Damodaran On Earning Mult

Earnings Multiples Aswath Damodaran

Aswath Damodaran

1

Price Earnings Ratio: Definition

PE = Market Price per Share / Earnings per Share n

n

n

There are a number of variants on the basic PE ratio in use. They are based upon how the price and the earnings are defined. Price: is usually the current price is sometimes the average price for the year EPS: earnings per share in most recent financial year earnings per share in trailing 12 months (Trailing PE) forecasted earnings per share next year (Forward PE) forecasted earnings per share in future year

Aswath Damodaran

2

PE Ratio: Descriptive Statistics Distribution of PE Ratios - September 2001

1200

1000

Number of firms

800

Current PE 600

Trailing PE Forward PE

400

200

0 0-4

4-6

6-8

8 - 10

10 - 15

15-20

20-25

25-30

30-35

35-40

40 - 45

45- 50

50 -75

75 100

> 100

PE ratio

Aswath Damodaran

3

PE: Deciphering the Distribution Current PE Trailing PE Forward PE Mean 30.93 30.33 21.13 Standard Error 2.70 2.74 0.73 Median 15.27 15.20 13.71 Mode 10 0 14 Standard Deviation 157.30 150.65 38.22 Kurtosis 795.82 1615.73 224.85 Skewness 26.28 36.04 12.97 Range 5370.00 7090.50 864.91 Maximum 5370.00 7090.50 865.00 Count 3387 3021 2737 Aswath Damodaran

4

PE Ratio: Understanding the Fundamentals

n

n

To understand the fundamentals, start with a basic equity discounted cash flow model. With the dividend discount model, P0 =

n

DPS1 r − gn

Dividing both sides by the earnings per share, P0 Payout Ratio *(1 + g n ) = PE = EPS 0 r - gn

n

If this had been a FCFE Model, P0 =

FCFE 1 r − gn

(FCFE/Earnings)*(1 + g n ) P0 = PE = EPS0 r-g n Aswath Damodaran

5

PE Ratio and Fundamentals

n

n

n

n

Proposition: Other things held equal, higher growth firms will have higher PE ratios than lower growth firms. Proposition: Other things held equal, higher risk firms will have lower PE ratios than lower risk firms Proposition: Other things held equal, firms with lower reinvestment needs will have higher PE ratios than firms with higher reinvestment rates. Of course, other things are difficult to hold equal since high growth firms, tend to have risk and high reinvestment rats.

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6

Using the Fundamental Model to Estimate PE For a High Growth Firm n

The price-earnings ratio for a high growth firm can also be related to fundamentals. In the special case of the two-stage dividend discount model, this relationship can be made explicit fairly simply: P0 =

 ( 1 +g)n  EPS0 * P a y o u t R a t i o * ( 1g + )* 1 −  ( 1 +r) n  r-g

+

EPS 0 *Payout Ration * ( 1 +g)n * ( 1 +g n ) (r - gn )(1+r)n

• For a firm that does not pay what it can afford to in dividends, substitute FCFE/Earnings for the payout ratio. n

Dividing both sides by the earnings per share:  (1+ g )n   Payout Ratio *(1 + g )*  1 − (1+ r) n   Payout Ratio n * ( 1 + g )n *(1 + gn ) P0 = + (r - g n )(1+ r) n EPS 0 r -g

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7

Expanding the Model

n

n

n

In this model, the PE ratio for a high growth firm is a function of growth, risk and payout, exactly the same variables that it was a function of for the stable growth firm. The only difference is that these inputs have to be estimated for two phases - the high growth phase and the stable growth phase. Expanding to more than two phases, say the three stage model, will mean that risk, growth and cash flow patterns in each stage.

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8

A Simple Example

Assume that you have been asked to estimate the PE ratio for a firm which has the following characteristics: Variable High Growth Phase Stable Growth Phase Expected Growth Rate 25% 8% Payout Ratio 20% 50% Beta 1.00 1.00 n Riskfree rate = T.Bond Rate = 6% n Required rate of return = 6% + 1(5.5%)= 11.5% n

 (1.25)5   0 . 2 * (1.25) *  1− 5 5  (1.115)  0.5 * (1.25) *(1.08) PE = + = 28.75 (.115-.08) (1.115) 5 (.115 - .25)

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9

PE and Growth: Firm grows at x% for 5 years, 8% thereafter PE Ratios and Expected Growth: Interest Rate Scenarios 180

160

140

PE Ratio

120

r=4% r=6% r=8% r=10%

100

80

60

40

20

0 5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Expected Growth Rate

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10

PE Ratios and Length of High Growth: 25% growth for n years; 8% thereafter PE Ratios and Length of High Growth Period 60

50

PE Ratio

40

g=25% g=20% g=15% g=10%

30

20

10

0 0

1

2

3

4

5

6

7

8

9

10

Length of High Growth Period

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11

PE and Risk: Effects of Changing Betas on PE Ratio: Firm with x% growth for 5 years; 8% thereafter

PE Ratios and Beta: Growth Scenarios 50 45 40 35

PE Ratio

30 g=25% g=20% g=15% g=8%

25 20 15 10 5 0 0.75

1.00

1.25

1.50

1.75

2.00

Beta

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12

PE and Payout

PE Ratios and Payour Ratios: Growth Scenarios 35

30

25

20

PE

g=25% g=20% g=15% g=10%

15

10

5

0 0%

20%

40%

60%

80%

100%

Payout Ratio

Aswath Damodaran

13

PE: Emerging Markets 35

30

25

20

15

10

5

0 Mexico

Malaysia

Aswath Damodaran

Singapore

Taiwan

Hong Kong

Venezuela

Brazil

Argentina

Chile

14

Comparisons across countries

n

o o n

In July 2000, a market strategist is making the argument that Brazil and Venezuela are cheap relative to Chile, because they have much lower PE ratios. Would you agree? Yes No What are some of the factors that may cause one market’s PE ratios to be lower than another market’s PE?

