTPUT - Calculating the justified P/E

Justified P/E

13.3

Overvalued

Chapter 6 - Market Based Valuation

Calculating the PEG and intrinsic value
Example for Slides 23-24

ASSUMPTIONS
Values for subject firm
5-year EPS growth rate
Consensus EPS forecast
Current stock price
Values for peer group
Median P/E
Median PEG

8.0%
$4.50
$28.00

9.00
1.60

OUTPUT - Calculating the PEG and intrinsic value

P/E for subject firm
6.2
PEG for subject firm
0.78
Undervalued
Estimated intrinsic value

$40.50
Undervalued

Chapter 6 - Market Based Valuation

Calculating the terminal value using the P/E ratio
Example for Slides 29-31

ASSUMPTIONS
Values for subject firm
Required rate of return
EPS forecast for year 3
Values for peer group
Mean dividend payout ratio
Mean ROE
Median P/E

11.0%
$2.50

0.40
8.0%
9.00

OUTPUT - Calculating the terminal value

Using the comparable P/E
$22.50
Using the Gordon Growth Model
Dividend in year 3
Retention ratio
Growth rate
Estimated value

$1.00
0.60
4.80%
$16.90

Chapter 6 - Market Based Valuation

Calculating the justified P/E, P/B and P/S ratios based on fundamentals
Example for Slides 39-42

ASSUMPTIONS
Stock Price
EPS
Dividends per share
Book value of equity per share
Sales per share
ROE
Required return on stock

$50.00
$2.00
$1.20
$6.25
$15.00
22.5%
12.0%

OUTPUT - Calculating the actual and justified ratios

Actual P/E
25.0
Actual P/B
8.0
Actual P/S
3.3
Dividend payout ratio
Retention ratio
Dividend growth rate
Net Profit Margin
Justified trailing P/E
Justified trailing P/B
Justified trailing P/S
Indicated Valuation by each ratio
Justified trailing P/E
Justified trailing P/B
Justified trailing P/S

60.00%
40.00%
9.00%
13.3%
21.80
4.50
2.91

Overvalued
Overvalued
Overvalued