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What are the three Present Value Factors?
- If no growth: 1/(1+r)^n
- If constant growth: 1/(r-g), where g=growth rate calculated as [retention rate x ROI] OR (1-payout rate) x ROI
- If variable growth: FCF x (1+g)^n / (1+r)^n
Present Value of an Annuity Factor
[1 - (1 / (1 + r) ^ n)] / r
Stock value (price) per Share Using Dividend Method w/o Growth
- P = D/R, where
- P=stock price, D=dividend, R=REQUIRED RETURN (not interest rate) like CAPM
- NOTE: The denominator is not (1+r), it's simply the required return.
Stock value (price) per Share Using Dividend Discount Model w/ Growth. How is this formula calculated if the purchase is planned to occur in 2 years time?
- Current share price = dividend amount in 1 year / (required return - growth rate).
- Dividend amount in 1 year would be current dividend x (1+growth rate).
- Share price in 2 years = dividend amt 3 years in the future / (required return - growth rate)
What is the calculation for EPS?
EPS = (Net income - preferred dividends) / shares outstanding
If a company's PE is 5x, but the industry avg PE is 7x, this company is relatively (a) undervalued, (b) appropriately valued, or (c) overvalued.
Price to earnings (P/E); modified to value (price) a stock
- P/E = Current price / EPS, where EPS is typically derived from the earnings projected over the next 4 quarters [aka Forward EPS] rather than previous 4 quarters [aka Trailing EPS].
- To value a stock, find the P/E of a similar company, then use the EPS of the current company as follows...
- PE (of competitor) * forward EPS (of this company) = the price this company's stock should be trading at.
PEG (price to earnings growth); modified to value a stock. Which is more attractive - a lower or higher PEG?
- P/E/G = Current price / (current EPS x (1+growth rate)) / (growth rate x 100), where EPS is typically Forward EPS which is why it's current EPS x (1+growth rate).
- To value a stock, find the P/E/G of a similar company, then use the EPS of the current company as follows...
- PEG (of competitor) * forward EPS (of this company) * (growth rate x 100) = the price this company's stock should be trading at.
- A lower PEG tends to indicate higher growth rates and are more attractive and indicates the stock is undervalued.
Which variable in the PEG creates the most dramatic change to the multiple?
A change in growth rate has the most dramatic effect.
What is the interpretation if P/E of a company is higher than the industry, but PEG is lower than the industry?
P/E may indicate the stock is overvalued; however, with PEG lower than the industry it is likely the market believes the company has a higher growth potential and is worth the higher price/share that drives PE up.
Price-to-Sales Ratio; modified to value a stock
- P/S = Current price / sales at end of year per share.
- To value a stock, find the P/S of a similar company, then use the expected sales of the current company as follows...
- P/S (of competitor) * sales (of this company) = the price this company's stock should be trading at.
What is the advantage of using Price to Sales ratio? P/S is best used with which types of companies?
- Sales are less subject to manipulation than earnings.
- This ratio is not as volatile.
- The Becker book says "mature or cyclical companies" but the video says "New or start-up companies" because new companies don't typically have positive earnings, but they should have revenues.
Price-to-Book Ratio; modified to value a stock
- P/B = Current price / book value per share of common equity.
- To value a stock, find the P/B of a similar company, then use the BV per share of common equity of the current company as follows...
- P/B (of competitor) * BV = the price this company's stock should be trading at.
How is Book Value per share calculated?
- (Assets - Liabilities - Preferred equity - Preferred stock dividends in arrears) / number of common stock shares outstanding OR
- (Total equity - preferred stock - preferred dividends in arrears) / number of common stock shares outstanding
What is the advantage of using the Price-to-Book ratio? What are the limitations?
- Because the balance sheet is cumulative, it is inherently less volatile and not as subject to manipulation as items on the income statement.
- Can also be used when EPS is negative or zero.
- Limitations: book value depends on the year assets were purchased (and thus their age and amount of depreciation taken); thus, this ratio isn't favored for capital-intensive industries.
- Intangibles aren't included in book value when developed internally and will skew fair market value of the equity b/c it's not included in the calculation.
Price-to-Cash Flow; modified to value a stock
- P/CF = current price / expected cash flow in one year on a per share basis
- To value a stock, find the P/CF of a similar company, then use the future CF of the current company as follows...
- P/CF (of competitor) * future CF (of this company) = the price this company's stock should be trading at.
Which of these is less subject to management bias and thus produces the most accurate ratio comparison? Ratios that use items from the (1) income statement, (2) balance sheet, (3) cash flow.
- (3) Cash flows cannot generally be manipulated by management bias and provide the best ratio analysis.
- (bonus) Sales are the next best option.
What is the limitation of using any of the ratios that include items from the income statement (such as net income)?
Methods of accounting can dramatically change these figures, such as different methods of inventory costing (affects COGS), or depreciation methods (affects depreciation expense).