Valuing Stocks - Relative Valuation

There are two basic methods of valuing stocks:

• Relative valuation
• Absolute valuation or Intrinsic Valuation

The most frequently used method is relative valuation, which compares a stock's valuation with those of other stocks or with the company's own historical valuations.  

For example, if you were considering the relative valuation for a chemical company CC, you would compare its stock's price/earnings ratio (or its price/sales ratio, etc.) with that of other chemicals makers or with that of the overall stock market.  

• If CC has a P/E ratio of 16 and the average for the industry is closer to, say 25, CC's shares are cheap on a relative basis.  
• You can also compare CC's P/E with the average P/E of an index, such as the S&P 500,  to see whether CC still looked cheap.  

The problem with relative valuations is that not all companies are made alike - not even all chemicals makers.

There could be very good reasons why CC has a lower P/E than its average peer.  

• Maybe the company doesn't have the growth prospects of other chemicals companies.  
• Maybe the possible liability from a product litigation rightly puts a damper on the stock's price.  

After all, a Hyundai has a lower sticker price than a Mercedes, but for very good reasons.

The key is to research your stocks well and be aware of the factors that might justifiably make them cheaper or more expensive than similar stocks.

It's actually growth that determines value. You can't encapsulate the inherent value of a business in a P/E ratio.

Some of the market's biggest winners were trading at prices above 30 times earnings before they made their move.

A stock with a P/E below 10 may be a better deal than another trading at a P/E above 20. But then again it might not. 

The point is, when you become a part owner in a company, you have a claim not just on today's earnings, but all future profits as well. The faster the company is growing, the more that future cash flow stream is worth to shareholders.

That's why Warren Buffett likes to say that "growth and value are joined at the hip."

You can't encapsulate the inherent value of a business in a P/E ratio.  It's actually growth that determines value.  

The PEG ratio is used to evaluate a stock's valuation while taking into account earnings growth. A rule of thumb is that a PEG of 1.0 indicates fair value, less than 1.0 indicates the stock is undervalued, and more than 1.0 indicates it's overvalued.  Here's how it works:

If Stock ABC is trading with a P/E ratio of 25, a value investor might deem it "expensive." But if its earnings growth rate is projected to be 30%, its PEG ratio would be 25 / 30 PEG.83. The PEG ratio says that Stock ABC is undervalued relative to its growth potential.

It is important to realize that relying on one metric alone will almost never give you an accurate measure of value. Being able to use and interprete a number of measures will give you a better idea of the whole picture when evaluating a stock's performance and potential. 

Why We Look at the PEG Ratio

One of the more popular ratios stock analysts look at is the P/E, or price to earnings, ratio. The drawback to a P/E ratio is that it does not account for growth. A low P/E may seem like a positive sign for the stock, but if the company is not growing, its stock's value is also not likely to rise. The PEG ratio solves this problem by including a growth factor into its calculation. PEG is calculated by dividing the stock's P/E ratio by its expected 12 month growth rate. 

How to Score the PEG Ratio
Pass—Give the PEG Ratio a passing score if its value is less than 1.0.
Fail—Give the PEG Ratio a failing score if its value is greater than 1.0.

Don't be a stockpicking monkey, mistaking skill for luck. Learn DCF and PER 101.

Don't be a stockpicking monkey
Greg Hoffman
March 21, 2011 - 12:06PM

Monkeys are great stockpickers. Had your common-or-garden variety primate randomly selected five stocks in March 2009, chances are it would now be sitting on huge capital gains, contemplating reinvesting them in bananas - by the truckload.

It's easy enough for us to see that our monkey, who now sees himself as a future fund manager, is mistaking skill for luck. What's harder for us to see is how we might be making the same mistake ourselves.

If examining your portfolio's returns over the past few years engenders in you a feeling of self-satisfaction, you're running that risk. With the sharemarket falling recently now is the time to educate yourself. Consider what follows a lesson in fire safety.


Value investing is theoretically simple: buy assets for less than they're worth and sell when they approach or move beyond fair value. So too are valuing assets: discount future cash flows back to today at an appropriate interest rate for the life of the asset. The discounted cash flow (DCF) model is a commonly-used tool, hammered into every finance and business student.

But DCF models quickly deteriorate when they meet a rapidly changing world. The fact that most analysts failed to consider the impact of falling US house prices on their models played a major role in triggering the global financial crisis. Worse still, the misleading precision imbues investors with unwarranted overconfidence. Too often, models are precisely wrong.

Other tools are available to help you avoid this error. The price-to-earnings ratio (PER) is a regularly used proxy for stock valuation but also one of the most overused and abused metrics. To make use of it you need to know when to use it and when not to.

PER 101

The PER compares the current price of a stock with the prior year's (historical) or the current year's (forecast) earnings per share (EPS). Usually the prior year's EPS is used, but be sure to check first.

Last financial year, XYZ Ltd made $8 million in net profit (or earnings). The company has 1 million shares outstanding, so it achieved earnings per share (EPS) of $8.00 ($8 million profit divided by 1 million shares). In the current year, XYZ is expected to earn $10 million; a forecast EPS of $10.00.

At the current share price of $100, the stock is therefore trading on a historic PER of 12.5 ($100/$8). Using the forecast for current year's earnings, the forward or “forecast PER” is 10 ($100/$10).

It's often said that the PER is an estimate of the number of years it'll take investors to recoup their money. Unless all profits are paid out as dividends, something that rarely persists in real life, this is incorrect.

So ignore what you might read in simplistic articles and note this down: a PER is a reflection not of what you earn from a stock, but “what investors as a group are prepared to pay for the earnings of a company”.