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15

A Comparison across countries: June 2000 Country UK Germany France Switzerland Belgium Italy Sweden Netherlands Australia Japan US Canada

Aswath Damodaran

PE 22.02 26.33 29.04 19.6 14.74 28.23 32.39 21.1 21.69 52.25 25.14 26.14

Dividend Yield 2-yr rate 2.59% 5.93% 1.88% 5.06% 1.34% 5.11% 1.42% 3.62% 2.66% 5.15% 1.76% 5.27% 1.11% 4.67% 2.07% 5.10% 3.12% 6.29% 0.71% 0.58% 1.10% 6.05% 0.99% 5.70%

10-yr rate 5.85% 5.32% 5.48% 3.83% 5.70% 5.70% 5.26% 5.47% 6.25% 1.85% 5.85% 5.77%

10yr - 2yr -0.08% 0.26% 0.37% 0.21% 0.55% 0.43% 0.59% 0.37% -0.04% 1.27% -0.20% 0.07%

16

Correlations and Regression of PE Ratios

n

Correlations • Correlation between PE ratio and long term interest rates = -0.733 • Correlation between PE ratio and yield spread = 0.706

n

Regression Results PE Ratio = 42.62 - 3.61 (10’yr rate) + 8.47 (10-yr - 2 yr rate) R2 = 59% Input the interest rates as percent. For instance, the predicted PE ratio for Japan with this regression would be: PE: Japan = 42.62 - 3.61 (1.85) + 8.47 (1.27) = 46.70 At an actual PE ratio of 52.25, Japanese stocks are slightly overvalued.

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17

Predicted PE Ratios Country Actual PE Predicted PE Under or Over Valued UK 22.02 20.83 5.71% Germany 26.33 25.62 2.76% France 29.04 25.98 11.80% Switzerland 19.6 30.58 -35.90% Belgium 14.74 26.71 -44.81% Italy 28.23 25.69 9.89% Sweden 32.39 28.63 13.12% Netherlands 21.1 26.01 -18.88% Australia 21.69 19.73 9.96% Japan 52.25 46.70 11.89% United States 25.14 19.81 26.88% Canada 26.14 22.39 16.75%

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18

An Example with Emerging Markets: June 2000

Aswath Damodaran

Country

PE Ratio

Argentina Brazil Chile Hong Kong India Indonesia Malaysia Mexico Pakistan Peru Phillipines Singapore South Korea Thailand Turkey Venezuela

14 21 25 20 17 15 14 19 14 15 15 24 21 21 12 20

Interest Rates 18.00% 14.00% 9.50% 8.00% 11.48% 21.00% 5.67% 11.50% 19.00% 18.00% 17.00% 6.50% 10.00% 12.75% 25.00% 15.00%

GDP Real Growth 2.50% 4.80% 5.50% 6.00% 4.20% 4.00% 3.00% 5.50% 3.00% 4.90% 3.80% 5.20% 4.80% 5.50% 2.00% 3.50%

Country Risk 45 35 15 15 25 50 40 30 45 50 45 5 25 25 35 45

19

Regression Results

n

The regression of PE ratios on these variables provides the following – PE = 16.16

- 7.94 Interest Rates + 154.40 Growth in GDP - 0.1116 Country Risk R Squared = 73%

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20

Predicted PE Ratios

Aswath Damodaran

Country

PE Ratio

Argentina Brazil Chile Hong Kong India Indonesia Malaysia Mexico Pakistan Peru Phillipines Singapore South Korea Thailand Turkey Venezuela

14 21 25 20 17 15 14 19 14 15 15 24 21 21 12 20

Interest Rates 18.00% 14.00% 9.50% 8.00% 11.48% 21.00% 5.67% 11.50% 19.00% 18.00% 17.00% 6.50% 10.00% 12.75% 25.00% 15.00%

GDP Real Growth 2.50% 4.80% 5.50% 6.00% 4.20% 4.00% 3.00% 5.50% 3.00% 4.90% 3.80% 5.20% 4.80% 5.50% 2.00% 3.50%

Country Risk 45 35 15 15 25 50 40 30 45 50 45 5 25 25 35 45

Predicted PE 13.57 18.55 22.22 23.11 18.94 15.09 15.87 20.39 14.26 16.71 15.65 23.11 19.98 20.85 13.35 15.35

21

Comparisons of PE across time: PE Ratio for the S&P 500 PE Ratio: 1960-2000 35.00

30.00

25.00

20.00

15.00

10.00

5.00

Aswath Damodaran

00

98

20

19

96 19

94 19

92 19

90 19

88 19

86 19

84 19

82 19

80 19

78 19

76 19

74 19

72 19

70 19

68 19

66

64

19

19

62 19

19

60

0.00

22

Is low (high) PE cheap (expensive)?

n

A market strategist argues that stocks are over priced because the PE ratio today is too high relative to the average PE ratio across time. Do you agree? q Yes q No

n

If you do not agree, what factors might explain the higer PE ratio today?

Aswath Damodaran

23

E/P Ratios , T.Bond Rates and Term Structure

16.00%

14.00%

12.00%

10.00%

8.00%

Earnings Yield T.Bond Rate Bond-Bill

6.00%

4.00%

2.00%

20 00

19 98

19 96

19 94

19 92

19 90

19 88

19 86

19 84

19 82

19 80

19 78

19 76

19 74

19 72

19 70

19 68

19 66

19 64

19 62

19 60

0.00%

-2.00%

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24

Regression Results

n

n

n

There is a strong positive relationship between E/P ratios and T.Bond rates, as evidenced by the correlation of 0.685 between the two variables., In addition, there is evidence that the term structure also affects the PE ratio. In the following regression, using 1960-2000 data, we regress E/P ratios against the level of T.Bond rates and a term structure variable (T.Bond - T.Bill rate) E/P = 1 .88% + 0.776 T.Bond Rate - 0.407 (T.Bond Rate-T.Bill Rate) (2.84) (6.08) (-2.37) R squared = 50%

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25

Estimate the E/P Ratio Today

n n n n

T. Bond Rate = T.Bond Rate - T.Bill Rate = Expected E/P Ratio = Expected PE Ratio =

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26

Comparing PE ratios across firms Company Name Coca-Cola Bottling Molson Inc. Ltd. 'A' Anheuser-Busch Corby Distilleries Ltd. Chalone Wine Group Ltd. Andres Wines Ltd. 'A' Todhunter Int'l Brown-Forman 'B' Coors (Adolph) 'B' PepsiCo, Inc. Coca-Cola Boston Beer 'A' Whitman Corp. Mondavi (Robert) 'A' Coca-Cola Enterprises

Trailing PE 29.18 43.65 24.31 16.24 21.76 8.96 8.94 10.07 23.02 33.00 44.33 10.59 25.19 16.47 37.14

Expected Growth 9.50% 15.50% 11.00% 7.50% 14.00% 3.50% 3.00% 11.50% 10.00% 10.50% 19.00% 17.13% 11.50% 14.00% 27.00%

Standard Dev 20.58% 21.88% 22.92% 23.66% 24.08% 24.70% 25.74% 29.43% 29.52% 31.35% 35.51% 39.58% 44.26% 45.84% 51.34%

Hansen Natural Corp

9.70

17.00%

62.45%

Aswath Damodaran

27

A Question

You are reading an equity research report on this sector, and the analyst claims that Andres Wine and Hansen Natural are under valued because they have low PE ratios. Would you agree? o Yes o No n Why or why not?

