Section 2 Per-share numbers and price multiples

Transcription

1 Section 2 Per-share numbers and price multiples Everything should be as simple as possible, but not simpler. --Albert Einstein 1

2 Learning objectives After studying this chapter, you will understand How per-share financial numbers are calculated How per-share financial numbers can be used for simple analysis and prediction of firms financial performance How price multiples are calculated How to use per-share financial numbers and price multiples to calculate the expected stock return 2

3 Per-share financial numbers Key financial statement items are also calculated as per-share numbers A given financial statement number is divided by the number of shares outstanding There is even an IFRS standard (IAS 33 Earnings per Share ) that describes how earnings are divided by the number of shares outstanding Per-share numbers typically include Earnings per share Dividends per share Book value of equity per share 3

4 Earnings per share, EPS According to IAS 33 Earnings per Share : An entity shall calculate basic earnings per share amounts of profits or loss attributable to ordinary equity holders of the parent entity. (IAS 33.9) Basic earnings per share shall be calculated by dividing profit or loss attributable to ordinary equity holders of the parent entity (the numerator) by the weighted average number of ordinary shares outstanding (the denominator) during the period. (IAS 33.10). IAS regulates the calculation of the diluted earnings per share US GAAP requires essentially similar EPS numbers 4

5 Example, Weighted average # of shares # of shares in the beginning of the fiscal year: 1000 On Jun 1, a firm issues 200 new shares On Dec 1, a firm buys back 100 shares # of shares varies during the year as follows: Jan 1 Beginning of the fiscal year 1000 Jun 1 Share issue: +200 new shares 1200 Dec 1 Stock repurchase: -100 shares 1100 Dec 31 End of the fiscal year 1100 Weighted average # of shares outstanding during the year is: ( / 12) + ( / 12 ) + ( / 12 ) =

6 6 Example, Average # of shares of Kone 701,8 / 512,639 = 1, , ,400 = 515, ,8 / 515,040 = 1,3626

7 Dividend per share (DPS), and book value of equity per share (BPS) Dividend per share, DPS, is calculated by dividing total dividends paid by the weighted average # of shares outstanding Book value of equity per share, BPS, is calculated by dividing book equity by the weighted average # of shares outstanding These per-share numbers are frequently used in financial statement analysis They are not regulated by IFRS 7

8 Example: EPS of Novo Nordisk 14,0 12,0 10,0 8,0 6,0 4,0 2,0 0,0 Have you heard about the financial crisis? 8

9 Example (cont.): Stock price (P) and EPS EPS P

10 Example (cont.): P/E-ratio (Stock price divided by EPS) 40,00 35,00 30,00 25,00 20,00 15,00 10,00 5,00 0,00 10

11 Example: EPS of another type of company 10,00 OUTOKUMPU OYJ 8,00 6,00 4,00 2,00 0,00-2,00-4,00-6,00 Will the financial crisis continue for ever? 11

12 Example (cont.): Stock price EPS of another type of company OUTOKUMPU OYJ 10,00 8,00 EPS P 180,00 160,00 6,00 140,00 4,00 120,00 2,00 100,00 80,00 0,00 60,00-2,00 40,00-4,00 20,00-6,00 0,00 12

13 P/E ratio: a price multiple P/E ratio is calculated by dividing stock price by (forecasted) earnings per share P/E = P/EPS Reflects the relative valuation of a stock given the current stock price and EPS P/E ratio changes over time for two reasons Earnings per share (EPS) changes Stock price (P) changes Market-level P/E-ratio predicts long-term stock returns There is also a huge literature showing that the firmlevel P/E ratio predicts stock returns 13

14 How to use forecasted EPS, DPS and P/E ratio to calculate expected stock return? 1. Forecast EPS over next few years 2. Calculate the average P/E ratio over past years 3. Calculate the forecasted stock price by using forecasted EPS and P/E ratio P/E = P/EPS P = P/E EPS 4. Include forecasted dividends (DPS) 5. Calculate the expected return Note: This methodology is very sensitive to forecast errors in EPS, and hence applies only to firms with a very strong and predictable business! 14

15 Example: Expected stock return of Novo Year Forecasted EPS 10,26 11,69 13,26 Forecasted DPS 4,86 5,41 6,28 Average P/E ratio over is 21,12 Projected stock price as of Dec 31, 2016: P(2016) = EPS(2016) P/E(2016) = 13,26 21,12 = 280,05 Expected annualized stock return in Dec, 2013: R = 1 + P 2016+D D D 2016 P 2013 P /3 1 = ,05+4,86+5,41+6,28 198,80 198,80 1/3 1 = 0,14 = 14%. 15

16 Example (cont.): Expected stock return of Novo The level of the purchasing price matters a lot for the level of expected return In Feb-March, 2014, stock price of Novo Nordisk was 230 If stocks were purchased at that price, the expected annualized stock return would have been: R = 1 + P 2016+D D D 2016 P 1/ = P ,05+4,86+5,41+6,28 230,00 1/3 1 = 0,088 = 8,8%. 230,00 16

17 Example (cont.): Expected stock return of Novo In October - November, 2013, stock price of Novo Nordisk was 180 If stocks were purchased at that price, the expected annualized stock return would have been: R = 1 + P D D D 2016 P ,05+4,86+5,41+6,28 180,00 180,00 P /3 1/3 1 = 0,181 = 18,1%. 1 = Timing the purchase by few months earlier increased the expected annual return from 8,8% to 18,1%!! 17

18 Simple facts about P/E ratios Stock price increases, but the stock becomes cheaper in terms of its P/E ratio! Earnings of the firm (E) increase more than stock price (P) Stock price decreases, but the stock becomes more expensive in terms of its P/E ratio! Earnings of the firm (E) decrease more than stock price (P) P/E ratio does not change, but stock price goes heavily up or down Earnings and stock price move at the same pace keeping P/E ratio unchanged 18

19 Simple facts about P/E ratios Look for companies, where Earnings are temporarily low, and/or Stock price is temporarily low Double effect expected due to the future 1. P/E-ratio expansion and 2. Earnings increase Avoid investing in companies, where Earnings are exceptionally high, and/or Stock price, i.e. pricing of earnings, is also at an exceptionally high level An excellent company may be a bad investment! 19

20 P/D ratio The price/dividends ratio is calculated by dividing stock price (P) by the dividends per share (DPS) P/D = P/DPS The logic of P/D ratio is similar to that of the P/E-ratio Recall that dividends are the part of earnings that is not reinvested to the firm Can be used to calculate the expected return on a stock Robert Schiller and many others have shown that the market-level P/D ratio predicts long-term stock returns 20

21 P/B ratio Price/Book ratio is calculated by dividing stock price (P) by the book value of equity per share (BPS) P/B = P/BPS Describes how the market value of equity differs from its book value High P/B ratio indicates high growth prospects for the firm Can be used to calculate the expected return on a stock 21

22 Financial statement analysis and firm valuation in the big picture Financial statement analysis - What drives current earnings? Profit margins Efficient use of capital Use of financial leverage - How to predict future earnings? Growth - What are the risks related to future earnings? Liquidity Financial leverage 22 Firm valuation: 1. Price multiples 2. Valuation models Current stock price is a function of future discounted earnings, cash flows or dividends

23 Summary Key financial statement items are often reported as pershare numbers Allow a direct comparison with stock price Price multiples indicate the relative valuation of a stock Price-to-earnings ratio indicates how earnings taste for investors Price multiples can be used to calculate the expected return on a stock Per-share numbers and price multiples may provide you with a very useful short-cut financial analysis of the company 23