All things being equal, the lower the PER, the better. But the list of caveats is long and vital to understand if you're to make full use of this metric.

Quality usually comes with a price to match. It costs more, for example, to buy handcrafted leather goods from France than it does a cheap substitute from China. Stocks are no different: high quality businesses generally, and rightfully, trade on higher PERs than poorer quality businesses.

Value investors love a bargain. Indeed, they're defined by this quality. But whilst a low PER for a quality business can indicate value, it doesn't alone guarantee it. Because PERs are only a shortcut for valuation, further research is mandatory.

Likewise, a high PER doesn't ensure that a stock is expensive. A company with strong future earnings growth may justify a high PER, and may even be a bargain. A stock with temporarily depressed profits, especially if caused by a one-off event, may justifiably trade at a high PER. But for a poor quality business with little prospects for growth, a high PER is likely to be undeserved.

Common trap

There's another trap: PERs are often calculated using reported profit, especially in newspapers or on financial websites. But one-off events often distort headline profit numbers and therefore the PER. Using underlying, or “normalised”, earnings in your PER calculation is likely to give a truer picture of a stock's value.

That begs the question; what is a normal level of earnings? That's the $64 million dollar question. If you don't know how to calculate these figures for the stocks in your portfolio, now is the time to establish whether it's skill or luck that's driving your returns. And if you don't know that, history may well make a monkey of you.



Greg Hoffman is research director of The Intelligent Investor.

http://www.brisbanetimes.com.au/business/dont-be-a-stockpicking-monkey-20110321-1c32p.html

Evaluating a Stock

HOW-TO GUIDE HOME
INVESTING

Evaluating a Stock

Main points:

The most common measure of a stock is the price/earnings, or P/E ratio, which takes the share price and divides it by a company's annual net income.

Generally, stocks with P/Es higher than the broader market P/E are considered expensive, while lower-P/E stocks are considered not so expensive.

Don't automatically go for stocks with low P/Es simply because they are cheaper. Cheap stocks aren't always good stocks.


The following is adapted from “The Complete Money and Investing Guidebook” by Dave Kansas.

In assessing investments such as stock, investors consider the stock’s valuation, strategy, plans for diversification and appetite for risk. Stocks are evaluated in many ways, and most of the common measuring sticks are easily available online or in the print and online versions of The Wall Street Journal.

The most basic measure of a stock’s worth involves that company’s earnings. When you buy a stock, you’re acquiring a piece of the company, so profitability is an important consideration. Imagine buying a store. Before deciding how much to spend, you want to know how much money that store makes. If it makes a lot, you’ll have to pay more to acquire it. Now imagine dividing the store into a thousand ownership pieces. These pieces are similar to stock shares, in the sense that you are acquiring a piece of the business, rather than the whole thing.

The business can pay you for your ownership stake in several ways. It can give you a portion of the profits, which for shareholders comes in the form of a periodic dividend. It can continue to expand the business, reinvesting money earned to increase profitability and raise the overall value of the business. In such cases, a more valuable business makes each piece, or share, of the business more valuable. In such a scenario, the more valuable share merits a higher price, giving the share’s owner capital appreciation, also known as a rising stock price.

Not every company pays a dividend. In fact, many fast-growing companies prefer to reinvest their cash rather than pay a dividend. Large, steadier companies are more likely to pay a dividend than are their smaller, more volatile counterparts.

The most common measure for stocks is the price to earnings ratio, known as the P/E. This measure, available in stock tables, takes the share price and divides it by a company’s annual net income. So a stock trading for $20 and boasting annual net income of $2 a share would have a price/earnings ratio, or P/E, of 10. Market experts disagree about what constitutes a cheap or expensive stock. Historically, stocks have averaged a P/E in the mid teens, though in recent years, the market P/E has been higher, often nearer to 20. As a general rule of thumb, stocks with P/Es higher than the broader market P/E are considered expensive, while stocks with a below-market P/E are considered cheaper.

But P/Es aren’t a perfect measure. A company that is small and growing fast may have a very high P/E, because it may earns little but has a high stock price. If the company can maintain a strong growth rate and rapidly increase its earnings, a stock that looks expensive on a P/E basis can quickly seem like a bargain. Conversely, a company may have a low P/E because its stock has been slammed in anticipation of poor future earnings. Thus, what looks like a “cheap” stock may be cheap because most people have decided that it’s a bad investment. Such a temptingly low P/E related to a bad company is called a “value trap.”

Other popular measures include the dividend yield, price-to-book and, sometimes, price-to-sales. These are simple ratios that examine the stock price against the second figure, and these measures can also be easily found by studying stock tables.

Investors seeking better value seek out stocks paying higher yields than the overall market, but that’s just one consideration for an investor when deciding whether or not to purchase a stock.

Picking stocks is much like evaluating any business or company you might consider buying. After all, when you buy a stock, you’re essentially purchasing a stake in a business.


http://guides.wsj.com/personal-finance/investing/how-to-evaluate-a-stock/?mod=rss_WSJBlog/#mod=how_to_widget

Sharemarket basics: a numbers game

Money Magazine, April 2007

Investing in shares can be something of a numbers game, especially when the financial press is peppered with mention of ratios such as "dividend yield" and "earnings per share". There is no shortage of these statistics and they can be useful as a means of assessing whether a particular share offers good returns or strong growth prospects.

On this basis, ratios are worth adding to your armoury of research, though they are by no means infallible. To begin with, ratios use historical data, which is not necessarily a guide for what will happen in the future. And the source data can be open to accounting manipulation, so any insights that ratios provide should be viewed with caution.

Let's take a look at some of the key share market ratios (though this list is by no means exhaustive).