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28

Comparing PE Ratios across a Sector Company Name PT Indosat ADR Telebras ADR Telecom Corporation of New Zealand ADR Telecom Argentina Stet - France Telecom SA ADR B Hellenic Telecommunication Organization SA ADR Telecomunicaciones de Chile ADR Swisscom AG ADR Asia Satellite Telecom Holdings ADR Portugal Telecom SA ADR Telefonos de Mexico ADR L Matav RT ADR Telstra ADR Gilat Communications Deutsche Telekom AG ADR British Telecommunications PLC ADR Tele Danmark AS ADR Telekomunikasi Indonesia ADR Cable & Wireless PLC ADR APT Satellite Holdings ADR Telefonica SA ADR Royal KPN NV ADR Telecom Italia SPA ADR Nippon Telegraph & Telephone ADR France Telecom SA ADR Korea Telecom ADR

Aswath Damodaran

PE 7.8 8.9 11.2 12.5 12.8 16.6 18.3 19.6 20.8 21.1 21.5 21.7 22.7 24.6 25.7 27 28.4 29.8 31 32.5 35.7 42.2 44.3 45.2 71.3

Growth 0.06 0.075 0.11 0.08 0.12 0.08 0.11 0.16 0.13 0.14 0.22 0.12 0.31 0.11 0.07 0.09 0.32 0.14 0.33 0.18 0.13 0.14 0.2 0.19 0.44

29

PE, Growth and Risk Dependent variable is: R squared = 66.2%

PE

R squared (adjusted) = 63.1%

Variable Coefficient SE t-ratio Constant 13.1151 3.471 3.78 Growth rate 121.223 19.27 6.29 Emerging Market -13.8531 3.606 -3.84 Emerging Market is a dummy: 1 if emerging market 0 if not

Aswath Damodaran

prob 0.0010 ≤ 0.0001 0.0009

30

Is Telebras under valued? n n

Predicted PE = 13.12 + 121.22 (.075) - 13.85 (1) = 8.35 At an actual price to earnings ratio of 8.9, Telebras is slightly overvalued.

Aswath Damodaran

31

Using comparable firms- Pros and Cons

n

The most common approach to estimating the PE ratio for a firm is • to choose a group of comparable firms, • to calculate the average PE ratio for this group and • to subjectively adjust this average for differences between the firm being valued and the comparable firms.

n

Problems with this approach. • The definition of a 'comparable' firm is essentially a subjective one. • The use of other firms in the industry as the control group is often not a solution because firms within the same industry can have very different business mixes and risk and growth profiles. • There is also plenty of potential for bias. • Even when a legitimate group of comparable firms can be constructed, differences will continue to persist in fundamentals between the firm being valued and this group.

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32

Using the entire crosssection: A regression approach

n

n

In contrast to the 'comparable firm' approach, the information in the entire cross-section of firms can be used to predict PE ratios. The simplest way of summarizing this information is with a multiple regression, with the PE ratio as the dependent variable, and proxies for risk, growth and payout forming the independent variables.

Aswath Damodaran

33

PE versus Growth 120

100

80

60

40

20

0 -20 -20

0

20

40

60

80

100

Expected Growth in EPS: next 5 years

Aswath Damodaran

34

PE Ratio: Standard Regression Model Summary Model 1

R

.478a

Adjusted R Square .227

R Square .229

Std. Error of the Estimate 803.9541

a. Predictors: (Constant), Expected Growth in EPS: next 5 y, PAYOUT1, Beta

Coefficients

Standar dized Coefficients

Unstandardized Coefficients Model 1

(Constant) Beta PAYOUT1 Expected Growth in EPS: next 5 y

a,b

B 13.090

Std. Error 1.164

-3.392 4.938

.908 1.190

.880

.040

Beta

t 11.242

Sig. .000

-.089 .098

-3.737 4.150

.000 .000

.527

22.115

.000

a. Dependent Variable: Current PE b. Weighted Least Squares Regression - Weighted by Market Cap

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35

Second Thoughts? n

Based on this regression, estimate the PE ratio for a firm with no growth, no payout and no risk.

n

Is there a problem with your prediction?

Aswath Damodaran

36

PE Regression- No Intercept Model Summary Model 1

R

a

R Square .832

.912b

Adjusted R Square .832

Std. Error of the Estimate 833.0224

a. For regression through the origin (the no-intercept model), R Square measures the proportion of the variability in the dependent variable about the origin explained by regression. This CANNOT be compared to R Square for models which include an intercept. b. Predictors: Expected Growth in EPS: next 5 y, PAYOUT1, Beta Coefficients

Standar dized Coefficients

Unstandardized Coefficients Model 1

Beta PAYOUT1 Expected Growth in EPS: next 5 y

a,b,c

B 4.389

Std. Error .609

Beta .188

t 7.212

Sig. .000

13.299

.962

.189

13.823

.000

1.014

.039

.608

25.786

.000

a. Dependent Variable: Current PE b. Linear Regression through the Origin c. Weighted Least Squares Regression - Weighted by Market Cap

Aswath Damodaran

37

Problems with the regression methodology

n

n

n

The basic regression assumes a linear relationship between PE ratios and the financial proxies, and that might not be appropriate. The basic relationship between PE ratios and financial variables itself might not be stable, and if it shifts from year to year, the predictions from the model may not be reliable. The independent variables are correlated with each other. For example, high growth firms tend to have high risk. This multi-collinearity makes the coefficients of the regressions unreliable and may explain the large changes in these coefficients from period to period.

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38

The Multicollinearity Problem Correlations

Current PE

Pearson Correlation Sig. (2-tailed)

Current PE 1.000 .

