Equity valuation

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ngaprock

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I have some questions about equity valuation by market-based approach.
1. Effects of price multiples by method of comparables also by method of forecasted fundamentals?
As I understood, the justified price multiple of a stock is used to:
- compare with the actual multiple to know the stock is over/ fair/ undervalued
- estimate the terminal value
-> Does the justified price multiple have any other effect?
2. To calculate intrinsic value of equity, analysts in my country can use many method (FCFE, DDM, multiples) & then combine results of each method with weights to give a final value. Problem is analysts give weight by their feeling without principles. So, how about in America & how your experience?
Tks you so much
 
1. No, it tells you what ratio is justified given the fundamentals of the stock, relative to the market, then you compare that to the actual ratio to find differences in valuation, or compute the terminal value for a given price level.
2. Generally weights are given mostly to FCF valuations (70%) and the rest to multiples (30%). But of course there are no rules and it depends on the firm’s policy and analyst’s subjectivity. But I don’t have any personal experience in the US to answer that properly.
 
Ok MrSmart
When chose the benchmark, we need consider the stocks are similar risk level -> this mean they are in same industry, same country, similar financial leverage -> anything else?
How about the conglomerate, multinational companies? Could we can use this approach to evaluate?
 
Unfortunately, no one can give you a clear cut answer on this.
They don’t need to be in the same industry, nor even the same country. The comparables should be close as possible to three characteristics. Growth, risk, and cash flow pattern. But there are huge limitations in using that concept. Primarily that relative growth, risk, and cash flow provide a biased measure of intrinsic value. However, using a multivariate regression, you can control for variables between firms that you think would lead to a big discrepency between multiples. But on the downside, variables like growth and risk are not independent most of the time.
In conglomerate companies, you break down the firm into seperate business units, and treat each SBU as a firm on it’s own. Then use the sum-of-parts valuation to adjust for synergies that all the business units provide to collectively create more value than their seperate performance alone.
 
You can’t be sure. This is why using stocks in the same industry provides a confirmation (biased more often than not) to the growth, risk, and cash flow pattern of the target company. Look at it this way, the P/E ratio (for example) would be justified and identical between two companies, let’s say an airline company and a hypermatket, if both of their growth patterns, exposure to risk, and cash flow stream are also identical. So in theory, you don’t need them to be in the same industry, but using stocks in the same industry, and as close to the target’s size as possible, provides a decent amount of certainity for the practitioner that the GRCF going forward will be closely correlated. This is basically the idea behind using a universe of comparables in relative valuation.
Comparing them cross country, you’d adjust for inflation and other macroeconomic factors, typically using real growth rates, required returns, and cash flow, and converting currency. Or using their nominal values but adjusting for interest rate and inflation rate differences. But that’s if you believe with a decent amount of certianity that their profiles are close.
Another method of getting the justified relative metrics is through regression, even using a global scale..Like running a multivariate regression on growth and risk, like P/E = Expected growth+Global beta, or P/E = Expected growth + Standard deviation of stock price. But three limitations for regressions like this are your choice of comparables need to be consistent, you have to assume that the relationship between multiples and fundamentals are linear, and the multicollinearaity has to be close to zero as possible. The regression result gives the predicted multiple using the fundamental variables of any company you choose, of course you have to take into account the significane level of the variables, and the R-squared value.
I’d suggest you read Damodaran’s book, since you seem to be famillar with his website. He is the only one I know of who has written extensively on relative valuation regressions. His CRP calculations are ok.
My 2 cents.
 
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