Dividend yield: Calculated by dividing the most recent dividend by the current share price and multiplying by 100 to achieve a percentage figure. Dividend yield is a measure of the regular income return (rather than capital growth) that a share is paying, which allows a comparison between different shares, and also against other asset classes. However, when the share price changes the dividend yield will also change. Indeed, if the share price crashed, the yield would soar, until the next dividend is declared — if there is one.

Earnings per share (EPS): calculated by dividing the net profit of a company by the total number of shares issued. By looking at a company's EPS history, it is possible to see the growth in earnings from one year to the next; and you can compare earnings to the dividend payouts and the share price each year.

Price earnings (PE) ratio: Calculated by dividing the share price by the earnings per share. This often-quoted ratio is a way of measuring investors' expectations about a company's performance, and it is often used to describe whether an individual company, or even the share market as a whole, is "expensive", in the sense that it is overpriced.

Overall share market conditions will have a bearing on the relative PE ratios of different shares but, as a guide, a company with a PE ratio of about 16 is considered to be a growth-orientated company, meaning there's a good chance its earnings will rise. By contrast, a company with a PE ratio of less than 11 may be regarded as having less rosy prospects for earnings growth.

While the PE ratio can be useful for making comparisons between companies, this ratio generally makes more sense if the companies under review operate within the same industry (as average PEs vary between industries), and face the same overall market conditions.

Dividend cover: Calculated as EPS divided by dividend per share. This ratio shows the proportion by which a company's dividend is covered by its earnings. A figure of less than 1.0, for example, suggests the company is paying out more than it is earning. Investors should look for a figure above 1.0, which suggests the company can comfortably pay its dividends.

Net Tangible Assets (NTA): Calculated as the value of shareholders' funds (as reported in the company's balance sheet) divided by the number of issued shares. Also known as the "asset backing", this ratio can give investors an indication of what each share in a company would be worth if all the assets were liquidated and all debts were paid and the remaining proceeds were distributed to ordinary shareholders on a per share basis.

Investors sometimes use the NTA to assess the desirability of a share. If the NTA is greater than the share price, it may be that the company is undervalued — potentially making it a takeover target. Conversely, if the NTA is below the share price, the market may be overvaluing the company.

For the complete story see Money Magazine's April 2007 issue.

http://money.ninemsn.com.au/article.aspx?id=260404

Short cuts for finding value

Companies and shares are worth the present value of the future cash they can generate for their owners.  This is a rather simple statement, and yet in practice, valuing companies is not so straightforward.

As the famous economist John Maynard Keynes put it, it's better to be vaguely right than precisely wrong, and the better bet is to stick to a few simple valuation tools.  Here are some ways to value companies or shares:

1.  Discount cash flow method.

2.  Asset-based valuation tools.

• Price/Book Value
• Graham's Net Current Asset approach

3.  Earnings-based valuation tools.

• PE ratio

4.  Cash flow-based valuation tools

• DY
• FCF Yield

These different valuation tools each have their own strengths and weaknesses.

• The price-to-book ratio tends to work best with low-quality businesses on steep discounts.  
• The PER tends to work best with high-quality growth companies.  
• The dividend yield and free cash flow yield tend to be suited to mature businesses generating steady returns.

But in every case, you'll probably get closest to the truth by looking at all the different measures.

Also, only invest in good quality businesses.

Comparing P/E ratios to growth rates can be significantly more useful than simply comparing two companies' P/E ratios. Why?

Let's compare Company A to its competitor in the same industry Company B to illustrate.

Company A

Price $10

Last year's EPS $1.16

Projected EPS  $1.33


Company B

Price $ 8

Last year's EPS  $1.14

Projected EPS  $1.14


Using the data above, you can see that Company A's trailing P/E is 8.6, while Company B's is just 7.

Why would you want to pay $10 for Company A's earnings when you can get Company B's - the same amount, no less  - for $2 off?  (You could even take the $2 to give yourself a treat. )  :-)

Which company would you buy - Company A or Company B?  Why?

Answer:  Click here.

Comparing the P/E to Growth Rates

Answer:

Company A's forward P/E is 7.5, while Company B's remains 7.

Remember, you are more concerned with what Company A is going to do - keep growing while Company B has apparently run out of gas - than what it has already done, and you don't want to pay nearly the same amount for no earnings growth as you would for a nice 15% growth of Company A.


The above is the answer to the question posed here:

Comparing P/E ratios to growth rates can be significantly more useful than simply comparing two companies' P/E ratios. Why?

How much should you pay for a business? Valuing a company (3)

Multipliers

Another simple approach is to use a multiplier to calculate a company's value. These multipliers will vary for different industries. One way of deciding what figure to pick for a multiplier is to analyse previous company takeovers within that sector, examining what was paid for these businesses compared to their sales or profit levels.

Caution must be taken in ensuring that the level of sales or profits in the accounting period being analysed is sustainable and does not contain one-off or abnormal conditions.

Sales multiplier

The sales multiplier uses a multiple of sales to assign a value to that company.

• This could be less than or greater than 1, depending on expectations for future growth. 
• Sales multipliers are particularly popular in start-up companies that are not yet profitable (eg. dot.com companies).

Profit multiplier
In the case of the profit multiplier, the multiplier used tends to be greater than 1 and will be based on 

• how many years' future profit are to be factored into the value of a business as well as 
• expectations for future profit growth.

So if a profit multiplier is 10 was used you might expect a 10% return for the next 10 years, with no change in business conditions to pay for this investment.