Expected Growth in EPS: next 5 y .342** .000

N Pearson Correlation Sig. (2-tailed) N

3303 .342** .000 2085

Beta

Pearson Correlation Sig. (2-tailed) N

.130** .000 3027

.397** .000 2393

1.000 . 4534

-.213** .000 3114

Payout Ratio

Pearson Correlation Sig. (2-tailed) N

.009 .594 3290

-.078** .000 2143

-.213** .000 3114

1.000 . 3388

Expected Growth in EPS: next 5 y

2085 1.000 . 2675

Beta Payout Ratio .130** .009 .000 .594 3027 .397** .000 2393

3290 -.078** .000 2143

**. Correlation is significant at the 0.01 level (2-tailed).

Aswath Damodaran

39

Using the PE ratio regression n

Assume that you were given the following information for Dell. The firm has an expected growth rate of 10%, a beta of 1.40 and pays no dividends. Based upon the regression, estimate the predicted PE ratio for Dell. Predicted PE = (Work with absolute values in regression - 10 for 10% etc.)

n

Dell is actually trading at 18 times earnings. What does the predicted PE tell you?

Aswath Damodaran

40

Investment Strategies that compare PE to the expected growth rate n

n

If we assume that all firms within a sector have similar growth rates and risk, a strategy of picking the lowest PE ratio stock in each sector will yield undervalued stocks. Portfolio managers and analysts sometimes compare PE ratios to the expected growth rate to identify under and overvalued stocks. • In the simplest form of this approach, firms with PE ratios less than their expected growth rate are viewed as undervalued. • In its more general form, the ratio of PE ratio to growth is used as a measure of relative value.

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41

Problems with comparing PE ratios to expected growth n

n

n

In its simple form, there is no basis for believing that a firm is undervalued just because it has a PE ratio less than expected growth. This relationship may be consistent with a fairly valued or even an overvalued firm, if interest rates are high, or if a firm is high risk. As interest rate decrease (increase), fewer (more) stocks will emerge as undervalued using this approach.

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42

PE Ratio versus Growth - The Effect of Interest rates: Average Risk firm with 25% growth for 5 years; 8% thereafter

Figure 14.2: PE Ratios and T.Bond Rates 45 40 35 30 25 20 15 10 5 0 5%

6%

7%

8%

9%

10%

T.Bond Rate

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43

PE Ratios Less Than The Expected Growth Rate

n

In September 2001, • 33% of firms had PE ratios lower than the expected 5-year growth rate • 67% of firms had PE ratios higher than the expected 5-year growth rate

n

In comparison, • 38.1% of firms had PE ratios less than the expected 5-year growth rate in September 1991 • 65.3% of firm had PE ratios less than the expected 5-year growth rate in 1981.

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44

PEG Ratio: Definition

n

n

The PEG ratio is the ratio of price earnings to expected growth in earnings per share. PEG = PE / Expected Growth Rate in Earnings Definitional tests: • Is the growth rate used to compute the PEG ratio – on the same base? (base year EPS) – over the same period?(2 years, 5 years) – from the same source? (analyst projections, consensus estimates..)

• Is the earnings used to compute the PE ratio consistent with the growth rate estimate? – No double counting: If the estimate of growth in earnings per share is from the current year, it would be a mistake to use forward EPS in computing PE – If looking at foreign stocks or ADRs, is the earnings used for the PE ratio consistent with the growth rate estimate? (US analysts use the ADR EPS) Aswath Damodaran

45

PEG Ratio: Distribution 400

300

200

100 Std. Dev = 1.05 Mean = 1.55 N = 2084.00

0

Price/ Expected Growth RAte

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46

PEG Ratios: The Beverage Sector Company Name Coca-Cola Bottling Molson Inc. Ltd. 'A' Anheuser-Busch Corby Distilleries Ltd. Chalone Wine Group Ltd. Andres Wines Ltd. 'A' Todhunter Int'l Brown-Forman 'B' Coors (Adolph) 'B' PepsiCo, Inc. Coca-Cola Boston Beer 'A' Whitman Corp. Mondavi (Robert) 'A' Coca-Cola Enterprises Hansen Natural Corp Average Aswath Damodaran

Trailing PE 29.18 43.65 24.31 16.24 21.76 8.96 8.94 10.07 23.02 33.00 44.33 10.59 25.19 16.47 37.14 9.70

Growth 9.50% 15.50% 11.00% 7.50% 14.00% 3.50% 3.00% 11.50% 10.00% 10.50% 19.00% 17.13% 11.50% 14.00% 27.00% 17.00%

Std Dev 20.58% 21.88% 22.92% 23.66% 24.08% 24.70% 25.74% 29.43% 29.52% 31.35% 35.51% 39.58% 44.26% 45.84% 51.34% 62.45%

PEG 3.07 2.82 2.21 2.16 1.55 2.56 2.98 0.88 2.30 3.14 2.33 0.62 2.19 1.18 1.38 0.57

22.66

0.13

0.33

2.00

47

PEG Ratio: Reading the Numbers

n

o o n

The average PEG ratio for the beverage sector is 2.00. The lowest PEG ratio in the group belongs to Hansen Natural, which has a PEG ratio of 0.57. Using this measure of value, Hansen Natural is the most under valued stock in the group the most over valued stock in the group What other explanation could there be for Hansen’s low PEG ratio?

Aswath Damodaran

48

PEG Ratio: Analysis

n

To understand the fundamentals that determine PEG ratios, let us return again to a 2-stage equity discounted cash flow model P0 =

n

 ( 1 +g)n  EPS0 * P a y o u t R a t i o * ( 1g + ) *1 −  ( 1 +r) n  r-g

+

EPS 0 *Payout Ration * ( 1 +g)n * ( 1 +g n ) (r - gn )(1+r)n

Dividing both sides of the equation by the earnings gives us the equation for the PE ratio. Dividing it again by the expected growth ‘g’  ( 1 +g)n  Payout Ratio*(1+ g) * 1 −  (1 + r) n  Payout Ratio n * ( 1 +g)n * ( 1 +g n ) PEG = + g(r - gn )(1 + r)n g(r - g)

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49

PEG Ratios and Fundamentals

n

Risk and payout, which affect PE ratios, continue to affect PEG ratios as well. • Implication: When comparing PEG ratios across companies, we are making implicit or explicit assumptions about these variables.

n

Dividing PE by expected growth does not neutralize the effects of expected growth, since the relationship between growth and value is not linear and fairly complex (even in a 2-stage model)

Aswath Damodaran

50

A Simple Example

Assume that you have been asked to estimate the PEG ratio for a firm which has the following characteristics: Variable High Growth Phase Stable Growth Phase Expected Growth Rate 25% 8% Payout Ratio 20% 50% Beta 1.00 1.00 n Riskfree rate = T.Bond Rate = 6% n Required rate of return = 6% + 1(5.5%)= 11.5% n The PEG ratio for this firm can be estimated as follows: n

