Business valuation with price earnings multiples
Tuesday, 12 December 2006 02:45 Anton Joseph
E-mail | Print | Tags: valuation | business sale/purchase | ip revenue | strategy
When it comes to selling or buying a business the sale price is the greatest obstacle and point of disagreement in many transactions. If there is a reasonable and easily understandable way of determining the value of the business the parties can quickly progress more than half way through the sale process. Although it is said that the right tools must be used to value businesses, no simple method suits all types of businesses. Instead, there are several financial and non-financial performance indicators that are commonly used by businesses to monitor their progress. Some are used to measure profitability whilst others are used to test liquidity.
Financial indicators are normally measured by using ratios calculated using numerical values appearing in the profit and loss account or the balance sheet. Since the indicators are snapshot calculations based on historical figures (figures for the past year), there is an understandable reluctance to always rely on them. This is especially so when a small business is examined for its value for sale.
A prudent business seller or buyer can use financial indicators (such as industry conventions, multiples and ratios) as part of a toolkit to negotiate an acceptable business sale price. One indicator is a price earnings multiple. Elsewhere we have examined business valuation with EBIT multiples.
PE multiple or PE ratio definition
A price earning multiple (PE multiple) is used mostly to estimate the performance of companies whose shares are traded in public and therefore reflect market expectation to a credible extent. The PE multiple of a share is also commonly called its "PE ratio", "earnings multiple", "multiple", "P/E", or "PE").
The PE multiple method, while unorthodox for small and medium-sized businesses, may provide a useful indicator of the value of a business for sale purposes.
Examples of use of PE multiples in Australian business
You can achieve better outcomes as a seller or buyer if you properly prepare for and anticipate positions that various interested parties might hold during the negotiation dance that takes place for a business sale, purchase, takeover, merger or acquisition. It is useful to study prior transactions and to keep a close watch on market developments. Here are recent examples illustrating the use of PE multiples in media commentary, research reports and takeover documents.
Wealth Creator Magazine in its Sep/Oct 2006 issue reviews "hot" stocks in the 2006-07 financial year. In its commentary it says John Fairfax Holdings Ltd (ASX code: FXJ) "...is currently trading on a price earnings of 16 x and provides a yield of 4.5% fully franked..." and Fosters Group Ltd (ASX code: FGL) "...is trading at a price earnings multiple of 15.6 x 2006 earnings, which we believe is reasonable earnings, reduced gearing and upside potential as the cycle improves."
Intersuisse Ltd in an investment research statement dated 24 August 2006 makes a buy recommendation about BHP Billiton (ASX code: BHP) concluding: "We believe the depth and quality of the company's earnings are such that the stock deserved to be placed on a higher price/earnings (p/e) multiple than the prospective p/e of 10.4 times for FY07 and 9.8 times for FY08 and that multiples of at least 12 to 14 times would be more appropriate."
In an Independent Expert's Report Grant Samuel & Associates Pty Ltd assesses the takeover bid by Rank Group Australia Pty Ltd for Burns, Philp & Company Ltd. Grant Samuel states (at its page 18):
"Capitalisation of earnings or cash flows is the most commonly used method for valuation of industrial businesses. This methodology is most appropriate for industrial businesses with a substantial operating history and a consistent earnings trend that is sufficiently stable to be indicative of ongoing earnings potential. This methodology is not particularly suitable for start-up businesses, businesses with an erratic earnings pattern or businesses that have unusual capital expenditure requirements. This methodology involves capitalising the earnings or cash flows of a business at a multiple that reflects the risks of the business and the stream of income that it generates. These multiples can be applied to a number of different earnings or cash flow measures including EBITDA, EBIT or net profit after tax. These are referred to respectively as EBITDA multiples, EBIT multiples and price earnings multiples. Price earnings multiples are commonly used in the context of the sharemarket. EBITDA and EBIT multiples are more commonly used in valuing whole businesses for acquisition purposes where gearing is in the control of the acquirer."
How to calculate the PE multiple for your business
The PE multiple method is the most commonly used earnings capitalisation methodology. It appears in the following two equations:
1.Total value of business = PE multiple x net profit after tax (NPAT)
2.Value per share = PE multiple x earnings per share
The above two equations can be used to provide some indication of the value of a business. First, using the second equation, dividing the market price of a share by the earnings per share you will be able to calculate the PE multiple for the business. Then by multiplying the PE multiple by NPAT a value for the business can be determined.
With a public company, assume the market value of a share of the company is $35 and the earnings per share is $5, then the PE multiple is 25 divided by 5 which is 7. If the NPAT is $110,000 then the value of the business is $110,000 multiplied by 7, which is $770,000.
As a first step in using the above method, one needs to find a listed company carrying on a business similar to the business of the company to be valued. Next, obtain a copy of the most recent financial statements published by the company, from which the NPAT and EPS of the company can be obtained. Now obtain the recent price quoted for the shares in the company from its Website or the ASX Website.
EPS is a measure of the amount of profit that can be attributed to ordinary shares in the company. If the financial statements of the company do not provide the EPS, it can be calculated by dividing NPAT (after deducting NPAT attributable to any outside equity interests, such as preference shares and any payments made to such outside equity interests) by the total number of ordinary shares on issue. The total number of shares on issue can be got from the balance sheet of the company.
If the PE multiple of the company selected is high it can mean that the shares of the company are overpriced and yet the market is expecting a high return in the future. This could be for several reasons, such as potential for growth in the overseas market or even a change of the CEO. Similarly the PE multiple could be low and the shares underpriced because the company selected is about to be brought under a strict regulatory regime by the Government or it has lost a crucial licence. What is suggested here is that the PE multiple calculated using a typical company in the industry may not totally reflect the situation of the business under review.
PE multiple caution
Since the PE multiple method of valuation is dependent on factors that are approximations, consideration of other relevant performance ratios is recommended, eg dividend per share, dividend yield, dividend cover, net tangible assets per share and cash flow per share.
Ultimately working out the PE multiple is a job for a specialist or professional. It is not a job for a lawyer. It is also not a job for a non-financial business executive who is not properly briefed. But it is useful for everyone to be aware of how the numbers are derived.
http://www.dilanchian.com.au/index.php?option=com_content&task=view&id=166&Itemid=148
Thursday, 12 November 2009
Modern trading making earnings multiples obsolete
Modern trading making earnings multiples obsolete
by Grace Chen on May 19, 2008
Price to earnings multiples were once the basis of investment decisions. The analysis was simple: the return divided by the stock price should properly valuate a certain company. But with many companies all over the map in both PE and PEG ratios, investors are looking for other guidelines for evaluating an investment. Technical trading has all but taken over the short term trader, and it looks ready to conquer the long term as well.
Old value investors
Warren Buffett dominates the field of value investing. Rather than following the world’s hottest stocks, he looks for companies that are considerably undervalued, both by assets and what he believes the company is really worth. While he’s made a large fortune from his studies on value investing, the markets are seemingly turning out of his favor. Valuing a company is no longer as easy as looking for cheap assets, as many companies have little assets to back their valuations. Others trade at huge multiples of their earnings, while their competitors enjoy smaller ratios, and even others are destined to stay cheap forever due only to the nature of the business.
Case in point
It seems that many companies are selling for high premiums, even with little to back up their valuations. Take for example the internet stocks. Google sells for a PE ratio of 41 but a PEG of 1.02. While Google does sell for an extreme premium over its earnings, adjusted for growth Google is still in the buy range. Compare these statistics to the lesser rival Yahoo, which trades for a PE of 33 and a PEG of 2.8. Even prior to the failed Microsoft bid, Yahoo traded at a similar PE and PEG ratio; for the most part, it’s horribly overvalued.
Traditionally, you would think that the two valuations would come to meet each other in the middle. Google’s price would ultimately rise while Yahoo would shed a few points to come back to earth. Though this is what the rational person would think, it seems like Yahoo will forever enjoy being overpriced and Google will always be under priced. In fact, Google has never traded for a PEG ratio higher than 2. Yahoo has traded for both extremely high PE ratios and PEGs, though its data is somewhat skewed by the y2k internet bubble fiasco.
Has technical analysis beat out fundamentals?
It appears as though technical traders have finally won over the market. By looking at today’s measurements, Yahoo’s stock is kept afloat largely by technical support and resistance, while Google is much the same. The difference in trading techniques even from just 2004 to today would suggest that stocks are now traded more independently than ever. Rarely are stocks compared to reasonable value to their competitors by investors. The new age of trading is systematically making investors “one stock” types, those only willing to trade the ups and downs and day to day of a specific stock, rather than comparing it to its competition.
Investing at its roots has been crippled. The sustainability or profitability of future results are rarely calculated in many investors algorithms. Technical analysis has instead brought trading to a whole new level, where stocks are nearly as good as any other commodity. The earnings of a company no longer matter, nor do its assets, nor its valuation. The digits in the stock price are the few things that matter to most modern day traders; forget the business behind the ticker.
http://www.investortrip.com/modern-trading-making-earnings-multiples-obsolete/
Comment: Ohhhh!!!!!
by Grace Chen on May 19, 2008
Price to earnings multiples were once the basis of investment decisions. The analysis was simple: the return divided by the stock price should properly valuate a certain company. But with many companies all over the map in both PE and PEG ratios, investors are looking for other guidelines for evaluating an investment. Technical trading has all but taken over the short term trader, and it looks ready to conquer the long term as well.
Old value investors
Warren Buffett dominates the field of value investing. Rather than following the world’s hottest stocks, he looks for companies that are considerably undervalued, both by assets and what he believes the company is really worth. While he’s made a large fortune from his studies on value investing, the markets are seemingly turning out of his favor. Valuing a company is no longer as easy as looking for cheap assets, as many companies have little assets to back their valuations. Others trade at huge multiples of their earnings, while their competitors enjoy smaller ratios, and even others are destined to stay cheap forever due only to the nature of the business.
Case in point
It seems that many companies are selling for high premiums, even with little to back up their valuations. Take for example the internet stocks. Google sells for a PE ratio of 41 but a PEG of 1.02. While Google does sell for an extreme premium over its earnings, adjusted for growth Google is still in the buy range. Compare these statistics to the lesser rival Yahoo, which trades for a PE of 33 and a PEG of 2.8. Even prior to the failed Microsoft bid, Yahoo traded at a similar PE and PEG ratio; for the most part, it’s horribly overvalued.
Traditionally, you would think that the two valuations would come to meet each other in the middle. Google’s price would ultimately rise while Yahoo would shed a few points to come back to earth. Though this is what the rational person would think, it seems like Yahoo will forever enjoy being overpriced and Google will always be under priced. In fact, Google has never traded for a PEG ratio higher than 2. Yahoo has traded for both extremely high PE ratios and PEGs, though its data is somewhat skewed by the y2k internet bubble fiasco.
Has technical analysis beat out fundamentals?
It appears as though technical traders have finally won over the market. By looking at today’s measurements, Yahoo’s stock is kept afloat largely by technical support and resistance, while Google is much the same. The difference in trading techniques even from just 2004 to today would suggest that stocks are now traded more independently than ever. Rarely are stocks compared to reasonable value to their competitors by investors. The new age of trading is systematically making investors “one stock” types, those only willing to trade the ups and downs and day to day of a specific stock, rather than comparing it to its competition.
Investing at its roots has been crippled. The sustainability or profitability of future results are rarely calculated in many investors algorithms. Technical analysis has instead brought trading to a whole new level, where stocks are nearly as good as any other commodity. The earnings of a company no longer matter, nor do its assets, nor its valuation. The digits in the stock price are the few things that matter to most modern day traders; forget the business behind the ticker.
http://www.investortrip.com/modern-trading-making-earnings-multiples-obsolete/
Comment: Ohhhh!!!!!