Also read:

Valuing a company (1)

Valuing a company using Asset Value (2)

Valuing a company using Multipliers (3)

Valuing a company using Market Capitalisation (4)

Valuing a company using Non-Financial Measures & Balanced Scoreboard (5)

Valuing a company using Cash Flows (6)

PEG Ratio: Why It’s More Relevant than P/E for Stocks

by DARWIN on APRIL 6, 2010

While many individual investors are familiar with the conventional Price to Earnings (P/E) ratio, the PEG ratio isn’t cited nearly as often but it really puts a stock’s valuation in the proper context.  While a P/E ratio will tell you whether a stock is “highly priced” just based on a forward earnings expectations or trailing earnings reports, a PEG ratio is the P/E ratio divided by the stock’s long term annual growth rate.  Now, the problem is estimating just what that growth rate will be.  But for relatively mature companies with transparent investor updates, it’s not too tough to reasonably discern whether you’re in the right ballpark.

PEG Ratio vs. P/E Ratio:

Consider two stocks.

1) Mature industrial company with steady earnings year over year.  P/E = 10.
2) Nimble, fast growing company. P/E = 45.

Let’s say the broad market is trading at an aggregate Price to Earnings ratio of 12.  One investor may view stock 1 as a “value” and stock 2 as being absurdly overpriced.  However, when looking at each in terms of their projected growth rate, the pendulum swings the other way.  If stock 1  is a utility that’s expected to grow at about 5% per year and stock 2 is growing at 30% per year, in the context of future growth, the PEG ratios tell a different story:

1) Stock 1 PEG ratio = 10/5 = 2
2) Stock 2 PEG ratio = 50/25 = 1.5

Stock 2 now appears to be much more of a value.  Often times, stocks with high growth rates are more volatile and prone to massive price swings.  But if you’re able to hang on to a stock for a few years and the projected growth rate assumptions are reasonable, you’re often rewarded with a higher net return.  This is broadly reflected in the long term outperformance of tech stocks, biotech stocks, small caps and emerging market stocks vs. their counterparts.

When I provided my last portfolio update you will have noticed that many holdings fall into the stock 2 bucket since I’m young and have a long time horizon and my ultimate goal is to maximize investment returns.  Conversely, when I’m 55 and approaching retirement, I will likely be more focused on stability and income via high yield investments.  So, there’s no “right” way to invest, but it’s important to consider the context of your investments as well as your time horizon.

Do You Use the PEG Ratio in Evaluating Stock Purchases?

http://www.darwinsfinance.com/peg-ratio/

Are You Paying Too Much For Stocks? Market Value is Not Equal to Actual Value

Are You Paying Too Much For Stocks?

Market Value Not Equal to Actual Value
A small loan can help you if you are short of cash until your next payday, but if you invest in the stock market and follow the crowd in their buying and selling habits, you may end up with many more liabilities than assets. Why? Have you noticed how much the stock market fluctuates in a day, and also the ups and downs of prices? Does that mean that the companies’ values goes up and down as much as the share price, or does that mean that there may be some other force at work here? As you can see, market value of a share doesn’t equal ACTUAL value of the same share, in terms of the value of a company.

Market Price Based on Emotions, Not Logic
One of the pioneers in value investing, Benjamin Graham, believed that many people rely too much on their emotions when investing rather than their logic. This explains the fluctuations of the market, and also why a lot of people think it’s risky to invest in it. What makes it risky is the constant buying and selling that goes on day after day, hour after hour. This constant buying and selling is what either drives the share price up or down, and it’s what creates the risk.

Ben Graham suggested in his book “The Intelligent Investor” that if you want to build your wealth from the stock market, you need to use a “dollar cost averaging” technique, meaning to consistently buy more shares at a lower price over time. As inflation and company values grow over time, your investments will be worth more in the long run. It’s also called “buy low and sell high” which you might have heard about. Unfortunately, most people tend to bring their emotions into their investing, and will panic and sell when the price is going down, because they are afraid to lose any more money on their investments, leaving them open to take out a small loan to survive.

Beyond the Smoke and Mirrors
The stock market is riddled with confusing terms, acronyms and policies, making it very difficult for the average investor to understand. All this is just smoke and mirrors designed to keep most people in the dark and dependent on high-priced brokers to navigate the investing maze for them. However, if you were to peek behind the curtain, you would see that all the confusion is just smoke and mirrors.

Inflated Price? Inflated Value!
In an effort to control the market prices, brokers and fund managers will either buy or sell enough shares to drive the price back up or down, depending on where the prices are going. Perhaps it’s due to a company that got good news or bad, and investors are trying to position themselves to not lose a lot of money, or make some. This tends to skew the value of a share price, and unbalances the market. Thus, a share price that has risen too quickly will have many shares sold off by fund managers or brokers to drive the price back down. Similarly, if a share price is dropping too fast, they’ll buy as many shares to even up. So if there are inflated prices, don’t go believing it’s actually worth that much. In fact, they may not be worth much at all!

P/E Ratio Tells it All
There is a very simple way to determine if a certain share price is on target or not—look at the Price per Earnings ratio. This is a valuation method that takes the company’s current share price on the market divided by the per-share earnings over a certain time frame, usually one year. If the price of shares in a company are $ 24 per share, and the earnings over the previous year were $ 2, the ratio of P/E is 12.

• Typically, the higher the P/E ratio is, the higher the expectations investors will have for company growth. This means that you will be able to see higher earnings within the next year with this company.
• However, the lower the ratio, the slower the growth regardless of what the market is doing.

Buy Low, Sell High
When you can learn how to find the correct value of a company or share, you will know when the share price is at its lowest, and when you can buy. After share prices crest, you can sell your shares and pocket the rest without needing a small loan. If you do this, you will be able to make money on the stock market when everyone else is losing money.

http://www.401kinformationblog.com/are-you-paying-too-much-for-stocks/

Market Multiple or "What the market is selling for".

