Relative valuation and Technical Analysis

Transcription

1 Relative valuation and Technical Analysis

2 Relative vs. fundamental valuation The DCF model is a method of fundamental valuation. Value of equity is the present value of future cash flows. Ignores the current level of the stock market. Appropriate for comparing investments across different asset classes In the long run, fundamental valuation is the theoretically correct method of valuing any asset.

3 Relative vs. fundamental valuation Relative valuation is based on P/E ratios and a host of other multiples Popular with the press, stock brokers, Used to value one stock against another. Cannot compare values across different asset classes Prices can be standardized using a common variable such as earnings, cashflows, book value or revenues.

4 Multiples Relative valuation relies on the use of multiples and a little algebra. For example: house prices.. House Price Sq ft. Price/sq ft A $ 629,500 4,032 $ B $ 595,000 3,621 $ C $ 545,000 3,400 $ D $ 499,000 3,400 $ E $ 439,000 3,000 $ Average $ What is the price of a 4,000 sq ft house? Answer: *4,000 = $619,080

5 Multiples can be misleading To use a multiple intelligently you must: Know what the fundamentals are that determine the multiple. Know how changes in these fundamentals change the multiple. Know what the distribution of the multiple looks like. Ensure that both the denominator and numerator represents claims to the same group OK: P/E Price => Equityholders, EPS => Equityholders Not OK: P/EBIT Price =>Equity, EBIT => all claimholders Ensure that the firms are comparable

6 Price Earnings Ratios PE = Market Price per Share / Earnings per Share 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: current price or average price for the year EPS: most recent financial year trailing 12 months (Trailing PE) forecasted eps (Forward PE)

7 PE Ratio: Understanding the Fundamentals To understand the fundamentals, start with a basic equity discounted cash flow model. With the constant growth dividend discount model, D k 1 V0 = g Dividing both sides by the (forecasted) earnings per share, V E 0 = 1 PE = 1 - b k -ROE(g)

8 PE Ratio: Understanding the Fundamentals Holding all else equal: higher growth firms higher risk firms firms with lower reinvestment needs Of course, other things are difficult to hold equal since high growth firms, tend to have risk and high reinvestment rates.

9 Example: Valuing a firm using P/E ratios In an industry we identify 4 stocks that are similar to the stock we wish to value. Stock A PE=14 Stock B PE=18 Stock C PE=24 Stock D PE=21 The average P/E = Our firm has EPS of $2.10

10 Value/?? Variants: Free cash flow to the firm or FCFF after-tax operating income or EBIT(1-t) pre-tax operating income or EBIT EBITDA, which is earnings before interest, taxes, depreciation and amortization. Value MV Equity + MV = EBITDA EBITDA Debt

11 Value/EBITDA Multiple The No-Cash Version EV EBITDA = Market Value of Equity + Market Value of Debt - Cash Earnings before Interest, Taxes and Depreciation 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. The no-cash version is also called Enterprise Value

12 Enterprise value EV =Market value of equity+debt-cash and marketable securities

13 Reasons for Increased Use of Value/EBITDA 1. The multiple can be computed even for firms that are reporting net losses, since EBITDA is usually positive. 2. More appropriate than the price/earnings ratio for high growth firms. 3 Allows for comparisons across firms with different financial leverage.

14 Price (market) to Book Value Ratio Ratio of the market value of equity to the book value of equity, i.e., the measure of shareholders equity in the balance sheet. P = B Market Value of Equity Book Value of Equity In 2004 the average Price/book for US firms was a little less than 4.

15 Market to Book Ratio: Stable Growth Firm P0 ROE* Payout Ratio* (1+ g) = PBV = BV0 k-g If the return on equity is based upon expected earnings in the next time period, this can be simplified to, P BV 0 = 0 PBV = ROE* Payout k-g Ratio

16 Market to Book Ratio: Stable Growth Firm This formulation can be simplified even further by relating growth to the return on equity: g = (1 - Payout ratio) * ROE=> payout ratio = 1 - g/roe Substituting back into the P/BV equation, P BV 0 PBV g ROE 1 ROE k - g 0 = = = ROE k-g - g

17 Price to Sales Ratio The price/sales ratio is the ratio of the market value of equity to the sales. P = S MV Equity Total Revenues V Sales 0 Net = Profit Margin* Payout k-g Ratio* (1 0 + g)

18 Price Sales Ratios and Profit Margins A key determinant of price-sales ratios is the profit margin. A decline in profit margins has a two-fold effect.

19 Choosing Between the Multiples There are dozens of multiples. The multiple that is used can be chosen in one of two ways: Use the multiple that best fits your objective. Thus, if you want the company to be undervalued, you pick the multiple that yields the highest value. Use the multiple that seems to make the most sense for that sector, given how value is measured and created.

20 Dow Theory The primary direction is either bullish or bearish, and reflects the long-run direction of the market. Prices Daily fluctuations are essentially noise and are of no real importance. Secondary trends are temporary departures from the primary direction. DJIA DJTA If a departure in one is followed by a departure in the other, then this is viewed as a confirmation that the primary trend has changed. Corrections are reversions back Time to the primary direction.

21 Support and Resistance Levels Support level Resistance level Resistance and support areas are usually viewed as psychological barriers - bargain hunters help support the lower level, while profit takers resist the upper level.

22 Point and Figure Chart

23 Candlestick

24 Technical Indicators Sentiment trin Odd-lot trading Confidence index Put/call ratio Mutual fund cash position

25 Technical Indicators Flow of Funds Short interest Credit balances in brokerage accounts Market Structure Moving averages Breadth Relative strength