PEG =

Aswath Damodaran

 (1.25) 5  0.2 * (1.25) * 1 −  (1.115) 5  .25(.115 - .25)

0.5 * (1.25)5 *(1.08) + = .115 or 1.15 .25(.115-.08) (1.115)5

51

PEG Ratios and Risk

PEG Ratios and Beta: Different Growth Rates 3

2.5

PEG Ratio

2 g =25% g=20% g=15% g=8%

1.5

1

0.5

0 0.75

1.00

1.25

1.50

1.75

2.00

Beta

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52

PEG Ratios and Quality of Growth

PEG Ratios and Retention Ratios 1.4

1.2

PEG Ratio

1

0.8 PEG 0.6

0.4

0.2

0 1

0.8

0.6

0.4

0.2

0

Retention Ratio

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53

PE Ratios and Expected Growth

PEG Ratios, Expected Growth and Interest Rates 2.50

2.00

1.50

PEG Ratio

r=6% r=8% r=10% 1.00

0.50

0.00 5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Expected Growth Rate

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PEG Ratios and Fundamentals: Propositions

n

Proposition 1: High risk companies will trade at much lower PEG ratios than low risk companies with the same expected growth rate. • Corollary 1: The company that looks most under valued on a PEG ratio basis in a sector may be the riskiest firm in the sector

n

Proposition 2: Companies that can attain growth more efficiently by investing less in better return projects will have higher PEG ratios than companies that grow at the same rate less efficiently. • Corollary 2: Companies that look cheap on a PEG ratio basis may be companies with high reinvestment rates and poor project returns.

n

Proposition 3: Companies with very low or very high growth rates will tend to have higher PEG ratios than firms with average growth rates. This bias is worse for low growth stocks. • Corollary 3: PEG ratios do not neutralize the growth effect.

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55

PE, PEG Ratios and Risk 2.5

45

40 2

35

30 1.5 25 PE PEG Ratio 20 1 15

10

0.5

5

0

0 Lowest

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2

3

4

Highest

56

PEG Ratio: Returning to the Beverage Sector Company Name Coca-Cola Bottling Molson Inc. Ltd. 'A' Anheuser-Busch Corby Distilleries Ltd. Chalone Wine Group Ltd. Andres Wines Ltd. 'A' Todhunter Int'l Brown-Forman 'B' Coors (Adolph) 'B' PepsiCo, Inc. Coca-Cola Boston Beer 'A' Whitman Corp. Mondavi (Robert) 'A' Coca-Cola Enterprises Hansen Natural Corp Average Aswath Damodaran

Trailing PE 29.18 43.65 24.31 16.24 21.76 8.96 8.94 10.07 23.02 33.00 44.33 10.59 25.19 16.47 37.14 9.70

Growth 9.50% 15.50% 11.00% 7.50% 14.00% 3.50% 3.00% 11.50% 10.00% 10.50% 19.00% 17.13% 11.50% 14.00% 27.00% 17.00%

Std Dev 20.58% 21.88% 22.92% 23.66% 24.08% 24.70% 25.74% 29.43% 29.52% 31.35% 35.51% 39.58% 44.26% 45.84% 51.34% 62.45%

PEG 3.07 2.82 2.21 2.16 1.55 2.56 2.98 0.88 2.30 3.14 2.33 0.62 2.19 1.18 1.38 0.57

22.66

0.13

0.33

2.00

57

Analyzing PE/Growth

Given that the PEG ratio is still determined by the expected growth rates, risk and cash flow patterns, it is necessary that we control for differences in these variables. n Regressing PEG against risk and a measure of the growth dispersion, we get: PEG = 3.61 - 2.86 (Expected Growth) - 3.75 (Std Deviation in Prices) R Squared = 44.75% n In other words, n

• PEG ratios will be lower for high growth companies • PEG ratios will be lower for high risk companies n

We also ran the regression using the deviation of the actual growth rate from the industry-average growth rate as the independent variable, with mixed results.

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58

Estimating the PEG Ratio for Hansen

n

Applying this regression to Hansen, the predicted PEG ratio for the firm can be estimated using Hansen’s measures for the independent variables: • Expected Growth Rate = 17.00% • Standard Deviation in Stock Prices = 62.45%

Plugging in, Expected PEG Ratio for Hansen = 3.61 - 2.86 (.17) - 3.75 (.6245) = 0.78 n With its actual PEG ratio of 0.57, Hansen looks undervalued, notwithstanding its high risk. n

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59

Extending the Comparables

n

n

This analysis, which is restricted to firms in the software sector, can be expanded to include all firms in the firm, as long as we control for differences in risk, growth and payout. To look at the cross sectional relationship, we first plotted PEG ratios against expected growth rates.

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60

PEG versus Growth 6

5

4

3

2

1

0 -1 -20

0

20

40

60

80

100

Expected Growth in EPS: next 5 years

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61

Analyzing the Relationship n

n

The relationship in not linear. In fact, the smallest firms seem to have the highest PEG ratios and PEG ratios become relatively stable at higher growth rates. To make the relationship more linear, we converted the expected growth rates in ln(expected growth rate). The relationship between PEG ratios and ln(expected growth rate) was then plotted.

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62

PEG versus ln(Expected Growth) 6

5

4

3

2

1

0 -1 -1

0

1

2

3

4

5

Ln(Expected Growth)

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63

Market PEG Ratio Regression Model Summary Model 1

R

.587a

R Square .344

Adjusted R Square .343

Std. Error of the Estimate 56.7746

a. Predictors: (Constant), LNGROWTH, PAYOUT1, Beta

Coefficients

Standar dized Coefficients

Unstandardized Coefficients Model 1

(Constant) Beta PAYOUT1 LNGROWTH

a,b

B 3.935

Std. Error .112

-7.249E-02 .575 -.867

.064 .084 .037

Beta -.025 .149 -.509

t 35.175

Sig. .000

-1.140 6.873 -23.522

.255 .000 .000

a. Dependent Variable: PEG1 b. Weighted Least Squares Regression - Weighted by Market Cap

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64

Applying the PEG ratio regression n

Consider Dell again. The stock has an expected growth rate of 10%, a beta of 1.40 and pays out no dividends. What should its PEG ratio be?

n

If the stock’s actual PE ratio is 18, what does this analysis tell you about the stock?