The P/E ratio is a complicated subject that merits further study, if you are serious about picking your own stocks. 

Here are some pointers about P/Es.

If you take a large group of companies, add their stock prices together, and divide by their earnings, you get an average P/E ratio. 

On Wall Street, they do this with the Dow Jones Industrials, S&P 500 stocks and other such indexes.  The result is known as the "market multiple" or "what the market is selling for."

• The market multiple is a useful thing to be aware of, because it tells you how much investors are willing to pay for earnings at any given time. 
• The market multiple goes up and down, but it tends to stay within the boundaries of 10 and 20. 
• The stock market in mid-1995 had an average P.E ratio of about 16, which meant that stocks in general weren't cheap, but they weren't outrageously expensive, either.

In general, the faster a company can grow its earnings, the more investors will pay for those earnings. 

• That's why aggressive young companies have P/.E ratios of 20 or higher.  People are expecting great things from these companies and are willing to pay a higher price to own the shares. 
• Older, established companies have P/E ratios in the mid to low teens.  Their stocks are cheaper relative to earnings, because established companies are expected to plod along and not do anything spectacular.

Some companies steadily increase their earnigns - they are the growth companies. 

Others are erratic earners, the rags-to-riches types.  They are the cyclicals -

• the autos, the steels, the heavy industries that do well only in certain economic climates. 
• Their P/E ratios are lower than the P/.Es of steady growers, because their perfomance is erratic. 
• What they will earn from one year to the next depends on the condition of the economy, which is a hard thing to predict.

Reading the Stock Pages

One way to tell who the investors are is by watching them read the paper.  Investors don't start with the comics, or sports, the way other readers do.  They head straight for the business section, and run their finger down the columns of stocks searching for yesterday's closing prices on the companies they own.

The price of the last trade, called the closing price, gets quoted in the papers the next morning.

A lot of information is packed into a single line. 

365-Day High-Low 
62 - 37

Stock
Disney

Div
0.36

Yld %
0.625

P/E
23

Sales
11090

High
57

Low
56

Last
57

Chg
+1

So, in the last 12 months, there's a wide range of prices that people will pay for the same stock

• In fact, the average stock on the NYSE moves up and down approximately 57 % from its base price in any given year. 
• More incredibe than that, one in every three stocks traded on the NYSE moves up and down 50 to 100 % from the base each year, and about 8% of the stocks rise and fall 100% or more.

A stock might start out the year selling for $12, rise to $16 during an optimistic stretch, and fall to $8 during a pessimistic stretch. 

• That's a 100% move:  from $16 to $8. 
• Clearly , some investors pay a lot less than others for the same company in the same year.

In the 4 columns:"High," "Low," "Last," and "Chg"(Change), you get a recap of what happened in yesterday's trading. 

• In this case, nothing much. 
• The highest price anybody paid for Disney during this particular session was $57, and the lowest was $56, and the last sale of the day was made at $57. 
• That was the closing price that everybody was looking for in the newspaper. 
• It was up $1 from the closing price of the day before, which is why +$1 appears in the "Chg" column.

"Div" stands for dividend.  Dividends are a company's way of rewarding the people who buy their stock.  Some companies

• pay big dividends,
• some pay small dividends, and
• some pay no dividend at all. 

The number shown 0.36 means "thirty-six cents."  That's Disney's current annual dividend - you get 36 cents for each share you own.

"Yld% (Yield), gives you more information about the diividend, so you can compare it, say to the yield from a savings account or bond.  Yield = curren dividend divided by the closing stock price. 

• The result is 0.625 % - the return you're getting on your money if you invest in Disney at the current price.
• This 0.625% is a very low return, as compared to the 3% that savings accounts are paying these days. 
• Disney is not a stock you'd buy just for the dividend.

P/E is the abbreviation for "price-earnings ratio."  You get the P/E ratio by dividing the price of a stock by the company's annual earnings.  The P/E can be found in the paper every day.

• When people are considering whether to buy a particular company, the P/E helps them figure out if the stock is cheap or expensive. 
• P/E ratios vary from industry to industry, and to some extent from company to company, so the simplest way to use this tool is to compare a company's current P/E ratio to the historical norm.

In today's market, the P/E of the average stock is about 16, and Disney's P/E of 23 makes it a bit expensive relative to the average stock. 

• But since Disney's P/E ratio has moved from 12 to 40 over the past 15 years, a P/E of 23 for Disney is not out of line, historically. 
• It is more expensive than the average stock because the company as been a terrific performer.

Finally,l there's "Sales":  (Volume) the number of shares that were bought and sold in yesterday's session at the stock exchange. 

• You always multiply this number by 100, so the 11,000 tells us that 1.1 million shares of Disney changed hands. 
• It's not crucial to know this, but it makes you realize that the stock market is a very busy place.

Thanks to home computers, electronic tickertape and other technologies, people no longer have to wait for tomorrow's newspaper to check their stocks.  All this technology has a drawback:  It can get you too worked up about the daily gyrations.

• Letting your emotions go up and down in sympathy with stocks can be very exhausting form of exercise, and it doesn't do you any good. 
• Whether Disney rises, falls, or goes sideways today, tomorrow, or next month isn't worth worrying about if you are a long-term investor.

Never Use P/E Ratios in Isolation

Different Types of P/E Ratios

It's important to understand that all P/E ratios are not created equally. Some are calculated using earnings from the past four quarters (known as a trailing P/E). Meanwhile, others use earnings from the last two quarters, plus projected earnings for the next two quarters (known as a current P/E). Finally, some are calculated based entirely on future earnings estimates (known as a forward P/E).