A Crash Course on Earnings Multiples
A Crash Course on Earnings Multiples
As a trusted business advisor you’ve probably heard former business owners telling people that they sold their business for “six times earnings.” As investment bankers, the first question we hear from prospective clients is “Can I get the same multiple if I sell my business?” The answer is an unequivocal "it depends." It depends on a number of things, but first and foremost, it depends on how you define “earnings”.
As all investment bankers and sellers know, “Cash is King.” After all, cash removes the seller’s risk in the transaction. However, when a buyer pays cash for a business, that buyer wants to know exactly how much the business is earning.
Let’s start with what seems to be a pretty basic concept: earnings.
The Definitions of Earnings
There are several definitions of earnings; each is potentially different from the other depending on the type of company and the way its owner runs the company. Typical measures of earnings include:
§ Net Operating Income: This is sales less the cost of goods sold and operating expenses.
§ Pre-tax Income: This is net operating income plus non-operating income (like interest on notes, etc.) less non-operating expenses (like one-time, non-recurring expenses).
§ After-tax Income: Pre-tax income, less all company (but not individual) taxes.
§ EBIT: This stands for earnings before interest and taxes.
§ EBITDA: This stands for earnings before interest, taxes, depreciation and amortization
Add to these measures, the need to “adjust" earnings by deducting capital expenditures, and adding back excess rents, excessive salary and bonuses paid to the owner and his or her family. The result is something called:
Owner’s Discretionary Cash Flow or True Cash Flow: This is the amount of pre-tax money distributed to owners via salary, bonus, distributions from the company such as S-distributions, and rental payments in excess of fair market rental value of the equipment or building used in the business. This provides buyers with the most accurate indicator of how much “cash” a company can actually produce and is often the most meaningful indicator of value.
Which brings us back to our original question: Is it realistic for a business owner to expect a six times multiple when he sells his business? There is no one right or wrong answer to this question.
To show you how tricky this can be, let’s look at a former client of ours. His business was not doing well. He had revenues of approximately $7 million but, even using the most generous definition of earnings, the company was not earning more that about $100,000 per year. We ultimately sold the company to a buyer of distressed companies who paid book value for its assets or about $2 million. Despite this low value, our client was extremely happy because his business sold for 20 times earnings! In this case the buyer was buying assets, not earnings, so an earning multiple wasn’t even appropriate.
To determine which measure of earnings is appropriate for a business, you need to look first at how the seller’s industry defines “earnings”. This "earnings" measure reflects how much a buyer can afford to pay for the business. The actual multiple applied will be based on:
§ which definition of cash flow is being used,
§ what is appropriate for a given industry,
§ what the company’s specific growth prospects are,
§ how the company’s earnings compare with similar companies in the same industry, and finally
§ how the company’s earnings compare with the company’s asset value.
Richard E. Jackim, JD, MBA, CEPA is the author of the critically acclaimed book, “The $10 Trillion Opportunity: Designing Successful Exit Strategies for Middle Market Business Owners”, available at http://www.exit-planning-institute.org/
http://www.imakenews.com/epi_hfco/e_article001197834.cfm?x=bdnqbsy,w
As a trusted business advisor you’ve probably heard former business owners telling people that they sold their business for “six times earnings.” As investment bankers, the first question we hear from prospective clients is “Can I get the same multiple if I sell my business?” The answer is an unequivocal "it depends." It depends on a number of things, but first and foremost, it depends on how you define “earnings”.
As all investment bankers and sellers know, “Cash is King.” After all, cash removes the seller’s risk in the transaction. However, when a buyer pays cash for a business, that buyer wants to know exactly how much the business is earning.
Let’s start with what seems to be a pretty basic concept: earnings.
The Definitions of Earnings
There are several definitions of earnings; each is potentially different from the other depending on the type of company and the way its owner runs the company. Typical measures of earnings include:
§ Net Operating Income: This is sales less the cost of goods sold and operating expenses.
§ Pre-tax Income: This is net operating income plus non-operating income (like interest on notes, etc.) less non-operating expenses (like one-time, non-recurring expenses).
§ After-tax Income: Pre-tax income, less all company (but not individual) taxes.
§ EBIT: This stands for earnings before interest and taxes.
§ EBITDA: This stands for earnings before interest, taxes, depreciation and amortization
Add to these measures, the need to “adjust" earnings by deducting capital expenditures, and adding back excess rents, excessive salary and bonuses paid to the owner and his or her family. The result is something called:
Owner’s Discretionary Cash Flow or True Cash Flow: This is the amount of pre-tax money distributed to owners via salary, bonus, distributions from the company such as S-distributions, and rental payments in excess of fair market rental value of the equipment or building used in the business. This provides buyers with the most accurate indicator of how much “cash” a company can actually produce and is often the most meaningful indicator of value.
Which brings us back to our original question: Is it realistic for a business owner to expect a six times multiple when he sells his business? There is no one right or wrong answer to this question.
To show you how tricky this can be, let’s look at a former client of ours. His business was not doing well. He had revenues of approximately $7 million but, even using the most generous definition of earnings, the company was not earning more that about $100,000 per year. We ultimately sold the company to a buyer of distressed companies who paid book value for its assets or about $2 million. Despite this low value, our client was extremely happy because his business sold for 20 times earnings! In this case the buyer was buying assets, not earnings, so an earning multiple wasn’t even appropriate.
To determine which measure of earnings is appropriate for a business, you need to look first at how the seller’s industry defines “earnings”. This "earnings" measure reflects how much a buyer can afford to pay for the business. The actual multiple applied will be based on:
§ which definition of cash flow is being used,
§ what is appropriate for a given industry,
§ what the company’s specific growth prospects are,
§ how the company’s earnings compare with similar companies in the same industry, and finally
§ how the company’s earnings compare with the company’s asset value.
Richard E. Jackim, JD, MBA, CEPA is the author of the critically acclaimed book, “The $10 Trillion Opportunity: Designing Successful Exit Strategies for Middle Market Business Owners”, available at http://www.exit-planning-institute.org/
http://www.imakenews.com/epi_hfco/e_article001197834.cfm?x=bdnqbsy,w
New Approach to Uncertainty in Business Valuations
- applying a premium or discount to a capitalization rate, or
- adjusting future revenue and
- adjusting future expense projections.
Thomas E. McKee, CMA, CIA, PhD, CPA, is a visiting professor in the department of accounting and legal studies at the College of Charleston, Charleston, S.C.
The earnings multiple valuation method
The earnings multiple valuation method
The earnings multiple valuation method is the preferred valuation method for most situations. It represents what someone would pay if you tried to sell under normal conditions, which is arguably the most appropriate valuation method for private equity investments.
In the broad strokes, this method entails applying an industry-based multiple to the earnings of a business to arrive at an implied enterprise value. From this enterprise value, subtracting net debt gives the equity value. In simple scenarios (involving only ordinary equity), a private equity firm’s relevant investment value is equal to their proportional stake in the investee’s equity.
The subjectivity of this method comes in the following forms:
•Do you use last year’s actual earnings number? Do you use a forecast? If so, whose forecast do you use? And what earnings are we talking about: NPBT, NPAT, EBIT, EBITDA? What about the effect of non-recurring costs, contributions from discontinued business units, forecast acquisition synergies, etc?
•What is an appropriate multiple? Are transactions from six months ago reasonable comparisons? Should I only use transactions from the same industry as comparables? What about company size: should I only compare those of similar size? What if there haven’t been any transactions for 12 months (this is especially applicable now)? Should I use the mean, mode or median of comparable transactions?
There are a lot of questions there and not many answers; it really depends on how honest you want to be with yourself and the limited partners. Here are my suggestions:
•Earnings - You should use the earnings number that you expect at the time of reporting. For example, this may be the current year’s EBIT forecast adjusted for the latest actual earnings figures (that is, if you were below budget, adjust the forecast months accordingly). If the trend is towards using the previous year’s earnings, then you should follow suit.
•Multiple - In the current climate, you may need to look outside your industry for trends, but also make sure to look for similar sized transactions. There’s no perfect multiple to use, but there’s certainly a range that will seem reasonable. I’d say in the current environment that anything over 8-10x would be unreasonable. For mid-market deals, I wouldn’t expect to see multiples over 6-7x, unless there is a strong case for exceptional growth. It may surprise you, but I’m seeing some interesting deals go for 3x now.
You’ll know in your own mind whether you’re being fair with your analysis. Try not to cheat yourself because there’s a real danger that it could come back to haunt you. There’s always the argument that if things really do get better, investors will be glad to see a significant uptick in your next report. If you’re too optimistic now, disappointing them twice will hardly be fun. Also, investors won’t be surprised with value losses now; they’re probably expecting them. So take this opportunity to take an honest look at your portfolio and move on to planning for the upturn (now there’s some positive thinking).
http://www.theprivateequiteer.com/the-earnings-multiple-valuation-method/
The earnings multiple valuation method is the preferred valuation method for most situations. It represents what someone would pay if you tried to sell under normal conditions, which is arguably the most appropriate valuation method for private equity investments.
In the broad strokes, this method entails applying an industry-based multiple to the earnings of a business to arrive at an implied enterprise value. From this enterprise value, subtracting net debt gives the equity value. In simple scenarios (involving only ordinary equity), a private equity firm’s relevant investment value is equal to their proportional stake in the investee’s equity.
The subjectivity of this method comes in the following forms:
•Do you use last year’s actual earnings number? Do you use a forecast? If so, whose forecast do you use? And what earnings are we talking about: NPBT, NPAT, EBIT, EBITDA? What about the effect of non-recurring costs, contributions from discontinued business units, forecast acquisition synergies, etc?
•What is an appropriate multiple? Are transactions from six months ago reasonable comparisons? Should I only use transactions from the same industry as comparables? What about company size: should I only compare those of similar size? What if there haven’t been any transactions for 12 months (this is especially applicable now)? Should I use the mean, mode or median of comparable transactions?
There are a lot of questions there and not many answers; it really depends on how honest you want to be with yourself and the limited partners. Here are my suggestions:
•Earnings - You should use the earnings number that you expect at the time of reporting. For example, this may be the current year’s EBIT forecast adjusted for the latest actual earnings figures (that is, if you were below budget, adjust the forecast months accordingly). If the trend is towards using the previous year’s earnings, then you should follow suit.
•Multiple - In the current climate, you may need to look outside your industry for trends, but also make sure to look for similar sized transactions. There’s no perfect multiple to use, but there’s certainly a range that will seem reasonable. I’d say in the current environment that anything over 8-10x would be unreasonable. For mid-market deals, I wouldn’t expect to see multiples over 6-7x, unless there is a strong case for exceptional growth. It may surprise you, but I’m seeing some interesting deals go for 3x now.
You’ll know in your own mind whether you’re being fair with your analysis. Try not to cheat yourself because there’s a real danger that it could come back to haunt you. There’s always the argument that if things really do get better, investors will be glad to see a significant uptick in your next report. If you’re too optimistic now, disappointing them twice will hardly be fun. Also, investors won’t be surprised with value losses now; they’re probably expecting them. So take this opportunity to take an honest look at your portfolio and move on to planning for the upturn (now there’s some positive thinking).
http://www.theprivateequiteer.com/the-earnings-multiple-valuation-method/
Earnings Multiple: A Valuation Method
Among various methods for determining the value of a small business, the "earnings multiple" approach is almost universally considered to be the most acceptable and useful.
- on the one hand--a manufacturing company in a troubled industry with several hundred thousands in hard assets, but less than $3,500 per month in owner earnings, and
- on the other hand, a distributorship generating more than $20,000 per month in owner earnings, and operated successfully with little in the way of assets--perhaps just a fax-capable telephone and an address book.
http://www.usabizmart.com/blog/earnings-multiple-business-valuation-120508.php
Price to Future Earnings
Price to Future Earnings
The price earnings ratio cannot be estimated for firms with negative earnings per share. While there are other multiples, such as the price to sales ratio, that can still be estimated for these firms, there are analysts who prefer the familiar ground of PE ratios.