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65

A Variant on PEG Ratio: The PEGY ratio n

n

The PEG ratio is biased against low growth firms because the relationship between value and growth is non-linear. One variant that has been devised to consolidate the growth rate and the expected dividend yield: PEGY = PE / (Expected Growth Rate + Dividend Yield) As an example, Con Ed has a PE ratio of 16, an expected growth rate of 5% in earnings and a dividend yield of 4.5%. • PEG = 16/ 5 = 3.2 • PEGY = 16/(5+4.5) = 1.7

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66

Relative PE: Definition

n

n

n

The relative PE ratio of a firm is the ratio of the PE of the firm to the PE of the market. Relative PE = PE of Firm / PE of Market While the PE can be defined in terms of current earnings, trailing earnings or forward earnings, consistency requires that it be estimated using the same measure of earnings for both the firm and the market. Relative PE ratios are usually compared over time. Thus, a firm or sector which has historically traded at half the market PE (Relative PE = 0.5) is considered over valued if it is trading at a relative PE of 0.7.

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Relative PE: Cross Sectional Distribution

1000

800

600

400

200

Std. Dev = .77 Mean = 1.00 N = 3303.00

0

Relative PE

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Relative PE: Distributional Statistics

n n

The average relative PE is always one. The median relative PE is much lower, since PE ratios are skewed towards higher values. Thus, more companies trade at PE ratios less than the market PE and have relative PE ratios less than one.

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69

Relative PE: Determinants

n

To analyze the determinants of the relative PE ratios, let us revisit the discounted cash flow model we developed for the PE ratio. Using the 2-stage DDM model as our basis (replacing the payout ratio with the FCFE/Earnings Ratio, if necessary), we get n  ( 1 +g j )   Payout Ratio j * ( 1+ g j ) * 1 − n ( 1 +r )   j

Relative PE j =

rj - g j  ( 1 +g m ) n    Payout Ratio m * ( 1 +g m ) * 1 − n ( 1 +rm )   rm - gm

where Aswath Damodaran

n

+

+

Payout Ratio j,n * ( 1+ g j ) * ( 1+ g j,n ) (rj - g j,n )(1 + rj )

n

Payout Ratio m,n * ( 1 +g m )n * ( 1+ gm,n ) (rm - gm,n ) ( 1 +rm )

n

Payoutj, gj, rj = Payout, growth and risk of the firm Payoutm, gm, rm = Payout, growth and risk of the market 70

Relative PE: A Simple Example

Consider the following example of a firm growing at twice the rate as the market, while having the same growth and risk characteristics of the market: Firm Market Expected growth rate 20% 10% Length of Growth Period 5 years 5 years Payout Ratio: first 5 yrs 30% 30% Growth Rate after yr 5 6% 6% Payout Ratio after yr 5 50% 50% Beta 1.00 1.00 Riskfree Rate = 6% n

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71

Estimating Relative PE

n

The relative PE ratio for this firm can be estimated in two steps. First, we compute the PE ratio for the firm and the market separately: PE firm =

5  (1.20)  0 . 3 * (1.20) * 1−  (1.115) 5 

PE market =

n

(.115 - .20)

5  (1.10)  0 . 3 * (1.10) *  1−  (1.115)5 

(.115 - .10)

0.5 * (1.20)5 * (1.06) = 15.79 5 (.115 -.06) (1.115)

+

+

0.5 * (1.10) 5 *(1.06) = 10.45 5 (.115-.06) (1.115)

Relative PE Ratio = 15.79/10.45 = 1.51

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72

Relative PE and Relative Growth

Relative PE and Relative Growth Rates: Market Growth Scenarios 3.50

3.00

Relative PE

2.50

2.00

Market g=5% Market g=10% Market g=15%

1.50

1.00

0.50

0.00 0%

50%

100%

150%

200%

250%

300%

Firm's Growth Rate/Market Growth Rate

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73

Relative PE: Another Example

In this example, consider a firm with twice the risk as the market, while having the same growth and payout characteristics as the firm: Firm Market Expected growth rate 10% 10% Length of Growth Period 5 years 5 years Payout Ratio: first 5 yrs 30% 30% Growth Rate after yr 5 6% 6% Payout Ratio after yr 5 50% 50% Beta in first 5 years 2.00 1.00 Beta after year 5 1.00 1.00 Riskfree Rate = 6% n

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74

Estimating Relative PE

n

The relative PE ratio for this firm can be estimated in two steps. First, we compute the PE ratio for the firm and the market separately: PE firm =

 (1.10) 5  0.3 * (1.10)* 1 −  (1.17) 5 

PE market =

n

(.17 - . 1 0 )

0 . 5 * (1.10)5 * (1.06) + = 8.33 (.115-.06) (1.17)5

5  (1.10)  0 . 3 * (1.10) *  1−  (1.115)5 

(.115 - .10)

+

0.5 * (1.10) 5 *(1.06) = 10.45 5 (.115-.06) (1.115)

Relative PE Ratio = 8.33/10.45 = 0.80

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75

Relative PE and Relative Risk

Relative PE and Relative Risk: Stable Beta Scenarios 4.5

4

3.5

3

2.5 Beta stays at current level Beta drops to 1 in stable phase 2

1.5

1

0.5

0 0.25

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0.5

0.75

1

1.25

1.5

1.75

2

76

Relative PE: Summary of Determinants

n

The relative PE ratio of a firm is determined by two variables. In particular, it will • increase as the firm’s growth rate relative to the market increases. The rate of change in the relative PE will itself be a function of the market growth rate, with much greater changes when the market growth rate is higher. In other words, a firm or sector with a growth rate twice that of the market will have a much higher relative PE when the market growth rate is 10% than when it is 5%. • decrease as the firm’s risk relative to the market increases. The extent of the decrease depends upon how long the firm is expected to stay at this level of relative risk. If the different is permanent, the effect is much greater.

n

Relative PE ratios seem to be unaffected by the level of rates, which might give them a decided advantage over PE ratios.

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Relative PE Ratios: The Auto Sector

Relative PE Ratios: Auto Stocks 1.20

1.00

0.80

Ford Chrysler GM

0.60

0.40

0.20

0.00 1993

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1994

1995

1996

1997

1998

1999

2000

78

Using Relative PE ratios

n

On a relative PE basis, all of the automobile stocks look cheap because they are trading at their lowest relative PE ratios in five years. Why might the relative PE ratio be lower today than it was 5 years ago?

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Relative PEs: Why do they change?

n

Historically, GM has traded at the highest relative PE ratio of the three auto companies, and Chrysler has traded at the lowest. In the last two or three years, this historical relationship has been upended with Ford and Chrysler now trading at the higher ratios than GM. Analyst projections for earnings growth at the three companies are about the same. How would you explain the shift?