Caution must be used when examining forward P/E ratios, as future growth estimates may ultimately prove to be inaccurate. Also, the underlying earnings used in the P/E calculation can vary from source to source. Some analysts, for example, choose to work with adjusted earnings figures, which exclude one-time gains or losses. Meanwhile, others prefer to use net income figures calculated based on traditional GAAP rules.

Never Use P/E Ratios in Isolation
Although a P/E ratio can provide a good approximation of how "expensive" a particular stock is relative to its underlying earnings stream, it is by no means a perfect gauge of a company's value. P/E ratios have a number of drawbacks, including:

-- Earnings Manipulation -- Companies often use a variety of accounting techniques to alter their reported net income. As a result, the reported earnings figures we read about are often not entirely representative of a company's true financial situation. Since net income is a critical component of a firm's P/E ratio, manipulated earnings can lead to misleading P/E data.

-- Industry Differences -- Different industries typically have different historical growth rates, risk levels, etc... and hence different average P/E ratios. Thus, stocks that may appear cheap in one industry may look expensive when stacked up against another. For this reason, it is typically more appropriate to compare a firm's P/E ratio to those of other companies within the same sector.

-- Other Factors -- It's important to remember that P/E ratios only take two items into account -- a firm's current stock price and its net income. As a result, P/E ratios completely ignore a variety of other important factors. One of the most notable of these factors is a firm's projected future growth rate. Two stocks could be identical in every respect (including on a P/E basis), but if one company is growing at twice the rate of the other firm, then the high-growth firm will likely make a better investment over the long haul. With this in mind, many investors prefer to examine PEG ratios as opposed to traditional P/E ratios.

-- Volatility and Risk -- P/E ratios also ignore such critical items as risk and volatility. Two firm's may sport identical P/E ratios, but if one firm's revenue and earnings base is extremely reliable, yet the other firm's earnings are highly uncertain, then the more reliable firm could make a better investment over the long haul.

With the above limitations in mind, when attempting to assess the value of a particular security, most experienced investors choose to analyze P/E ratios in conjunction with a variety of other ratios, including Price/Sales (P/S), Price/Cash Flow (P/CF), etc...



http://web.streetauthority.com/terms/p/pe-ratio.asp

What's the difference between absolute P/E ratio and relative P/E ratio?

What's the difference between absolute P/E ratio and relative P/E ratio?

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The simple answer to this question is that absolute P/E, which is the most quoted of the two ratios, is the price of a stock divided by the company's earnings per share (EPS). This measure indicates how much investors are willing to pay per dollar of earnings. The relative P/E ratio, on the other hand, is a measure that compares the current P/E ratio to the past P/E ratios of the company or to the current P/E ratio of a benchmark. Let's look at both absolute and relative P/E in more detail.

Absolute P/E

The nominator of this ratio is usually the current stock price, and the denominator may be

• the trailing EPS (from the trailing 12 months [TTM]),
• the estimated EPS for the next 12 months (forward P/E) or
• a mix of the trailing EPS of the last two quarters and
• the forward projected EPS for the next two quarters.

When distinguishing absolute P/E from relative P/E, it is important to remember that absolute P/E represents the P/E of the current time period.

For example, if the price of the stock today is $100, and the TTM earnings are $2 per share, the P/E is 50 ($100/$2).

Relative P/E

Relative P/E compares the current absolute P/E to

• a benchmark or
• a range of past P/Es over a relevant time period, such as the last 10 years.

Relative P/E shows what portion or percentage of the past P/Es the current P/E has reached.

• Relative P/E usually compares the current P/E value to the highest value of the range, but investors might also compare the current P/E to the bottom side of the range, measuring how close the current P/E is to the historic low.
• The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the past high or low).
• If the relative P/E measure is 100% or more, this tells investors that the current P/E has reached or surpassed the past value.

Suppose a company's P/Es over the last 10 years have ranged between 15 and 40.

• If the current P/E ratio is 25, the relative P/E comparing the current P/E to the highest value of this past range is 0.625 (25/40), and the current P/E relative to the low end of the range is 1.67 (25/15).
• These value tell investors that the company's P/E is currently 62.5% of the 10-year high, and 67% higher than the 10-year low.

If all is equal over the time period, the closer the P/E gets to the high side of the range and further away from the low side, the more caution an investor needs since this could mean the stock is overvalued.

• There is, however, a lot of discretion that goes into interpreting relative P/E.
• Fundamental shifts in the company such as an acquisition of a highly profitable entity can justifiably increase the P/E above the historic high.

As we mentioned above, relative P/E may also compare the current P/E to the average P/E of a benchmark such as the S&P 500.

• Continuing with the example above where we have a current P/E ratio of 25, suppose the P/E of the market is 20.
• The relative P/E of the company to the index is therefore 1.25 (25/20).
• This shows investors that the company has a higher P/E relative to the index, indicating that the company's earnings are more expensive than that of the index.
• A higher P/E, however, does not mean it is a bad investment. On the contrary, it may mean the company's earnings are growing faster than those represented by the index.
• If, however, there is a large discrepancy between the P/E of the company and the P/E of the index, investors may want to do additional research into the discrepancy.

Conclusion
Absolute P/E, compared to relative P/E, is the most-often used measure and is useful in investment decision making; however, it is often wise to expand the application of that measure with the relative P/E measure to gain further information.

http://www.investopedia.com/ask/answers/05/051005.asp

Normalizing Earnings for PE ratios

Normalizing Earnings for PE ratios

The dependence of PE ratios on current earnings makes them particularly vulnerable to the year-to-year swings that often characterize reported earnings.