One way in which the price earnings ratio can be modified for use in these firms is to use expected earnings per share in a future year in computing the PE ratio.
For instance, assume that a firm has earnings per share currently of -$2.00 but is expected to report earnings per share in 5 years of $1.50 per share. You could divide the price today by the expected earnings per share in five years to obtain a PE ratio.
How would such a PE ratio be used? The PE ratio for all of the comparable firms would also have to be estimated using expected earnings per share in 5 years and the resulting values can be compared across firms. Assuming that all of the firms in the sample share the same risk, growth and payout characteristics after year 5, firms with low price to future earnings ratios will be considered undervalued.
An alternative approach is to estimate a target price for the negative earnings firm in five years, divide that price by earnings in that year and compare this PE ratio to the PE ratio of comparable firms today.
While this modified version of the PE ratio increases the reach of PE ratios to cover many firms that have negative earnings today, it is difficult to control for differences between the firm being valued and the comparable firms, since you are comparing firms at different points in time.
Illustration: Analyzing Amazon using Price to Future Earnings per share Amazon.com has negative earnings per share in 2000. Based upon consensus estimates, analysts expect it to lose $0.63 per share in 2001 but is expected to earn $1.50 per share in 2004. At its current price of $49 per share, this would translate into a price/future earnings per share of 32.67.
In the first approach, this multiple of earnings can be compared to the price/future earnings ratios of comparable firms. If you define comparable firms to be e-tailers, Amazon looks reasonably attractive since the average price/future earnings per share of etailers
is 65. If, on the other hand, you compared Amazon’s price to future earnings per share to the average price to future earnings per share (in 2004) of specialty retailers, the picture is bleaker. The average price to future earnings for these firms is 12, which would lead to a conclusion that Amazon is over valued. Implicit in both these comparisons is the assumption that Amazon will have similar risk, growth and cash flow characteristics as the comparable firms in five years. You could argue that Amazon will still have much higher growth potential than other specialty retailers after 2004 and that this could explain the difference in multiples. You could even use differences in expected growth after 2004 to adjust for the differences, but estimates of these growth rates are usually not made by analysts.
In the second approach, the current price to earnings ratio for specialty retailers, which is estimated to be 20.31, and the expected earnings per share of Amazon in 2004, which is estimated to be $1.50. This would yield a target price of $30.46. Discounting this price back to the present using Amazon’s cost of equity of 12.94% results in a value per share.
= Target price in five years / (1+ Cost of equity)^5
Value per share
= 30.46 / (1.1294^5)
= $16.58
At its current price of $49, this would again suggest an over valued stock. Here again, though, you are assuming that Amazon in five years will resemble a specialty retailer today in terms of risk, growth and cash flow characteristics.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
The price earnings ratio cannot be estimated for firms with negative earnings per share. While there are other multiples, such as the price to sales ratio, that can still be estimated for these firms, there are analysts who prefer the familiar ground of PE ratios.
One way in which the price earnings ratio can be modified for use in these firms is to use expected earnings per share in a future year in computing the PE ratio.
For instance, assume that a firm has earnings per share currently of -$2.00 but is expected to report earnings per share in 5 years of $1.50 per share. You could divide the price today by the expected earnings per share in five years to obtain a PE ratio.
How would such a PE ratio be used? The PE ratio for all of the comparable firms would also have to be estimated using expected earnings per share in 5 years and the resulting values can be compared across firms. Assuming that all of the firms in the sample share the same risk, growth and payout characteristics after year 5, firms with low price to future earnings ratios will be considered undervalued.
An alternative approach is to estimate a target price for the negative earnings firm in five years, divide that price by earnings in that year and compare this PE ratio to the PE ratio of comparable firms today.
While this modified version of the PE ratio increases the reach of PE ratios to cover many firms that have negative earnings today, it is difficult to control for differences between the firm being valued and the comparable firms, since you are comparing firms at different points in time.
Illustration: Analyzing Amazon using Price to Future Earnings per share Amazon.com has negative earnings per share in 2000. Based upon consensus estimates, analysts expect it to lose $0.63 per share in 2001 but is expected to earn $1.50 per share in 2004. At its current price of $49 per share, this would translate into a price/future earnings per share of 32.67.
In the first approach, this multiple of earnings can be compared to the price/future earnings ratios of comparable firms. If you define comparable firms to be e-tailers, Amazon looks reasonably attractive since the average price/future earnings per share of etailers
is 65. If, on the other hand, you compared Amazon’s price to future earnings per share to the average price to future earnings per share (in 2004) of specialty retailers, the picture is bleaker. The average price to future earnings for these firms is 12, which would lead to a conclusion that Amazon is over valued. Implicit in both these comparisons is the assumption that Amazon will have similar risk, growth and cash flow characteristics as the comparable firms in five years. You could argue that Amazon will still have much higher growth potential than other specialty retailers after 2004 and that this could explain the difference in multiples. You could even use differences in expected growth after 2004 to adjust for the differences, but estimates of these growth rates are usually not made by analysts.
In the second approach, the current price to earnings ratio for specialty retailers, which is estimated to be 20.31, and the expected earnings per share of Amazon in 2004, which is estimated to be $1.50. This would yield a target price of $30.46. Discounting this price back to the present using Amazon’s cost of equity of 12.94% results in a value per share.
= Target price in five years / (1+ Cost of equity)^5
Value per share
= 30.46 / (1.1294^5)
= $16.58
At its current price of $49, this would again suggest an over valued stock. Here again, though, you are assuming that Amazon in five years will resemble a specialty retailer today in terms of risk, growth and cash flow characteristics.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Relative PE Ratios and Market Growth
Relative PE Ratios and Market Growth
As the expected growth rate on the market increases, the divergence in PE ratios increases, resulting in a bigger range for relative PE ratios.
This can be illustrated very simply, if you consider the relative PE for a company that grows at half the rate as the market.
When the market growth rate is 4%, this firm will trade at a PE that is roughly 80% of the market PE. When the market growth rate increases to 10%, the firm will trade at a PE that is 60% of the market PE.
This has consequences for analysts who use relative PE ratios. Stocks of firms whose earnings grow at a rate much lower than the market growth rate, will often look cheap on a relative PE basis when the market growth rate is high, and expensive when the market growth rate is low.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
As the expected growth rate on the market increases, the divergence in PE ratios increases, resulting in a bigger range for relative PE ratios.
This can be illustrated very simply, if you consider the relative PE for a company that grows at half the rate as the market.
When the market growth rate is 4%, this firm will trade at a PE that is roughly 80% of the market PE. When the market growth rate increases to 10%, the firm will trade at a PE that is 60% of the market PE.
This has consequences for analysts who use relative PE ratios. Stocks of firms whose earnings grow at a rate much lower than the market growth rate, will often look cheap on a relative PE basis when the market growth rate is high, and expensive when the market growth rate is low.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Relative PE Ratios
Note that the relative PE ratio is a function of all of the variables that determine the PE ratio – the expected growth rate, the risk of the firm and the payout ratio – but stated in terms relative to the market. Thus, a firm’s relative PE ratio is a function of its relative growth rate in earnings per share (Growth Ratefirm/Growth Ratemarket), its relative cost of equity (Cost of Equityfirm/Cost of Equitymarket) and its relative return on equity (ROEfirm/ROEmarket). Firms with higher relative growth, lower relative costs of equity and higher relative returns on equity should trade at higher relative PE ratios.
There are two ways in which they are used in valuation.
- One is to compare a firm’s relative PE ratio to its historical norms; Ford, for instance, may be viewed as under valued because its relative PE ratio of 0.24 today is lower than the relative PE that it has historically traded at.
- The other is to compare relative PE ratios of firms in different markets; this allows comparisons when PE ratios in different markets vary significantly.
Illustration:
Comparing Relative PE ratios for automobile stock – December 2000
In December 2000, the S&P 500 was trading at a multiple of 29.09 times earnings. At the same time, Ford, Chrysler and GM were trading at 7.05, 8.95 and 6.93 times earnings, respectively. Their relative PE ratios are reported.
Relative PE for Ford = 7.05 / 29.09 = 0.24
Relative PE for Chrysler = 8.95 / 29.09 = 0.30
Relative PE for GM = 6.93 / 29.09 = 0.24
Does this mean that GM and Ford are more under valued than Chrysler? Not necessarily, since there are differences in growth and risk across these firms. In fact, Figure 18.13 graphs the relative PE ratios of the three firms going back to the early 1990s. In 1993, GM traded at a significantly higher relative PE ratio than the other two firms. In fact, the conventional wisdom until that point in time was that GM was less risky than the other two firms because of its dominance of the auto market and should trade at a higher multiple of earnings. During the 1990s, the premium paid for GM largely disappeared and the three automobile firms traded at roughly the same relative PE ratios.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Whose Growth rate to use in PEG calculations?
Whose Growth rate?
In computing PEG ratios, we are often faced with the question of whose growth rate we will use in estimating the PEG ratios.
If the number of firms in the sample is small, you could estimate expected growth for each firm yourself.
If the number of firms increases, you will have no choice but to use analyst estimates of expected growth for the firms. Will this expose your analyses to all of the biases in these estimates? Not necessarily. If the bias is uniform – for instance, analysts over estimate growth for all of the firms in the sector – you will still be able to make comparisons of PEG ratios across firms and draw reasonable conclusions.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
In computing PEG ratios, we are often faced with the question of whose growth rate we will use in estimating the PEG ratios.
If the number of firms in the sample is small, you could estimate expected growth for each firm yourself.
If the number of firms increases, you will have no choice but to use analyst estimates of expected growth for the firms. Will this expose your analyses to all of the biases in these estimates? Not necessarily. If the bias is uniform – for instance, analysts over estimate growth for all of the firms in the sector – you will still be able to make comparisons of PEG ratios across firms and draw reasonable conclusions.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Using the PEG Ratio for Comparisons
- the risk,
- growth potential and
- the payout ratio of a firm.
In this section, you look at ways of using the PEG ratio and examine some of the problems in comparing PEG ratios across firms.
Direct Comparisons
PEG Ratios and Retention Ratios
Most analysts who use PEG ratios compute them for firms within a business (or comparable firm group) and compare these ratios.
Firms with lower PEG ratios are usually viewed as undervalued, even if growth rates are different across the firms being compared.
This approach is based upon the incorrect perception that PEG ratios control for differences in growth. In fact, direct comparisons of PEG ratios work only if firms are similar in terms of growth potential, risk and payout ratios (or returns on equity). If this were the case, however, you could just as easily compare PE ratios across firms.
When PEG ratios are compared across firms with different risk, growth and payout characteristics and judgments are made about valuations based on this comparison, you will tend to find that:
· Lower growth firms will have higher PEG ratios and look more over valued than higher growth firms, because PEG ratios tend to decrease as the growth rate decreases, at least initially.
· Higher risk firms will have lower PEG ratios and look more under valued than higher risk firms, because PEG ratios tend to decrease as a firm’s risk increases.
· Firms with lower returns on equity (or lower payout ratios) will have lower PEG ratios and look more under valued than firms with higher returns on equity and higher payout ratios.
In short, firms that look under valued based upon direct comparison of the PEG ratios may in fact be firms with higher risk, higher growth or lower returns on equity that are, in fact, correctly valued.
Controlled Comparisons
When comparing PEG ratios across firms, then, it is important that you control for differences in risk, growth and payout ratios when making the comparison. While you can attempt to do this subjectively, the complicated relationship between PEG ratios and these fundamentals can pose a challenge. A far more promising route is to use the regression approach suggested for PE ratios and to relate the PEG ratios of the firms being compared to measures of risk, growth potential and the payout ratio.