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80

Relative PE Ratios: Market Analysis Model Summary Model 1

R

.478a

R Square .229

Adjusted R Square .227

Std. Error of the Estimate 41.4196

a. Predictors: (Constant), Beta, RELPYT, RELGR

Coefficients

Standar dized Coefficients

Unstandardized Coefficients Model 1

(Constant) RELGR RELPYT Beta

B

a,b

.674

Std. Error .060

.835 4.431E-02 -.175

.038 .011 .047

Beta .527 .098 -.089

t 11.242

Sig. .000

22.115 4.150 -3.737

.000 .000 .000

a. Dependent Variable: RELPE b. Weighted Least Squares Regression - Weighted by Market Cap

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81

Value/Earnings and Value/Cashflow Ratios

While Price earnings ratios look at the market value of equity relative to earnings to equity investors, Value earnings ratios look at the market value of the firm relative to operating earnings. Value to cash flow ratios modify the earnings number to make it a cash flow number. n The form of value to cash flow ratios that has the closest parallels in DCF valuation is the value to Free Cash Flow to the Firm, which is defined as: Value/FCFF = (Market Value of Equity + Market Value of Debt-Cash) EBIT (1-t) - (Cap Ex - Deprecn) - Chg in WC n Consistency Tests: n

• •

Aswath Damodaran

If the numerator is net of cash (or if net debt is used, then the interest income from the cash should not be in denominator The interest expenses added back to get to EBIT should correspond to the debt in the numerator. If only long term debt is considered, only long term interest should be added back.

82

Value/FCFF Distribution 800

600

400

200 Std. Dev = 21.77 Mean = 20.6 N = 3063.00

0

Enterprise Value/FCFF

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83

Value of Firm/FCFF: Determinants

n

Reverting back to a two-stage FCFF DCF model, we get:  (1 + g)n  FCFF (1 + g) 1  n ( 1 +g ) 0 n FCFF ( 1 +g)  ( 1 +WACC)  0 n V0 = + WACC - g (WACC - g )(1 + WACC)n n • • •

V0 = Value of the firm (today) FCFF0 = Free Cashflow to the firm in current year g = Expected growth rate in FCFF in extraordinary growth period (first n years) • WACC = Weighted average cost of capital • gn = Expected growth rate in FCFF in stable growth period (after n years)

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Value Multiples

n

Dividing both sides by the FCFF yields,  (1 + g)n  (1 + g) 1  (1 + WACC)n  V0 ( 1 +g)n ( 1 +gn ) = + WACC - g FCFF0 (WACC - gn )(1 + WACC)n

n

The value/FCFF multiples is a function of • the cost of capital • the expected growth

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85

Alternatives to FCFF - EBIT and EBITDA

n

Most analysts find FCFF to complex or messy to use in multiples (partly because capital expenditures and working capital have to be estimated). They use modified versions of the multiple with the following alternative denominator: • after-tax operating income or EBIT(1-t) • pre-tax operating income or EBIT • net operating income (NOI), a slightly modified version of operating income, where any non-operating expenses and income is removed from the EBIT • EBITDA, which is earnings before interest, taxes, depreciation and amortization.

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86

Value/FCFF Multiples and the Alternatives

n

o o o o n

Assume that you have computed the value of a firm, using discounted cash flow models. Rank the following multiples in the order of magnitude from lowest to highest? Value/EBIT Value/EBIT(1-t) Value/FCFF Value/EBITDA What assumption(s) would you need to make for the Value/EBIT(1-t) ratio to be equal to the Value/FCFF multiple?

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87

Illustration: Using Value/FCFF Approaches to value a firm: MCI Communications n

n

n

n

n

MCI Communications had earnings before interest and taxes of $3356 million in 1994 (Its net income after taxes was $855 million). It had capital expenditures of $2500 million in 1994 and depreciation of $1100 million; Working capital increased by $250 million. It expects free cashflows to the firm to grow 15% a year for the next five years and 5% a year after that. The cost of capital is 10.50% for the next five years and 10% after that. The company faces a tax rate of 36%.

 (1.15)5  (1.15)  1V0 (1.105)5  (1.15) 5 (1.05) = 31.28 = + 5 FCFF0 .105 -.15 (.10 - .05)(1.105) Aswath Damodaran

88

Multiple Magic

n

In this case of MCI there is a big difference between the FCFF and short cut measures. For instance the following table illustrates the appropriate multiple using short cut measures, and the amount you would overpay by if you used the FCFF multiple. Free Cash Flow to the Firm = EBIT (1-t) - Net Cap Ex - Change in Working Capital = 3356 (1 - 0.36) + 1100 - 2500 - 250 = $ 498 million $ Value Correct Multiple FCFF $498 31.28382355 EBIT (1-t) $2,148 7.251163362 EBIT $ 3,356 4.640744552 EBITDA $4,456 3.49513885

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Reasons for Increased Use of Value/EBITDA

1. The multiple can be computed even for firms that are reporting net losses, since earnings before interest, taxes and depreciation are usually positive. 2. For firms in certain industries, such as cellular, which require a substantial investment in infrastructure and long gestation periods, this multiple seems to be more appropriate than the price/earnings ratio. 3. In leveraged buyouts, where the key factor is cash generated by the firm prior to all discretionary expenditures, the EBITDA is the measure of cash flows from operations that can be used to support debt payment at least in the short term. 4. By looking at cashflows prior to capital expenditures, it may provide a better estimate of “optimal value”, especially if the capital expenditures are unwise or earn substandard returns. 5. By looking at the value of the firm and cashflows to the firm it allows for comparisons across firms with different financial leverage. Aswath Damodaran 90

Value/EBITDA Multiple

n

The Classic Definition Market Value of Equity + Market Value of Debt Value = EBITDA Earnings before Interest, Taxes and Depreciation

n

The No-Cash Version

Enterprise Value Market Value of Equity + Market Value of Debt - Cash = EBITDA Earnings before Interest, Taxes and Depreciation n

When cash and marketable securities are netted out of value, none of the income from the cash and securities should be reflected in the denominator.