In making comparisons, therefore, it may make much more sense to use normalized earnings.

The process used to normalize earnings varies widely but the most common approach is a simple averaging of earnings across time.

For a cyclical firm, for instance, you would average the earnings per share across a cycle. In doing so, you should adjust for inflation.

If you do decide to normalize earnings for the firm you are valuing, consistency demands that you normalize it for the comparable firms in the sample as well.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Comparing PE Ratios across firms in a sector

Comparing PE Ratios across firms in a sector

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. There are several problems with this approach.

First, 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 the 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. One clear example of this is in takeovers, where a high PE ratio for the target firm is justified, using the price-earnings ratios of a control group of other firms that have been taken over. This group is designed to give an upward biased estimate of the PE ratio and other multiples.

Second, 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. It is very difficult to subjectively adjust for differences across firms. Thus, knowing that a firm has much higher growth potential than other firms in the comparable firm list would lead you to estimate a higher PE ratio for that firm, but how much higher is an open question.

The alternative to subjective adjustments is to control explicitly for the one or two variables that you believe account for the bulk of the differences in PE ratios across companies in the sector in a regression. The regression equation can then be used to estimate predicted PE ratios for each firm in the sector and these predicted values can be compared to the actual PE ratios to make judgments on whether stocks are under or over priced.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Price/earnings ratio

5 Price/earnings ratio

The price/earnings ratio (P/E ratio) is the value of a business divided by its profits after tax.

Once you have decided on the appropriate P/E ratio to use (see below), you multiply the business’ most recent profits after tax by this figure. For example, using a P/E ratio of 5 for a business with post-tax profits of £100,000 gives a P/E valuation of £500,000.

5.1 P/E ratios are used to value businesses with an established, profitable history.
• P/E ratios vary widely
Multiple values
A small unquoted business is usually valued at between five and ten times its annual post-tax profit. Previously — most notably in the IT market — the ratio has exploded, with some valuations being drawn from multiples of 70 or more. However, the differential has closed significantly, with IT-based companies seeing the sharpest drops.
Following the so-called ‘correction’, commonly accepted earnings multiples to value quoted firms range from nine or ten to 25, although some exceptions remain.

5.2 Quoted companies have a higher P/E ratio. Their shares are much easier to buy and sell. This makes them more attractive to investors than shares in comparable, unquoted businesses.
• A typical P/E ratio for a large, growing quoted company with excellent prospects might be 20.
• Typically the P/E ratio of a small, unquoted company is 50 per cent lower than that of
a comparable quoted company in the same sector.

5.3 Compare your business with others.
• What are your quoted competitors’ P/E ratios? Newspapers’ financial pages give historic P/E ratios for quoted companies.
• What price have similar businesses been sold for?

5.4 P/E ratios are weighted by commercial conditions.
• Higher forecast profit growth means a higher P/E ratio.
• Businesses with repeat earnings are safer investments, so they are generally awarded higher P/E ratios.

5.5 Adjust the post-tax profit figure to give a true sustainable picture.
How to calculate profit
If you are considering buying a business, work out what the ‘true’ profitability is.
A Compare the owner’s stated profits with the audited figures.
• Question any differences.
B Look for costs which could be reduced under your ownership. For example:
• Consultancy fees.
• Payments to the owner and to other shareholders.
• Unnecessary property leases.
• Supplies — is there a cheaper supplier?
• Overlapping overheads.
C Look for areas to ‘restate’ (the accountancy term for changing a figure from one kind of cost to another). For example, money spent on software development may have been capitalised by the owner. You might consider that it should have been treated as a cost.
• Use your own accounting policies when calculating the business’ profits.
This will often result in a significantly different profit figure.
D When looking at future profits, bear in mind the costs of achieving them. These may include:
• Servicing increased borrowings.
• Depreciation of investment in plant, machinery, or new technology.
• Redundancy payments.
The arrival of new management often leads to major changes which may mean higher costs and lower productivity in the first year.


http://www.iod.com/intershoproot/eCS/Store/en/pdfs/cf1val.PDF

****How much is your business worth?

How much is your business worth?
If you are thinking of selling up, what could you get for your business?


General Principals
The largest influence on the price you will get for your business is the Law of Supply & Demand. If, when you sell, there are plenty of buyers with ready cash and few sellers, you will get a good price. If the converse is true, you will either not get a good price or, even worse, you may find you cannot sell up.

Generally, people do not buy a business for what it is; they will buy for what the business does for them. Namely earn them cash to repay their investment, provide them with a living, and build for the future. With cash (not profits) uppermost in their mind on the first two of these, the price is often based on something called 'EBITDA'. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) is an accountancy term that represents the sustainable cash profits of the business assuming nil borrowing costs.

To value the business, a multiple is applied to EBITDA. The Law of Supply & Demand essentially dictates the multiple for a particular business sector, or any part of it, or any particular firm. There is no universally agreed multiple for a particular sector, or firm, and multiples vary widely between and within particular sectors depending on a number of factors, but principally the certainty and size of the future cash flows of the business. The multiple applied to your business will depend on a combination of factors, we go into some of these factors in detail below.

Pricing a business is thus more of an art than a precise science. It is not merely a calculation based on two predetermined numbers, and valuers, purchasers and vendors often arrive at differing figures. At the end of the day it is you who has to be satisfied that you have got the best deal under the circumstances.