As with the PE ratio, the comparable firms in this analysis can be defined narrowly (as other firms in the same business), more expansively as firms in the same sector or as all firms in the market. In running these regressions, all the caveats that were presented for the PE regression continue to apply. The independent variables continue to be correlated with each other and the relationship is both unstable and likely to be nonlinear.
A scatter plot of PEG ratios against growth rates, for all U.S. stocks in July 2000, indicates the degree of non-linearity.
In running the regression, especially when the sample contains firms with very different levels of growth, you should transform the growth rate to make the relationship more linear. A scatter plot of PEG ratios against the natural log of the expected growth rate, for
instance, yields a much more linear relationship.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Using PEG ratio: Not all growth is created equal.
As the risk increases, the PEG ratio of a firm decreases. When comparing the PEG ratios of firms with different risk levels, even within the same sector, the riskier firms should have lower PEG ratios than safer firms.
Not all growth is created equal. A firm that is able to grow at 20% a year, while paying out 50% of its earnings to stockholders, has higher quality growth than another firm with the same growth rate that reinvests all of its earnings back. Thus, the PEG ratio should increase as the payout ratio increases, for any given growth rate.
As with the PE ratio, the PEG ratio is used to compare the valuations of firms that are in the same business. The PEG ratio is a function of:
As with the PE ratio, the PEG ratio is used to compare the valuations of firms that are in the same business. The PEG ratio is a function of:
- the risk,
- growth potential and
- the payout ratio of a firm.
The PEG Ratio
The PEG Ratio
Portfolio managers and analysts sometimes compare PE ratios to the expected growth rate to identify undervalued and overvalued stocks. In the simplest form of this approach, firms with PE ratios less than their expected growth rate are viewed as undervalued. In its more general form, the ratio of PE ratio to growth is used as a measure of relative value, with a lower value believed to indicate that a firm is under valued.
For many analysts, especially those tracking firms in high-growth sectors, these approaches offer the promise of a way of controlling for differences in growth across firms, while preserving the inherent simplicity of a multiple.
Definition of the PEG Ratio
The PEG ratio is defined to be the price earnings ratio divided by the expected growth rate in earnings per share:
PEG ratio = PE ratio /Expected Growth Rate
For instance, a firm with a PE ratio of 20 and a growth rate of 10% is estimated to have a PEG ratio of 2.
Consistency requires the growth rate used in this estimate be the growth rate in earnings per share, rather than operating income, because this is an equity multiple.
Given the many definitions of the PE ratio, which one should you use to estimate the PEG ratio? The answer depends upon the base on which the expected growth rate is computed. If the expected growth rate in earnings per share is based upon earnings in the most recent year (current earnings), the PE ratio that should be used is the current PE ratio. If it based upon trailing earnings, the PE ratio used should be the trailing PE ratio.
The forward PE ratio should never be used in this computation, since it may result in a double counting of growth. To see why, assume that you have a firm with a current price of $30 and current earnings per share of $1.50. The firm is expected to double its earnings per share over the next year (forward earnings per share will be $3.00) and then have earnings growth of 5% a year for the following four years. An analyst estimating growth in earnings per share for this firm, with the current earnings per share as a base, will estimate a growth rate of 19.44%.
A consistent estimate of the PEG ratio would require using a current PE and the expected growth rate over the next 5 years.
Building upon the theme of uniformity, the PEG ratio should be estimated using the same growth estimates for all firms in the sample. You should not, for instance, use 5-year growth rates for some firms and 1-year growth rates for others. One way of ensuring uniformity is to use the same source for earnings growth estimates for all the firms in the group.
For instance, both I/B/E/S and Zacks provide consensus estimates from analysts of earnings per share growth over the next 5 years for most U.S. firms.
As the risk increases, the PEG ratio of a firm decreases. When comparing the PEG ratios of firms with different risk levels, even within the same sector, the riskier firms should have lower PEG ratios than safer firms.
Not all growth is created equal. A firm that is able to grow at 20% a year, while paying out 50% of its earnings to stockholders, has higher quality growth than another firm with the same growth rate that reinvests all of its earnings back. Thus, the PEG ratio should increase as the payout ratio increases, for any given growth rate.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Portfolio managers and analysts sometimes compare PE ratios to the expected growth rate to identify undervalued and overvalued stocks. In the simplest form of this approach, firms with PE ratios less than their expected growth rate are viewed as undervalued. In its more general form, the ratio of PE ratio to growth is used as a measure of relative value, with a lower value believed to indicate that a firm is under valued.
For many analysts, especially those tracking firms in high-growth sectors, these approaches offer the promise of a way of controlling for differences in growth across firms, while preserving the inherent simplicity of a multiple.
Definition of the PEG Ratio
The PEG ratio is defined to be the price earnings ratio divided by the expected growth rate in earnings per share:
PEG ratio = PE ratio /Expected Growth Rate
For instance, a firm with a PE ratio of 20 and a growth rate of 10% is estimated to have a PEG ratio of 2.
Consistency requires the growth rate used in this estimate be the growth rate in earnings per share, rather than operating income, because this is an equity multiple.
Given the many definitions of the PE ratio, which one should you use to estimate the PEG ratio? The answer depends upon the base on which the expected growth rate is computed. If the expected growth rate in earnings per share is based upon earnings in the most recent year (current earnings), the PE ratio that should be used is the current PE ratio. If it based upon trailing earnings, the PE ratio used should be the trailing PE ratio.
The forward PE ratio should never be used in this computation, since it may result in a double counting of growth. To see why, assume that you have a firm with a current price of $30 and current earnings per share of $1.50. The firm is expected to double its earnings per share over the next year (forward earnings per share will be $3.00) and then have earnings growth of 5% a year for the following four years. An analyst estimating growth in earnings per share for this firm, with the current earnings per share as a base, will estimate a growth rate of 19.44%.
A consistent estimate of the PEG ratio would require using a current PE and the expected growth rate over the next 5 years.
Building upon the theme of uniformity, the PEG ratio should be estimated using the same growth estimates for all firms in the sample. You should not, for instance, use 5-year growth rates for some firms and 1-year growth rates for others. One way of ensuring uniformity is to use the same source for earnings growth estimates for all the firms in the group.
For instance, both I/B/E/S and Zacks provide consensus estimates from analysts of earnings per share growth over the next 5 years for most U.S. firms.
As the risk increases, the PEG ratio of a firm decreases. When comparing the PEG ratios of firms with different risk levels, even within the same sector, the riskier firms should have lower PEG ratios than safer firms.
Not all growth is created equal. A firm that is able to grow at 20% a year, while paying out 50% of its earnings to stockholders, has higher quality growth than another firm with the same growth rate that reinvests all of its earnings back. Thus, the PEG ratio should increase as the payout ratio increases, for any given growth rate.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
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
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
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
Comparing PE ratios across Countries
Comparing PE ratios across Countries
Comparisons are often made between price-earnings ratios in different countries with the intention of finding undervalued and overvalued markets. Markets with lower PE ratios are viewed as under valued and those with higher PE ratios are considered over valued.
Given the wide differences that exist between countries on fundamentals, it is clearly misleading to draw these conclusions. For instance, you would expect to see the following, other things remaining equal:
· Countries with higher real interest rates should have lower PE ratios than countries with lower real interest rates.
· Countries with higher expected real growth should have higher PE ratios than countries with lower real growth.
· Countries that are viewed as riskier (and thus command higher risk premiums) should have lower PE ratios than safer countries
· Countries where companies are more efficient in their investments (and earn a higher return on these investments) should trade at higher PE ratios.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Comparisons are often made between price-earnings ratios in different countries with the intention of finding undervalued and overvalued markets. Markets with lower PE ratios are viewed as under valued and those with higher PE ratios are considered over valued.
Given the wide differences that exist between countries on fundamentals, it is clearly misleading to draw these conclusions. For instance, you would expect to see the following, other things remaining equal:
· Countries with higher real interest rates should have lower PE ratios than countries with lower real interest rates.
· Countries with higher expected real growth should have higher PE ratios than countries with lower real growth.
· Countries that are viewed as riskier (and thus command higher risk premiums) should have lower PE ratios than safer countries
· Countries where companies are more efficient in their investments (and earn a higher return on these investments) should trade at higher PE ratios.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Comparing a Market’s PE ratio across time
Comparing a Market’s PE ratio across time
Analysts and market strategists often compare the PE ratio of a market to its historical average to make judgments about whether the market is under or over valued.
Thus, a market which is trading at a PE ratio which is much higher than its historical norms is often considered to be over valued, whereas one that is trading at a ratio lower is considered under valued.
While reversion to historic norms remains a very strong force in financial markets, we should be cautious about drawing too strong a conclusion from such comparisons. As the fundamentals (interest rates, risk premiums, expected growth and payout) change over
time, the PE ratio will also change. Other things remaining equal, for instance, we would expect the following.
· An increase in interest rates should result in a higher cost of equity for the market and a lower PE ratio.
· A greater willingness to take risk on the part of investors will result in a lower risk premium for equity and a higher PE ratio across all stocks.
· An increase in expected growth in earnings across firms will result in a higher PE ratio for the market.
· An increase in the return on equity at firms will result in a higher payout ratio for any given growth rate (g = (1- Payout ratio)ROE) and a higher PE ratio for all firms.
In other words, it is difficult to draw conclusions about PE ratios without looking at these fundamentals. A more appropriate comparison is therefore not between PE ratios across time, but between the actual PE ratio and the predicted PE ratio based upon fundamentals
existing at that time.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Analysts and market strategists often compare the PE ratio of a market to its historical average to make judgments about whether the market is under or over valued.
Thus, a market which is trading at a PE ratio which is much higher than its historical norms is often considered to be over valued, whereas one that is trading at a ratio lower is considered under valued.
While reversion to historic norms remains a very strong force in financial markets, we should be cautious about drawing too strong a conclusion from such comparisons. As the fundamentals (interest rates, risk premiums, expected growth and payout) change over
time, the PE ratio will also change. Other things remaining equal, for instance, we would expect the following.
· An increase in interest rates should result in a higher cost of equity for the market and a lower PE ratio.
· A greater willingness to take risk on the part of investors will result in a lower risk premium for equity and a higher PE ratio across all stocks.
· An increase in expected growth in earnings across firms will result in a higher PE ratio for the market.
· An increase in the return on equity at firms will result in a higher payout ratio for any given growth rate (g = (1- Payout ratio)ROE) and a higher PE ratio for all firms.
In other words, it is difficult to draw conclusions about PE ratios without looking at these fundamentals. A more appropriate comparison is therefore not between PE ratios across time, but between the actual PE ratio and the predicted PE ratio based upon fundamentals
existing at that time.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf
Wednesday, 11 November 2009
Brain drain and middle-income trap key issues
Brain drain and middle-income trap key issues
Tags: Attracting talent | Datuk Johan Raslan | Datuk Justin Leong | Datuk R Karunakaran | Dr Soh Chee Seng | GDP | Genting Group Malaysia | HSBC Bank Bhd | ISIS | Jon Addis | Malaysia | MICPA | Steven CM Wong | Talented people
Written by Loong Tse Min
Wednesday, 11 November 2009 11:39
KUALA LUMPUR: Malaysia needs to reach out to talented people wherever they come from, apart from bringing back its own, said Malaysian Institute of Certified Public Accountants (MICPA) vice-president Datuk Johan Raslan.
He said many Malaysians could be found working overseas as they were often adaptable, multi-lingual and inexpensive.
“The world wants Malaysians. We need to get them back, but we must not hold them back,” Johan said in the opening address of the two-day MICPA-Bursa Malaysia Business Forum 2009.
Cities such as Hong Kong, Singapore, London and Sydney were open to attracting talent and Malaysia needed to be equally so, he said.
“We should not shut out people with skills and expertise simply because they were not born here. We need to reach out to talented people wherever they come from,” he said.
Johan added that the country’s liberalisation measures put it “on the starting block” towards becoming a high-income economy and what was needed now were the fine details.