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91

Value/EBITDA Distribution 1200

1000

800

600

400

200

Std. Dev = 8.06 Mean = 8.0 N = 3630.00

0

EV/EBITDA

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92

The Determinants of Value/EBITDA Multiples: Linkage to DCF Valuation n

Firm value can be written as:

FCFF1 V0 = WACC - g n

The numerator can be written as follows: FCFF

Aswath Damodaran

= EBIT (1-t) - (Cex - Depr) - ∆ Working Capital = (EBITDA - Depr) (1-t) - (Cex - Depr) - ∆ Working Capital = EBITDA (1-t) + Depr (t) - Cex - ∆ Working Capital

93

From Firm Value to EBITDA Multiples

n

Now the Value of the firm can be rewritten as, Value =

EBITDA (1-t) + Depr (t) - Cex - ∆ Working Capital WACC - g

n Dividing both sides of the equation by EBITDA, (1- t) Depr (t)/EBITDA CEx/EBITDA ∆ Working Capital/EBITDA Value = + WACC-g WACC - g WACC - g WACC - g EBITDA

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94

A Simple Example

n

Consider a firm with the following characteristics: • • • • • •

Aswath Damodaran

Tax Rate = 36% Capital Expenditures/EBITDA = 30% Depreciation/EBITDA = 20% Cost of Capital = 10% The firm has no working capital requirements The firm is in stable growth and is expected to grow 5% a year forever.

95

Calculating Value/EBITDA Multiple

n

In this case, the Value/EBITDA multiple for this firm can be estimated as follows: Value = EBITDA

Aswath Damodaran

( 1 -.36) (0.2)(.36) 0.3 0 + = 8.24 .10 - . 0 5 .10 - . 0 5 .10 - .05 .10 - .05

96

Value/EBITDA Multiples and Taxes

VEBITDA Multiples and Tax Rates 16

14

12

Value/EBITDA

10

8

6

4

2

0 0%

10%

20%

30%

40%

50%

Tax Rate

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97

Value/EBITDA and Net Cap Ex

Value/EBITDA and Net Cap Ex Ratios 12

10

Value/EBITDA

8

6

4

2

0 0%

5%

10%

15%

20%

25%

30%

Net Cap Ex/EBITDA

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98

Value/EBITDA Multiples and Return on Capital

Value/EBITDA and Return on Capital 12

10

Value/EBITDA

8

WACC=10% WACC=9% WACC=8%

6

4

2

0 6%

7%

8%

9%

10%

11%

12%

13%

14%

15%

Return on Capital

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99

Value/EBITDA Multiple: Trucking Companies Company Name KLLM Trans. Svcs. Ryder System Rollins Truck Leasing Cannon Express Inc. Hunt (J.B.) Yellow Corp. Roadway Express Marten Transport Ltd. Kenan Transport Co. M.S. Carriers Old Dominion Freight Trimac Ltd Matlack Systems XTRA Corp. Covenant Transport Inc Builders Transport Werner Enterprises Landstar Sys. AMERCO USA Truck Frozen Food Express Arnold Inds. Greyhound Lines Inc. USFreightways Golden Eagle Group Inc. Arkansas Best Airlease Ltd. Celadon Group Amer. Freightways Transfinancial Holdings Vitran Corp. 'A' Interpool Inc. Intrenet Inc. Swift Transportation Landair Services CNF Transportation Budget Group Inc Caliber System Knight Transportation Inc Heartland Express Greyhound CDA Transn Corp Mark VII Coach USA Inc US 1 Inds Inc. Average

Aswath Damodaran

Value $ 114.32 $ 5,158.04 $ 1,368.35 $ 83.57 $ 982.67 $ 931.47 $ 554.96 $ 116.93 $ 67.66 $ 344.93 $ 170.42 $ 661.18 $ 112.42 $ 1,708.57 $ 259.16 $ 221.09 $ 844.39 $ 422.79 $ 1,632.30 $ 141.77 $ 164.17 $ 472.27 $ 437.71 $ 983.86 $ 12.50 $ 578.78 $ 73.64 $ 182.30 $ 716.15 $ 56.92 $ 140.68 $ 1,002.20 $ 70.23 $ 835.58 $ 212.95 $ 2,700.69 $ 1,247.30 $ 2,514.99 $ 269.01 $ 727.50 $ 83.25 $ 160.45 $ 678.38 $ 5.60

EBITDA Value/EBITDA $ 48.81 2.34 $ 1,838.26 2.81 $ 447.67 3.06 $ 27.05 3.09 $ 310.22 3.17 $ 292.82 3.18 $ 169.38 3.28 $ 35.62 3.28 $ 19.44 3.48 $ 97.85 3.53 $ 45.13 3.78 $ 174.28 3.79 $ 28.94 3.88 $ 427.30 4.00 $ 64.35 4.03 $ 51.44 4.30 $ 196.15 4.30 $ 95.20 4.44 $ 345.78 4.72 $ 29.93 4.74 $ 34.10 4.81 $ 96.88 4.87 $ 89.61 4.88 $ 198.91 4.95 $ 2.33 5.37 $ 107.15 5.40 $ 13.48 5.46 $ 32.72 5.57 $ 120.94 5.92 $ 8.79 6.47 $ 21.51 6.54 $ 151.18 6.63 $ 10.38 6.77 $ 121.34 6.89 $ 30.38 7.01 $ 366.99 7.36 $ 166.71 7.48 $ 333.13 7.55 $ 28.20 9.54 $ 64.62 11.26 $ 6.99 11.91 $ 12.96 12.38 $ 51.76 13.11 $ (0.17) NA 5.61

100

A Test on EBITDA

n

Ryder System looks very cheap on a Value/EBITDA multiple basis, relative to the rest of the sector. What explanation (other than misvaluation) might there be for this difference?

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101

Analyzing the Value/EBITDA Multiple

n

While low value/EBITDA multiples may be a symptom of undervaluation, a few questions need to be answered: • Is the operating income next year expected to be significantly lower than the EBITDA for the most recent period? (Price may have dropped) • Does the firm have significant capital expenditures coming up? (In the trucking business, the life of the trucking fleet would be a good indicator) • Does the firm have a much higher cost of capital than other firms in the sector? • Does the firm face a much higher tax rate than other firms in the sector?

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102

Value/EBITDA Multiples: Market

n

The multiple of value to EBITDA varies widely across firms in the market, depending upon: • how capital intensive the firm is (high capital intensity firms will tend to have lower value/EBITDA ratios), and how much reinvestment is needed to keep the business going and create growth • how high or low the cost of capital is (higher costs of capital will lead to lower Value/EBITDA multiples) • how high or low expected growth is in the sector (high growth sectors will tend to have higher Value/EBITDA multiples)

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103