To get the best price, the main issue you should concentrate on is timing. When the business is ripe for sale, it is often not the right time for you personally or there are too few purchasers with ready cash. All other permutations apply, except the one where all the circumstances fit together neatly. Consequently selling your business generally involves some form of compromise. This makes the decision more difficult for you, especially if you are emotionally tied to the business. There is always a lot going on in the business when you sell, negotiations are intense, and feelings high: selling is a stressful time for you. So it is important that you plan in advance how you are going to sell the business. Only by doing so will you maximise the price you will get. When planning, you should bear in mind the following:

Size
Forget the old maxim, size is important. Large firms attract bigger multiples and more interest than smaller firms because they are perceived as being less risky. Larger firms are less likely to fail and are less reliant on the owner's involvement. Your firm, however large it grows in its niche or how profitable it becomes, may be too small to attract the right purchaser, namely the one with cash. Thus ignore the price achieved for one of your larger, more inefficient, competitors: you may never achieve a similar multiple however good your business is.


Growth
Growth prospects are one of the more major factors affecting the multiple. Buyers will pay more for businesses with higher growth rates as they repay their initial investment quicker than those with low or no growth. Consider selling up before turnover or profits have levelled out. This may go against the grain where you have put in place the basis for such growth, but increasing the multiple, as opposed to increasing the EBITDA, will have a bigger impact on the price you achieve.

Profitability
High gross margins and good levels of cash generation from profits give buyers more flexibility going forward and reduce the risk of the investment proving bad. Buyers will pay more for businesses that consistently report better than industry average figures.

However, the fact that you operate an extremely tight ship may put a buyer off paying too high a price. Buyers will look for easy wins/cost savings, so if a buyer identifies areas where he can make large efficiency savings or growth that could make your company more valuable to him. It is often worthwhile specifically targeting potential purchasers able to achieve such synergies.

Sector
Some sectors attract better multiples than others. There are a number of reasons for this: fashion (such as the dot-coms, energy businesses etc); estimates as to future growth prospects; robustness at times of boom and bust etc. In general, the more certain the future cash flows of a sector, or company, the higher the multiple.

However, some niches within a sector can command a premium from time to time, depending on the then demand for the particular product/service. Building a 'sustainable competitive advantage' and 'Unique Selling Point(s)' in a small niche can produce a handsome price at a time of boom in that sector generally and a better than average price when times are bad.

Business Mix
Diversification, although often reducing operating risk, does not always add to value: it can reduce the value of the overall business. Buyers may only be willing to take on that part of your business that fits in well with theirs; they could either discount the overall price, leave you with the part they do not want or, in the worst case, you could find your business un-saleable. It may be safer to stay in a particular part of the sector, especially for smaller businesses, as it can be difficult to find a buyer who will appreciate diversity.

Customer Base
The quality of your customer base is one of the main factors influencing the multiple used. Customer bases made up of blue chip clients in growing industries attract higher multiples, particularly if there are opportunities for the buyer to sell additional services in to them. If specific customers, or customers in a particular industry, make up a large part of your business, it will affect your pricing, because buyers will see you as having too many eggs in one basket.

Other Factors
Another important component is the strength of the balance sheet. Once buyers have bought a business, they want to focus on growing it and integrating it into their own organisation, rather than deal with historic balance sheet problems.

Buyers will assess the former owner's management of working capital. Businesses with a history of good cash, debtor, and creditor management attract higher multiples than those with a poor track record.

Other balance sheet factors that can influence a firm's value such as the amount of bank / factor debt, and any impending litigation.

The Deal
It is important to many buyers to retain the owner, at least for a period of time, to help introduce them to customers and make sure staff are comfortable with the new regime.

Often a buyer will agree to pay an incentive (this is termed an 'earnout') to the owner to encourage him to stay and to seek to avoid bearing the entire risk of the acquisition. Buyers often look to pay the former owner a share of profits earned over a two or three year period.

Earnouts can constitute a major part of the purchase price. The smaller the company, the more uncertainties there are that could affect how the business might perform, and thus the more likely it is that the buyer will seek an earnout. With planning an exit taking up to two/three years, and the earnout a similar period, it could be five years before you can book your sun lounger fulltime.

Earnouts is one area where your advisers really earn their money. Earnouts create conflicting interests between the current and former owners of the business; there is a risk that the buyer will look to reduce or defer profits in order to minimise the earnout paid. The former owner will look to maximise profits and hasten their recognition. With the former owner having little or no influence post sale over strategy, accounting policies, expenditure etc, there is a very real risk that he could receive less than originally envisaged for the business. It is important that your advisers protect your position wherever possible.

There is a balancing act to be struck, you will have to decide how much money you are willing to wait for and form your own view of the risks involved based on the likely future profitability of the business and your assessment of the purchaser, as against accepting a lesser, but more certain, sum now.

Today's Market
At the end of the day, any business is only worth what you can get for it at the time you sell it. A mathematical calculation of value is a mere indication of potential worth, a discussion tool to be used during the negotiation process. Confidence levels set the level of demand for your business, and in turn how much purchasers may be willing to pay for it. Whilst any downturn will ultimately effect multiples, to get maximum value and increase the certainty of a sale, it is more important than ever that owners considering selling prepare and position their business ready for sale early, and that during the sale process is carried out in such a way as to target purchasers with the right fit, hunger and cash to complete a deal.


http://www.startinbusiness.co.uk/features/features/29_01_2003_biz_valuation.htm

Different PE ratios

Price = estimated EPS x PE

Estimated EPS is based on a number of assumptions about the behaviour of revenues and costs. The reliability of the EPS forecast hinges critically on how realistic are these assumptions.

The other half of the valuation exercise is concerned with the price-earnings ratio which reflects the price investors are willing to pay per cents of EPS. In essence, it represens the market's summary evaluation of a company's prospects.

We will generally use the PE ratio based on current year's expected earnings.

http://myinvestingnotes.blogspot.com/search/label/different%20PE%20ratios