He also said the corporate sector must take ownership of abolishing corruption and not just consider it the responsibility of the government alone. “For every taker, there is a giver,” he said.
“In the final analysis, it is equally important to provide a conducive environment that is clean, fair and predictable, to attract companies to set up here, stay here and do business.”
Speaking in the first discussion session on Competing in the New Global Landscape, Institute of Strategic and International Studies (ISIS) Malaysia assistant director general Steven CM Wong, suggested that to become a high-value economy, the country should “get off protective industries”, “get rid of energy subsidies” and “get off the dependence on foreign workers”.
He said the potential disruption to business of some of his proposals such as the last one was really part of “transition costs”. Wong, whose research interests include international economics and international relations, also suggested that the Malaysian economy was too much consumption driven and there was a need to focus on production aspects.
Datuk R Karunakaran, a former director-general of the Malaysian Industrial Development Authority, who was moderating, pointed out that one key issue to higher salary was higher productivity. “With productivity comes better pay and better income,” he said.
In terms of composition of the economy for most developed countries, more than 60% of annual gross domestic product (GDP) came from the services sector, with Malaysia somewhere just over 50%. “That is a characteristic of a high-income economy and that is the transformation we will have to go through,” he said.
Deputy director in the Public-Private Partnership Centre and Secretariat to the Economic Council of the Economic Planning Unit Dr Soh Chee Seng said: “Our productivity levels are not really low, it is just that they are falling behind other rapidly developing countries like China, India, Indonesia and Thailand.”
He agreed that it was necessary for the country to be more open to attract the talent in the areas that it needed, “not just foreign talent but also Malaysians who are attracted elsewhere”.
HSBC Bank Bhd executive director Jon Addis said the diaspora of Malaysians was not a bad thing, as his home country Britain had benefited from a similar trend.
“If those skills and money return to Malaysia, that’s a good thing.”
He questioned whether foreign workers should be an issue and suggested that it might be a better strategy to raise the standard of education for Malaysians so that they could do the higher-value jobs while leaving the low-wage jobs to foreign labour.
He also said the country’s infrastructure was still “patchy” such as in terms of public transit, which had some idiosyncrasies.
Genting Group Malaysia’s head of strategic investments and corporate affairs Datuk Justin Leong said the Malaysian culture of adaptability and flexibility provided a good talent pool for businesses to expand overseas.
He said that from his experience, most Malaysians working overseas still held Malaysian passports and continued to have a lot of goodwill towards the country. Attracting them back was a possibility through sufficiently attractive job opportunities as well as improved safety and rule of law, he said.
This article appeared in The Edge Financial Daily, November 11, 2009.
Tags: Attracting talent | Datuk Johan Raslan | Datuk Justin Leong | Datuk R Karunakaran | Dr Soh Chee Seng | GDP | Genting Group Malaysia | HSBC Bank Bhd | ISIS | Jon Addis | Malaysia | MICPA | Steven CM Wong | Talented people
Written by Loong Tse Min
Wednesday, 11 November 2009 11:39
KUALA LUMPUR: Malaysia needs to reach out to talented people wherever they come from, apart from bringing back its own, said Malaysian Institute of Certified Public Accountants (MICPA) vice-president Datuk Johan Raslan.
He said many Malaysians could be found working overseas as they were often adaptable, multi-lingual and inexpensive.
“The world wants Malaysians. We need to get them back, but we must not hold them back,” Johan said in the opening address of the two-day MICPA-Bursa Malaysia Business Forum 2009.
Cities such as Hong Kong, Singapore, London and Sydney were open to attracting talent and Malaysia needed to be equally so, he said.
“We should not shut out people with skills and expertise simply because they were not born here. We need to reach out to talented people wherever they come from,” he said.
Johan added that the country’s liberalisation measures put it “on the starting block” towards becoming a high-income economy and what was needed now were the fine details.
He also said the corporate sector must take ownership of abolishing corruption and not just consider it the responsibility of the government alone. “For every taker, there is a giver,” he said.
“In the final analysis, it is equally important to provide a conducive environment that is clean, fair and predictable, to attract companies to set up here, stay here and do business.”
Speaking in the first discussion session on Competing in the New Global Landscape, Institute of Strategic and International Studies (ISIS) Malaysia assistant director general Steven CM Wong, suggested that to become a high-value economy, the country should “get off protective industries”, “get rid of energy subsidies” and “get off the dependence on foreign workers”.
He said the potential disruption to business of some of his proposals such as the last one was really part of “transition costs”. Wong, whose research interests include international economics and international relations, also suggested that the Malaysian economy was too much consumption driven and there was a need to focus on production aspects.
Datuk R Karunakaran, a former director-general of the Malaysian Industrial Development Authority, who was moderating, pointed out that one key issue to higher salary was higher productivity. “With productivity comes better pay and better income,” he said.
In terms of composition of the economy for most developed countries, more than 60% of annual gross domestic product (GDP) came from the services sector, with Malaysia somewhere just over 50%. “That is a characteristic of a high-income economy and that is the transformation we will have to go through,” he said.
Deputy director in the Public-Private Partnership Centre and Secretariat to the Economic Council of the Economic Planning Unit Dr Soh Chee Seng said: “Our productivity levels are not really low, it is just that they are falling behind other rapidly developing countries like China, India, Indonesia and Thailand.”
He agreed that it was necessary for the country to be more open to attract the talent in the areas that it needed, “not just foreign talent but also Malaysians who are attracted elsewhere”.
HSBC Bank Bhd executive director Jon Addis said the diaspora of Malaysians was not a bad thing, as his home country Britain had benefited from a similar trend.
“If those skills and money return to Malaysia, that’s a good thing.”
He questioned whether foreign workers should be an issue and suggested that it might be a better strategy to raise the standard of education for Malaysians so that they could do the higher-value jobs while leaving the low-wage jobs to foreign labour.
He also said the country’s infrastructure was still “patchy” such as in terms of public transit, which had some idiosyncrasies.
Genting Group Malaysia’s head of strategic investments and corporate affairs Datuk Justin Leong said the Malaysian culture of adaptability and flexibility provided a good talent pool for businesses to expand overseas.
He said that from his experience, most Malaysians working overseas still held Malaysian passports and continued to have a lot of goodwill towards the country. Attracting them back was a possibility through sufficiently attractive job opportunities as well as improved safety and rule of law, he said.
This article appeared in The Edge Financial Daily, November 11, 2009.
Selangor to redevelop PJ, Klang, Kajang
Selangor to redevelop PJ, Klang, Kajang
Tags: Kajang | Klang | land value | Petaling Jaya | Petaling Jaya City Council | redevelopment | Section 13 | Selangor Government | Tan Sri Khalid Ibrahim
Written by Au Foong Yee
Tuesday, 10 November 2009 12:00
SHAH ALAM: Certain industrial and older housing enclaves in Petaling Jaya, Klang and Kajang have been identified for redevelopment in a bid by the Selangor government to enhance their land value and to create a stimulus for the state.
Selangor Menteri Besar Tan Sri Khalid Ibrahim said the regeneration exercise would kick off in PJ. Owners of buildings in “three or four” areas, among them Section 13, would be given incentives to redevelop their buildings for commercial use.
“We have written to the industries concerned to relocate. If they agree to move, they can rebuild on the existing tract of commercial property with certain densities,” Khalid told The Edge Financial Daily and theedgeproperty.com in an interview here yesterday.
These industrial operations would be allowed to be relocated to other more acceptable areas in Selangor, such as those near ports, Khalid said.
The redevelopment would be in the interest of the property owners, he added. “What we gain is that PJ will become redeveloped and vibrant. They [landowners] will make the money — the state is just making the environment conducive for them.”
Asked whether redevelopment would create traffic and transportation related issues,with congestion being at the top of the list, Khalid conceded, “In a way, yes.”
“We have to show them that we cannot leave PJ in this [current] manner; we have to convince them that we will plan for and provide facilities to reduce congestion,” he said.
Towards this end, the state government has asked for another transportation study to be carried out, based on increased densities in the areas concerned. This is to establish whether the higher densities are feasible. The concept of park-and-ride is also being considered.
According to a report earlier this year in City & Country, the property pullout of The Edge weekly , the 220-acre hub of industrial activity in Section 13 was now dotted with “limited commercial” developments in the form of modern offices and retail blocks.
Factories have been operating in Section 13 since the 1960s, but in recent years, the area's growing potential for commercial activities could not be ignored, given its strategic location. This explained the Petaling Jaya City Council’s approval for “limited commercial” activities there, based on certain guidelines.
Meanwhile, on the revival and rehabilitation of abandoned housing projects in Selangor, Khalid said they had been quite successful — thanks to land-value appreciation over time, resulting in people willing to pay more for the completed units.
The challenge, however, was in the selection of the best contractors or developers to complete the projects.
Some of the rehabilitation projects were initiated by the state government which was willing to lose “a bit” so long as the project was completed, added Khalid.
This article appeared in The Edge Financial Daily, Nov 10, 2009.
Tags: Kajang | Klang | land value | Petaling Jaya | Petaling Jaya City Council | redevelopment | Section 13 | Selangor Government | Tan Sri Khalid Ibrahim
Written by Au Foong Yee
Tuesday, 10 November 2009 12:00
SHAH ALAM: Certain industrial and older housing enclaves in Petaling Jaya, Klang and Kajang have been identified for redevelopment in a bid by the Selangor government to enhance their land value and to create a stimulus for the state.
Selangor Menteri Besar Tan Sri Khalid Ibrahim said the regeneration exercise would kick off in PJ. Owners of buildings in “three or four” areas, among them Section 13, would be given incentives to redevelop their buildings for commercial use.
“We have written to the industries concerned to relocate. If they agree to move, they can rebuild on the existing tract of commercial property with certain densities,” Khalid told The Edge Financial Daily and theedgeproperty.com in an interview here yesterday.
These industrial operations would be allowed to be relocated to other more acceptable areas in Selangor, such as those near ports, Khalid said.
The redevelopment would be in the interest of the property owners, he added. “What we gain is that PJ will become redeveloped and vibrant. They [landowners] will make the money — the state is just making the environment conducive for them.”
Asked whether redevelopment would create traffic and transportation related issues,with congestion being at the top of the list, Khalid conceded, “In a way, yes.”
“We have to show them that we cannot leave PJ in this [current] manner; we have to convince them that we will plan for and provide facilities to reduce congestion,” he said.
Towards this end, the state government has asked for another transportation study to be carried out, based on increased densities in the areas concerned. This is to establish whether the higher densities are feasible. The concept of park-and-ride is also being considered.
According to a report earlier this year in City & Country, the property pullout of The Edge weekly , the 220-acre hub of industrial activity in Section 13 was now dotted with “limited commercial” developments in the form of modern offices and retail blocks.
Factories have been operating in Section 13 since the 1960s, but in recent years, the area's growing potential for commercial activities could not be ignored, given its strategic location. This explained the Petaling Jaya City Council’s approval for “limited commercial” activities there, based on certain guidelines.
Meanwhile, on the revival and rehabilitation of abandoned housing projects in Selangor, Khalid said they had been quite successful — thanks to land-value appreciation over time, resulting in people willing to pay more for the completed units.
The challenge, however, was in the selection of the best contractors or developers to complete the projects.
Some of the rehabilitation projects were initiated by the state government which was willing to lose “a bit” so long as the project was completed, added Khalid.
This article appeared in The Edge Financial Daily, Nov 10, 2009.
Plantation sector rating cut to neutral from overweight
http://www.theedgemalaysia.com/business-news/153204-PLANTATION%20[%3Cspan%20class-
Plantation sector rating cut to neutral from overweight
Tags: CPO price | Crude Oil | Genting Plantations Bhd | Indofood Agri-Resources Ltd | IOI Corp Bhd | Kuala Lumpur Kepong Bhd | Kulim (Malaysia) Bhd | neutral | plantation sector | Sarawak Oil Palms Bhd | TH Plantations Bhd | Wilmar International Ltd
Written by AmResearch
Monday, 09 November 2009 10:43
WE HAVE downgraded the PLANTATION [] sector from overweight to neutral. In addition, we have revised our recommendations on IOI CORPORATION BHD [] (IOI), KUALA LUMPUR KEPONG BHD [] (KLK), Wilmar International Ltd and Indofood Agri-Resources (IndoAgri) from buys to holds.
Earning estimates trimmed; fair values cut
Due to our lower average CPO price assumption for 2010F, we have revised earnings forecasts for companies under our coverage downwards by 4% to 11%, with the exception of SARAWAK OIL PALMS BHD [] (SOP). Despite this downward revision in our earnings estimates, EPS growth for FY10F will still be positive, driven by production growth and a low base effect in FY09F. Recall that earnings of bigger-caps like IOI and KLK in FY09F were affected by forex losses, provisions and lower manufacturing contribution resulting from writedowns.
CPO price assumption lowered to RM2,300/tonne
A result of our recent visits to companies under our coverage is that we are taking a more conservative stance on crude palm oil’s (CPO) pricing cycle — moving into 2010. We now expect prices of CPO to oscillate around RM2,300 per tonne — from our previous assumption of RM2,500/tonne. This implies that CPO prices are expected to remain somewhat flattish in 2010F.
Demand expansion may not keep pace with exceptionally strong supply growth from bumper harvests. We see demand and supply dynamics for CPO turning less favourable — pointing towards potential inventory imbalances — thus putting a cap on prices.
Supply concern is admittedly not new but this time around, we believe production will surprise on the upside due to: (1) A combination of expected normalisation in fresh fruit bunches (FFB) yields off depressed levels this year; and (2) Maturing acreage in 2010F. We reckon that FFB output could rise between 8% and 10% next year.
FFB production this year was affected by low yields resulting from poor fruit pollination and heavy rainfall. We think that palm oil inventory will range between 1.8 and two million tonnes next year — exerting downward pressure on CPO prices.
From January 2001 to September 2009, Malaysia’s average palm oil inventory was about 1.4 million tonnes per month. Average palm oil inventory for the past three years has been roughly 1.6 million tonnes/month while average stock usage was 1.3 times. We reckon that with a higher inventory level, stock usage could rise to 1.4 times to 1.5 times next year.
Plantation sector rating cut to neutral from overweight
Tags: CPO price | Crude Oil | Genting Plantations Bhd | Indofood Agri-Resources Ltd | IOI Corp Bhd | Kuala Lumpur Kepong Bhd | Kulim (Malaysia) Bhd | neutral | plantation sector | Sarawak Oil Palms Bhd | TH Plantations Bhd | Wilmar International Ltd
Written by AmResearch
Monday, 09 November 2009 10:43
WE HAVE downgraded the PLANTATION [] sector from overweight to neutral. In addition, we have revised our recommendations on IOI CORPORATION BHD [] (IOI), KUALA LUMPUR KEPONG BHD [] (KLK), Wilmar International Ltd and Indofood Agri-Resources (IndoAgri) from buys to holds.
Earning estimates trimmed; fair values cut
Due to our lower average CPO price assumption for 2010F, we have revised earnings forecasts for companies under our coverage downwards by 4% to 11%, with the exception of SARAWAK OIL PALMS BHD [] (SOP). Despite this downward revision in our earnings estimates, EPS growth for FY10F will still be positive, driven by production growth and a low base effect in FY09F. Recall that earnings of bigger-caps like IOI and KLK in FY09F were affected by forex losses, provisions and lower manufacturing contribution resulting from writedowns.
CPO price assumption lowered to RM2,300/tonne
A result of our recent visits to companies under our coverage is that we are taking a more conservative stance on crude palm oil’s (CPO) pricing cycle — moving into 2010. We now expect prices of CPO to oscillate around RM2,300 per tonne — from our previous assumption of RM2,500/tonne. This implies that CPO prices are expected to remain somewhat flattish in 2010F.
Demand expansion may not keep pace with exceptionally strong supply growth from bumper harvests. We see demand and supply dynamics for CPO turning less favourable — pointing towards potential inventory imbalances — thus putting a cap on prices.
Supply concern is admittedly not new but this time around, we believe production will surprise on the upside due to: (1) A combination of expected normalisation in fresh fruit bunches (FFB) yields off depressed levels this year; and (2) Maturing acreage in 2010F. We reckon that FFB output could rise between 8% and 10% next year.
FFB production this year was affected by low yields resulting from poor fruit pollination and heavy rainfall. We think that palm oil inventory will range between 1.8 and two million tonnes next year — exerting downward pressure on CPO prices.
From January 2001 to September 2009, Malaysia’s average palm oil inventory was about 1.4 million tonnes per month. Average palm oil inventory for the past three years has been roughly 1.6 million tonnes/month while average stock usage was 1.3 times. We reckon that with a higher inventory level, stock usage could rise to 1.4 times to 1.5 times next year.
KLSE TRADE STATISTICS: LOCAL VS FOREIGN October 2009
http://spreadsheets.google.com/pub?key=txKJ-CJ_m_KD-Agbe6RtG5g&output=html
http://www.klse.com.my/website/bm/market_information/market_statistics/equities/downloads/trading_participation_investor2009.pdf
Observations:
The average price per unit volume of shares for the foreign institutions was MR 3.63; that for the local institution was MR 3.33.
The local retail investors were mostly into penny shares. The average value per unit volume traded was MR 0.66.
Half the volume of shares (49.96%) traded in October were generated by local retail investors.
Foreign Institutions were net buyers in October.
Local Institutions were net sellers in October.
No net change in value in trades of local retail investors. However, the volume of shares bought were higher than those sold.
The local retail investors were selling higher priced shares to buy into lower priced shares in October.
Based on value of shares traded, the Local Institutional funds were the biggest players in the local KLSE (43.69%).
http://www.klse.com.my/website/bm/market_information/market_statistics/equities/downloads/trading_participation_investor2009.pdf
Observations:
The average price per unit volume of shares for the foreign institutions was MR 3.63; that for the local institution was MR 3.33.
The local retail investors were mostly into penny shares. The average value per unit volume traded was MR 0.66.
Half the volume of shares (49.96%) traded in October were generated by local retail investors.
Foreign Institutions were net buyers in October.
Local Institutions were net sellers in October.
No net change in value in trades of local retail investors. However, the volume of shares bought were higher than those sold.
The local retail investors were selling higher priced shares to buy into lower priced shares in October.
Based on value of shares traded, the Local Institutional funds were the biggest players in the local KLSE (43.69%).
Russian shares are cheap again
Russian shares are cheap again
Eastern Europe has witnessed momentous changes since the fall of the Berlin Wall 20 years ago.
By Elena Shaftan
Published: 5:54AM GMT 05 Nov 2009
In the two decades since this historic event, the lives of people in the former Communist Bloc have changed beyond recognition – changes that have increasingly attracted the attention of investors since stock exchanges started to open up in the region in the early to mid 1990s.
During this time, investors' focus has largely been on the opportunities presented by the convergence of Eastern European economies with those in the West.
Commodity shares to rise However, 20 years on from the symbolic collapse of the Wall and notwithstanding some setbacks, a lot of the "easy gains" have arguably been made from this story.
Having been through some difficult adjustments in the 1990s, most former Communist states are now members of the EU and share a common legal and regulatory framework with the West.
Living standards in the region have improved across the board as wages have risen and consumers have begun to discover credit. However, labour costs in many economies remain about a quarter of those in the West and taxes are a third lower than in Germany, ensuring the region remains an attractive destination for companies seeking to lower production costs.
Yet the development of these young democracies has hardly been uniform – some very clear winners and losers have emerged and it is worth casting a fresh eye over the new opportunities ahead of us.
Followers of the region will be all too aware that some of the smaller countries in the Baltics and Balkans got carried away with borrowing their way to growth, resulting in much publicised economic imbalances. However, the situation in economies such as Poland, Turkey, Russia and the Czech Republic couldn't be more different and this is where I believe the greatest prospects now lie.
These countries are benefiting from an improving economic outlook. They have substantial and still under-developed domestic markets and, with consumer debt levels of only 10pc to 30pc of gross domestic product (GDP) - versus 100pc for the UK - offer superior growth prospects than their less-fortunate neighbours.
In Poland for example, economic growth was 1.1pc in the second quarter, having remained positive even during the depths of the financial and economic crisis. Poland has benefited from relatively low exposure to exports but its solid performance has also been underpinned by structural factors.
While many other emerging economies thrived in 2001-2002, Poland struggled as unemployment and interest rates hit 20pc. Now they are just 11pc and 3.5pc respectively and the economy is benefiting from the unleashing of substantial pent-up demand.
This, together with a far smaller debt burden than in many other European countries, has allowed consumers to continue spending and support the economy.
Poland and the Czech Republic are also net beneficiaries of EU funding that aims to improve infrastructure. In Poland for example these transfers are worth around 3pc of GDP per annum for the next four years and are set to boost investment and construction.
Turkey offers further opportunities. While the Turkish economy suffered a sharp contraction last winter, it rebounded rapidly with 12pc quarter on quarter growth between April and July.
A positive side effect of the crisis has been the taming of inflation which has been above 20pc for 25 of the past 30 years, but is now down to a historic low of 5.3pc. This has allowed the central bank to slash interest rates from almost 17pc a year ago to an all time low of 6.75pc.
Lower interest rates should feed through to loan growth and stimulate the economy. Signs of recovery are already emerging with home sales rising 72pc year on year in the second quarter, while seasonally-adjusted automobile sales in September are at record levels.
The Russian economy has also stabilised now that the financing constraints that held back businesses over the winter have eased. After a sharp sell off last year, shares in Russian oil and gas companies now appear cheap compared to historical norms and their international peers.
While the events of 2008 have demonstrated that commodity prices can fluctuate in the short term, the development of China and India provides a structural source of incremental demand that is likely to exert upward pressure on prices over time.
But Russia is not just about oil. It is a country of 140m people – a huge consumer market, with a growing middle class aspiring to raise living standards.
Consumption patterns are changing as a result. Russians still drink on average around eight times more vodka than Britons, yet over the past decade, consumption of beer and fruit juices have leapt from next to nothing to near European levels.
Similar trends are emerging for other goods such as yoghurts, mineral water, vitamins, computers, broadband and banking services. These trends are likely to develop over time, benefiting the strongest local companies.
There are other reasons why we like these markets. First, their stock markets are large and liquid compared to others in the region, making them a more attractive destination for international investors, even though they carry more risk and experience greater volatility than Western counterparts.
Second, they often have very different dynamics, so investors can diversify while making the most of any economic and financial recovery.
Russia, for example, is the world's largest oil exporter, while Turkey imports most of the oil that it consumes. Investing in both means fund managers can take advantage of not only rising but also falling energy prices.
The Polish economy is driven primarily by domestic demand, which helped it to grow even when the rest of Europe was contracting in the first half of 2009. Czech equity markets, meanwhile, contain several solid defensive stocks that tend to be less susceptible to difficult economic conditions.
While stocks listed in the 'big four' markets of eastern Europe are most important for us at present, our ability to invest in the broader region means we can discover some hidden gems in smaller regional markets from time to time.
The ability to invest in a wide range of markets - including for example Israel and Croatia, and former Soviet republics such as Kazakhstan and Georgia - has given us the flexibility to adapt to different market conditions.
We are also exploring opportunities among West European companies with successful operations in Eastern Europe, further broadening the investment horizon.
The Eastern Europe of today is a very different place to that of 20 years ago. There have been economic winners and sadly, some losers. However, the opportunities for investors to profit from the region's success stories are clearer than ever.
Elena Shaftan is the fund manager of Jupiter Emerging European Opportunities Fund
http://www.telegraph.co.uk/finance/personalfinance/investing/6501437/Russian-shares-are-cheap-again.html
Eastern Europe has witnessed momentous changes since the fall of the Berlin Wall 20 years ago.
By Elena Shaftan
Published: 5:54AM GMT 05 Nov 2009
In the two decades since this historic event, the lives of people in the former Communist Bloc have changed beyond recognition – changes that have increasingly attracted the attention of investors since stock exchanges started to open up in the region in the early to mid 1990s.
During this time, investors' focus has largely been on the opportunities presented by the convergence of Eastern European economies with those in the West.
Commodity shares to rise However, 20 years on from the symbolic collapse of the Wall and notwithstanding some setbacks, a lot of the "easy gains" have arguably been made from this story.
Having been through some difficult adjustments in the 1990s, most former Communist states are now members of the EU and share a common legal and regulatory framework with the West.
Living standards in the region have improved across the board as wages have risen and consumers have begun to discover credit. However, labour costs in many economies remain about a quarter of those in the West and taxes are a third lower than in Germany, ensuring the region remains an attractive destination for companies seeking to lower production costs.
Yet the development of these young democracies has hardly been uniform – some very clear winners and losers have emerged and it is worth casting a fresh eye over the new opportunities ahead of us.
Followers of the region will be all too aware that some of the smaller countries in the Baltics and Balkans got carried away with borrowing their way to growth, resulting in much publicised economic imbalances. However, the situation in economies such as Poland, Turkey, Russia and the Czech Republic couldn't be more different and this is where I believe the greatest prospects now lie.
These countries are benefiting from an improving economic outlook. They have substantial and still under-developed domestic markets and, with consumer debt levels of only 10pc to 30pc of gross domestic product (GDP) - versus 100pc for the UK - offer superior growth prospects than their less-fortunate neighbours.
In Poland for example, economic growth was 1.1pc in the second quarter, having remained positive even during the depths of the financial and economic crisis. Poland has benefited from relatively low exposure to exports but its solid performance has also been underpinned by structural factors.
While many other emerging economies thrived in 2001-2002, Poland struggled as unemployment and interest rates hit 20pc. Now they are just 11pc and 3.5pc respectively and the economy is benefiting from the unleashing of substantial pent-up demand.
This, together with a far smaller debt burden than in many other European countries, has allowed consumers to continue spending and support the economy.
Poland and the Czech Republic are also net beneficiaries of EU funding that aims to improve infrastructure. In Poland for example these transfers are worth around 3pc of GDP per annum for the next four years and are set to boost investment and construction.
Turkey offers further opportunities. While the Turkish economy suffered a sharp contraction last winter, it rebounded rapidly with 12pc quarter on quarter growth between April and July.
A positive side effect of the crisis has been the taming of inflation which has been above 20pc for 25 of the past 30 years, but is now down to a historic low of 5.3pc. This has allowed the central bank to slash interest rates from almost 17pc a year ago to an all time low of 6.75pc.
Lower interest rates should feed through to loan growth and stimulate the economy. Signs of recovery are already emerging with home sales rising 72pc year on year in the second quarter, while seasonally-adjusted automobile sales in September are at record levels.
The Russian economy has also stabilised now that the financing constraints that held back businesses over the winter have eased. After a sharp sell off last year, shares in Russian oil and gas companies now appear cheap compared to historical norms and their international peers.
While the events of 2008 have demonstrated that commodity prices can fluctuate in the short term, the development of China and India provides a structural source of incremental demand that is likely to exert upward pressure on prices over time.
But Russia is not just about oil. It is a country of 140m people – a huge consumer market, with a growing middle class aspiring to raise living standards.
Consumption patterns are changing as a result. Russians still drink on average around eight times more vodka than Britons, yet over the past decade, consumption of beer and fruit juices have leapt from next to nothing to near European levels.
Similar trends are emerging for other goods such as yoghurts, mineral water, vitamins, computers, broadband and banking services. These trends are likely to develop over time, benefiting the strongest local companies.
There are other reasons why we like these markets. First, their stock markets are large and liquid compared to others in the region, making them a more attractive destination for international investors, even though they carry more risk and experience greater volatility than Western counterparts.
Second, they often have very different dynamics, so investors can diversify while making the most of any economic and financial recovery.
Russia, for example, is the world's largest oil exporter, while Turkey imports most of the oil that it consumes. Investing in both means fund managers can take advantage of not only rising but also falling energy prices.
The Polish economy is driven primarily by domestic demand, which helped it to grow even when the rest of Europe was contracting in the first half of 2009. Czech equity markets, meanwhile, contain several solid defensive stocks that tend to be less susceptible to difficult economic conditions.
While stocks listed in the 'big four' markets of eastern Europe are most important for us at present, our ability to invest in the broader region means we can discover some hidden gems in smaller regional markets from time to time.
The ability to invest in a wide range of markets - including for example Israel and Croatia, and former Soviet republics such as Kazakhstan and Georgia - has given us the flexibility to adapt to different market conditions.
We are also exploring opportunities among West European companies with successful operations in Eastern Europe, further broadening the investment horizon.
The Eastern Europe of today is a very different place to that of 20 years ago. There have been economic winners and sadly, some losers. However, the opportunities for investors to profit from the region's success stories are clearer than ever.
Elena Shaftan is the fund manager of Jupiter Emerging European Opportunities Fund
http://www.telegraph.co.uk/finance/personalfinance/investing/6501437/Russian-shares-are-cheap-again.html
The great natural gas conundrum
The great natural gas conundrum
Nebulous, drifting, volatile: all good ways to describe both natural gas and the conflicted outlook for the commodity among industry experts at the moment.
By Rowena Mason
Published: 9:38PM GMT 08 Nov 2009
A gas field exploration platform owned by China National Offshore Oil Corporation (CNOOC) in South China Sea.
On the one hand, a growing number of economists are the early-bird canaries in the mine, warning of a dangerous build up of natural gas on the verge of suffocating the market with an oversupply. On the other side, there is no shortage of energy companies dashing into the biggest gas extraction projects the world has ever known, proclaiming that a new era of burgeoning demand will be upon us.
So what has caused the commentators to float apart to such a degree? And whose sums look set to turn out to be an expensive mistake?
First, a look through the hazy clouds of forecasting at the fundamentals of the gas market. Henry Hub prices at the New York Mercantile Exchange have crashed 62pc this year. Reserves in the US are at historic highs. In fact, there's a glut of the stuff packed into disused fields and liquefied natural gas storage units across the globe. For many months now, producers have been hopefully waiting for gas prices to follow the oil price upwards, but the traditional connection – with a time lag between gas trailing oil – appears to have drifted out of kilter.
Part of this is the recession: Royal Dutch Shell, Europe's biggest energy company, warned two weeks ago that it had seen absolutely no increase in need for gas in Europe, and only a slight upturn in the US. In the short term, there has even been talk among Morgan Stanley analysts that the natural state of contango – where spot prices are lower than forward prices – could collapse causing the entire gas market to seize up next year.
Now the International Energy Agency is expected to warn this week that there is little chance of a recovery in demand before 2015, fuelled by a global drive to decarbonise with a new emphasis on renewable sources, nuclear power and energy efficiency.
But looking beyond the stagnant demand, oversupply has also been caused by technological breakthroughs in extraction techniques that mean so-called "tight" formations are getting cheaper to develop. The US was at one point speeding its way through natural gas reserves at an alarming rate, but over the past two decades, unconventional gas–from shales and coal-bed methane –has grown from 10pc to 40pc of the market.
Some commentators, including the Pulitzer Prize winning author of Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power, have hailed this as a revolution in the fossil fuel industry that could change the world's whole gas balance if other countries follow America's lead. Technology has also given greater competition to the markets.
So why, if gas has become suddenly abundant, mobile and unwanted, are there still energy majors from BP to Shell to ExxonMobil keen to exploit expensive developments in far-flung, often hostile corners of the globe from Iraq to Russia's Yamal peninsula reserves?
The energy world still appears desperate to develop major gas developments like never before – the biggest being the massive Gorgon fields in Australia, where the energy giants have already signed multi-billion dollar contracts to supply China and India for decades to come. Frank Chapman, the chief executive of BG Group, even claims we will need "a Gorgon a year for the next 10 years" to meet ballooning global needs. Meanwhile, ExxonMobil, looking ahead, predicts that demand for gas in the West alone will grow by 2pc a year, or 30pc by 2030.
Part of the optimism is likely to be political: although countries are desperate to reduce emissions from fossil fuels, gas releases only half the carbon dioxide of coal when burned and is a much cheaper option than developing renewables. As the world also eventually weans itself off petrol and other oil-based products for transportation, electricity demand is set to double or triple.
One day in decades to come, cars and other modes of transport may all either be powered directly by natural gas or electricity generated by gas-powered and renewable power stations. Seizing on this opportunity, Tony Hayward, chief executive of BP, has recently been taking every chance to trumpet the potential of gas as the primary fuel of the medium-term future.
Some even believe the revolution in unconventional gas supplies will be unable to keep pace with this impending thirst for the commodity. Ofgem, the energy regulator, has taken forecast "tight" gas production into its estimates, but remains deeply concerned about the availability of gas in Europe over the next decade.
With all these shifting factors, one thing is for certain. Gas isn't behaving like ever before. And its future as a commodity is entirely interwoven with political decisions – highly unpredictable ones – about its reliability as a replacement for coal and oil.
http://www.telegraph.co.uk/finance/markets/6526528/Future-of-gas-linked-with-political-decisions.html
Nebulous, drifting, volatile: all good ways to describe both natural gas and the conflicted outlook for the commodity among industry experts at the moment.
By Rowena Mason
Published: 9:38PM GMT 08 Nov 2009
On the one hand, a growing number of economists are the early-bird canaries in the mine, warning of a dangerous build up of natural gas on the verge of suffocating the market with an oversupply. On the other side, there is no shortage of energy companies dashing into the biggest gas extraction projects the world has ever known, proclaiming that a new era of burgeoning demand will be upon us.
So what has caused the commentators to float apart to such a degree? And whose sums look set to turn out to be an expensive mistake?
First, a look through the hazy clouds of forecasting at the fundamentals of the gas market. Henry Hub prices at the New York Mercantile Exchange have crashed 62pc this year. Reserves in the US are at historic highs. In fact, there's a glut of the stuff packed into disused fields and liquefied natural gas storage units across the globe. For many months now, producers have been hopefully waiting for gas prices to follow the oil price upwards, but the traditional connection – with a time lag between gas trailing oil – appears to have drifted out of kilter.
Part of this is the recession: Royal Dutch Shell, Europe's biggest energy company, warned two weeks ago that it had seen absolutely no increase in need for gas in Europe, and only a slight upturn in the US. In the short term, there has even been talk among Morgan Stanley analysts that the natural state of contango – where spot prices are lower than forward prices – could collapse causing the entire gas market to seize up next year.
Now the International Energy Agency is expected to warn this week that there is little chance of a recovery in demand before 2015, fuelled by a global drive to decarbonise with a new emphasis on renewable sources, nuclear power and energy efficiency.
But looking beyond the stagnant demand, oversupply has also been caused by technological breakthroughs in extraction techniques that mean so-called "tight" formations are getting cheaper to develop. The US was at one point speeding its way through natural gas reserves at an alarming rate, but over the past two decades, unconventional gas–from shales and coal-bed methane –has grown from 10pc to 40pc of the market.
Some commentators, including the Pulitzer Prize winning author of Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power, have hailed this as a revolution in the fossil fuel industry that could change the world's whole gas balance if other countries follow America's lead. Technology has also given greater competition to the markets.
So why, if gas has become suddenly abundant, mobile and unwanted, are there still energy majors from BP to Shell to ExxonMobil keen to exploit expensive developments in far-flung, often hostile corners of the globe from Iraq to Russia's Yamal peninsula reserves?
The energy world still appears desperate to develop major gas developments like never before – the biggest being the massive Gorgon fields in Australia, where the energy giants have already signed multi-billion dollar contracts to supply China and India for decades to come. Frank Chapman, the chief executive of BG Group, even claims we will need "a Gorgon a year for the next 10 years" to meet ballooning global needs. Meanwhile, ExxonMobil, looking ahead, predicts that demand for gas in the West alone will grow by 2pc a year, or 30pc by 2030.
Part of the optimism is likely to be political: although countries are desperate to reduce emissions from fossil fuels, gas releases only half the carbon dioxide of coal when burned and is a much cheaper option than developing renewables. As the world also eventually weans itself off petrol and other oil-based products for transportation, electricity demand is set to double or triple.
One day in decades to come, cars and other modes of transport may all either be powered directly by natural gas or electricity generated by gas-powered and renewable power stations. Seizing on this opportunity, Tony Hayward, chief executive of BP, has recently been taking every chance to trumpet the potential of gas as the primary fuel of the medium-term future.
Some even believe the revolution in unconventional gas supplies will be unable to keep pace with this impending thirst for the commodity. Ofgem, the energy regulator, has taken forecast "tight" gas production into its estimates, but remains deeply concerned about the availability of gas in Europe over the next decade.
With all these shifting factors, one thing is for certain. Gas isn't behaving like ever before. And its future as a commodity is entirely interwoven with political decisions – highly unpredictable ones – about its reliability as a replacement for coal and oil.
http://www.telegraph.co.uk/finance/markets/6526528/Future-of-gas-linked-with-political-decisions.html
Diary of a Private Investor
Diary of a Private Investor: My aggressive investment strategy has backfired
By the beginning of this month, my portfolio had felt the full, unhindered power of the setback and fallen close to 10pc.
By James Bartholomew
Published: 6:49AM GMT 04 Nov 2009
I have to admit I jumped the gun.
As we were getting towards the end of October without suffering any significant setback in the stock market, I thought, "Hurrah! We have survived the most dangerous month of the year and now we have the run up to Christmas and beyond which usually is pretty good for shares."
Related Articles
Commodity shares are heading up So, thinking I would get ahead of the crowd, I put remaining cash into shares. I sold my Japanese yen bonds and put these into shares, too. What happened?
The October setback arrived late. My portfolio fell more than the market generally because I have been favouring what you could call "aggressive recovery plays".
I subscribed to the rights issue of Barratts, the house builder, and bought some extra shares into the bargain. I reckoned the price had been depressed by the rights issue and would rise when all the money was secured. I bought at 153p, only to see the shares fall back even further – to 122p.
I bought more Enterprise Inns, the pub owner, too, paying 139.9p. The shares had jumped 20p after the Office for Fair Trading said it has not found evidence that companies such as Enterprise Inns, which require their tenants to buy their beer, are reducing competition in a way that damages consumers.
This removed one of a little pile of concerns that has been weighing down the shares. I was hoping that as these various concerns were dealt with or found not to be quite so bad as feared that the price would float nearer to its net asset value. Instead, the shares fell more than most and traded around 118p this week.
I also recently bought a few shares in Indo-China Capital Vietnam Holdings at US$4.54. I like Vietnam, but did not quite realise when buying that the company seems to be winding itself down.
I also bought a few Real Estate Investors, a small property company, at 4.96p. I had noticed some director buying and, on looking into the detail, liked the look of it.
Finally, I bought a small holding Chaoda Modern Agriculture, an agribusiness quoted in Hong Kong. Chaoda grows vegetables, fruit and tea and sells to supermarkets and abroad. I bought at HK$6.33.
So I bought up to the hilt. All my cash was gone and most of my bonds, making me 95pc invested in shares or even more if you count my mortgage as financing my shares which is about right. Thus, by the beginning of this month, my portfolio had felt the full, unhindered power of the setback and fallen close to 10pc.
I can't give a precise figure because my curiosity about exact changes in my portfolio's value dwindles when I am losing money.
And this is without counting my shares in Aero Inventory, which have been suspended, as I write, because the company had a problem with valuing, ahem, its inventory.
What now? I still believe November to Christmas and beyond is generally good for shares. David Schwartz, who looks at stock market statistics, has said there has not been much evidence of a seasonal trend this millennium.
It is possible something has changed or that the trend has become self-defeating as people try to get ahead of it. But, even on recent figures, shares have risen in more than half the November-to-March periods. I think there is some unknown force that tries to sustain the market. And I still think some of my shares are excellent value.
In the case of Barratt, I am encouraged by recent experiences of the property market. I am an executor of my uncle's estate. We put his house on the market and within three days agents had taken 42 people to it and we had an offer at the asking price. I am also an executor of another estate, where three potential buyers were vying for the house.
As for the stock market, the Bank of England has decided to do another £50bn of quantitative easing. I think and hope this should help keep shares out of trouble for a while at least.
http://www.telegraph.co.uk/finance/personalfinance/investing/6498737/Diary-of-a-Private-Investor-My-aggressive-investment-strategy-has-backfired.html
By the beginning of this month, my portfolio had felt the full, unhindered power of the setback and fallen close to 10pc.
By James Bartholomew
Published: 6:49AM GMT 04 Nov 2009
I have to admit I jumped the gun.
As we were getting towards the end of October without suffering any significant setback in the stock market, I thought, "Hurrah! We have survived the most dangerous month of the year and now we have the run up to Christmas and beyond which usually is pretty good for shares."
Related Articles
Commodity shares are heading up So, thinking I would get ahead of the crowd, I put remaining cash into shares. I sold my Japanese yen bonds and put these into shares, too. What happened?
The October setback arrived late. My portfolio fell more than the market generally because I have been favouring what you could call "aggressive recovery plays".
I subscribed to the rights issue of Barratts, the house builder, and bought some extra shares into the bargain. I reckoned the price had been depressed by the rights issue and would rise when all the money was secured. I bought at 153p, only to see the shares fall back even further – to 122p.
I bought more Enterprise Inns, the pub owner, too, paying 139.9p. The shares had jumped 20p after the Office for Fair Trading said it has not found evidence that companies such as Enterprise Inns, which require their tenants to buy their beer, are reducing competition in a way that damages consumers.
This removed one of a little pile of concerns that has been weighing down the shares. I was hoping that as these various concerns were dealt with or found not to be quite so bad as feared that the price would float nearer to its net asset value. Instead, the shares fell more than most and traded around 118p this week.
I also recently bought a few shares in Indo-China Capital Vietnam Holdings at US$4.54. I like Vietnam, but did not quite realise when buying that the company seems to be winding itself down.
I also bought a few Real Estate Investors, a small property company, at 4.96p. I had noticed some director buying and, on looking into the detail, liked the look of it.
Finally, I bought a small holding Chaoda Modern Agriculture, an agribusiness quoted in Hong Kong. Chaoda grows vegetables, fruit and tea and sells to supermarkets and abroad. I bought at HK$6.33.
So I bought up to the hilt. All my cash was gone and most of my bonds, making me 95pc invested in shares or even more if you count my mortgage as financing my shares which is about right. Thus, by the beginning of this month, my portfolio had felt the full, unhindered power of the setback and fallen close to 10pc.
I can't give a precise figure because my curiosity about exact changes in my portfolio's value dwindles when I am losing money.
And this is without counting my shares in Aero Inventory, which have been suspended, as I write, because the company had a problem with valuing, ahem, its inventory.
What now? I still believe November to Christmas and beyond is generally good for shares. David Schwartz, who looks at stock market statistics, has said there has not been much evidence of a seasonal trend this millennium.
It is possible something has changed or that the trend has become self-defeating as people try to get ahead of it. But, even on recent figures, shares have risen in more than half the November-to-March periods. I think there is some unknown force that tries to sustain the market. And I still think some of my shares are excellent value.
In the case of Barratt, I am encouraged by recent experiences of the property market. I am an executor of my uncle's estate. We put his house on the market and within three days agents had taken 42 people to it and we had an offer at the asking price. I am also an executor of another estate, where three potential buyers were vying for the house.
As for the stock market, the Bank of England has decided to do another £50bn of quantitative easing. I think and hope this should help keep shares out of trouble for a while at least.
http://www.telegraph.co.uk/finance/personalfinance/investing/6498737/Diary-of-a-Private-Investor-My-aggressive-investment-strategy-has-backfired.html
Gold: how high can the price go?
Gold has reached an all-time high, breaking through the $1,100 an ounce barrier on a weaker US dollar and the continued appetite from investors for the precious metal's safe-haven attributes.
Published: 2:51PM GMT 10 Nov 2009
Demand continues to be strong – even Harrods, the famous Knightsbridge store, is getting in on the act by selling gold bars and coins to its upmarket customers.
Gold has returned more than 20pc over the past year but the question remains: how high can the price of gold go?
Here are the thoughts of analysts taken from around the globe.
Suki Cooper, commodities analyst, Barclays Capital
Ms Cooper said: “We expect prices to maintain their upward momentum through to at least the first half of 2010, where we expect prices to average $1,140 in the second quarter. The unexpected purchase of gold by the Reserve Bank of India has only added to the positive sentiment towards gold. Even though gold's attributes have not changed, we have seen a change in attitude from investors towards gold. From the official sector through to retail investors, there has been a structural shift in the demand side.”
Jim Rogers, chairman of Singapore-based Rogers Holdings
Mr Rogers argues that gold hasn't begun to peak, adding that it will climb from a nominal record near $1,100 an ounce to $2,000 an ounce in the future. He said: “Just to get back to the old high back in 1980, adjusted for inflation, the price would need to be over $2,000 now. So we’ll certainly get there some time in the next decade.”
London Bullion Market Association
A poll of about 370 delegates at the London Bullion Market Association's annual conference predicted that gold would be at $1,181 in 12 months' time. The poll covered 368 traders, analysts, miners and central bankers.
Ellison Chu, Standard Bank Asia
The Hong Kong based manager of precious metals at the bank expects the price of gold to maintain four-figure levels given the strong demand, particularly from Asia.
"India's purchase [India’s central bank recently bought 200 tonnes of gold] had a psychological impact on investors. They think other central banks will also buy gold for their reserves. Gold will probably hang on to these high levels. We're seeing good seasonal demand ahead of Christmas and the Chinese New Year."
Nouriel Roubini, professor of economics at New York University’s Stern School of Business
In an interview with Hard Assets Investor, Mr Roubini said there were only two scenarios that would see gold go much higher: inflation and Armageddon.
“We don’t have Armageddon, we don’t have inflation, so gold can maybe go slightly higher. But those people who delude themselves that gold can go to $1,500 or $2,000 are just talking nonsense. The fundamentals are not justified, and those people are just talking their books.”
David Levenstein, investment adviser
Writing on Mineweb, David Levenstein, a veteran of 29 years in futures, equities, forex and bullion, said gold appeared to be on course for a shift to $1,300 because of the gloomy outlook for the dollar.
"Frankly, I cannot see any bit of news that may suddenly appear that could have a miraculously powerful effect on the value of the dollar," he wrote. "While my experience has taught me that it is very difficult to predict future prices, all the empirical evidence tends to indicate that we can expect much higher prices for gold."
Bill Downey, investor and price analyst
“Cycles suggest we are nearing a pullback. We have arrived at a key resistance area at a time when key cycles are due. We're modifying key resistance to $1,105-$1,110 followed by $1,132-$1,150. The potential for a high to be established this week and an autumn correction unfolding thereafter has grown significantly. We want to see at least a bit of price weakness first ... but longs [those who hold gold] should be cautious.”
http://www.telegraph.co.uk/finance/personalfinance/investing/gold/6537637/Gold-how-high-can-the-price-go.html
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