New insights into equity valuation using multiples (original) (raw)
Related papers
Equity Valuation Using Multiples
Journal of Accounting Research, 2002
We examine the valuation performance of a comprehensive list of value drivers and find that multiples derived from forward earnings explain stock prices remarkably well: pricing errors are within 15 percent of stock prices for about half our sample. In terms of relative performance, the following general rankings are observed consistently each year: forward earnings measures are followed by historical earnings measures, cash flow measures and book value of equity are tied for third, and sales performs the worst. Curiously, performance declines when we consider more complex measures of intrinsic value based on short-cut residual income models. Contrary to the popular view that different industries have different "best" multiples, these overall rankings are observed consistently for almost all industries examined. Since we require analysts' earnings and growth forecasts and positive values for all measures, our results may not be representative of the many firm-years excluded from our sample.
Comparison of the Residual Income and the Pricing - Multiples Equity Valuation Models
International Journal of Economics and Business Administration
The paper aims at analyzing the performance of two of the equity valuation models, the residual income (RIVM) and the pricing-multiples model. I test first how the residual income valuation model performs relative to the pricing-multiples model for a set of different value drivers and industries, second whether the performance of the different multiples increases when these are measured either with the mean, the median or the harmonic mean of the absolute prediction error and the signed prediction error. The pricing-multiples approach is in most cases a better predictor of market prices than the residual income valuation model. In addition, the harmonic mean yields to more reliable estimates of value for a set of different industries. Finally, there are some value drivers that are supposed to be more reliable than others in specific industries, but there isn't any value driver that dominates all the industries. 2 Easton (1999) refers to other, more detailed studies concerning the relation between prices and accounting data, such as those of Feltham and Ohlson (1995), Basu (1997) and Zhang (1999). These three papers examine this relation when a firm's policies are conservative. Comparison of the Residual Income and the Pricing-Multiples Equity Valuation Models 90 as value estimates derived from this model track intrinsic value better than dividends, earnings or book value. Liu, Nissim and Thomas (2002a) provide a more complete comparison of the relative and absolute performance of numerous multiples. They have considered multiples based on diverse measures, such as accrual flows (earnings to price, sales to price), accrual stocks (book to price), cash flows (EBITDA to price, operating cash flow to price), forward-looking data (one and two year ahead earnings forecasts to price), the RIVM (V/P following Lee and Swaminathan (1999)). The first three measures are based on historical data while on the contrary, the remaining two on forecasts. Moreover, all the multiples have been computed with the harmonic mean. Consistent with Lee and Swaminathan (1999), they observe that multiples based on the RIVM perform better than those based on historical data. However, they provide additional evidence that forward-looking earnings outperform the residual income based multiples, contradicting the conclusions of Lee and Swaminathan (1999). Finally, they go further, suggesting that among the multiples based on historical data, earnings are the best value estimates whereas all the others perform poorly.
The Valuation Accuracy of the Price-Earnings and Price-Book Benchmark Valuation Methods
2000
Performance of the benchmark valuation methods relies on the de®nition of comparable ®rms. In this paper, comparable ®rms are selected based on industry membership, size and return on equity as well as combinations of industry membership with size and with return on equity. We ®nd that within the P/E and P/B benchmark valuation methods, the best de®nition of the comparable ®rms are based on industry membership combined with return on equity. However, only the industry membership is necessary to de®ne the comparable ®rms for the combined P/E-P/B method. In sum, the results suggest that, when ®rm's value is unknown, the combined P/E-P/B valuation approach selecting comparable ®rms based on industry membership performs the best among all the approaches evaluated in this paper. We also ®nd that the P/E benchmark valuation method performs better than the P/B benchmark valuation method and the combined method outperforms either the P/E or the P/B method. These results imply that earnings are more important than book value as a single-number ®rm valuator over our sample years (from 1973 to 1992) and that both earnings and book values are value relevant, one does not substitute perfectly for the other.
The valuation performance of mathematically-optimised, equity-based composite multiples
Journal of Economics, Finance and Administrative Science, 2017
Purpose This paper aims to examine the valuation precision of composite models in each of six key industries in South Africa. The objective is to ascertain whether equity-based composite multiples models produce more accurate equity valuations than optimal equity-based, single-factor multiples models. Design/methodology/approach This study applied principal component regression and various mathematical optimisation methods to test the valuation precision of equity-based composite multiples models vis-à-vis equity-based, single-factor multiples models. Findings The findings confirmed that equity-based composite multiples models consistently produced valuations that were substantially more accurate than those of single-factor multiples models for the period between 2001 and 2010. The research results indicated that composite models produced up to 67 per cent more accurate valuations than single-factor multiples models for the period between 2001 and 2010, which represents a substantia...
2018
The main motivation behind the paper is to present multiple linear regression models as an alternative for market multiples, which appear to be the only way of doing relative equity valuation. To be more precise, the goal is to find a method for valuing the equity of private companies based on their accounting metrics by relying on comparison with the valuation of public companies – bypassing a lengthy bottom-up calculation. Despite being seemingly more complicated than traditional techniques, the outlined regressions are far easier to use once understood, as they do not require manual peer selection and are more or less applicable in Excel. According to Damodaran (2006), one of the most famous equity appraisal theorists, “Most equity research reports and many acquisition valuations are based upon a multiple such as a price to sales ratio or the value to EBITDA multiple and a group of comparable firms.” Even when a discounted cash flow model is used to calculate the value of equity,...
2013
One common belief in equity valuation is all valuation models measure the same intrinsic value. This paper explains why this is not the case theoretically, and addresses an unresolved question in Liu, Nissim and Thomas (2002): how simple earnings multiples outperform complex discount based valuation models (DBVM). Our theoretical reasoning suggests the DBVMs are designed to measure the intrinsic value of stock, while the multiples are to measure the current stock price. The paper extends the pricing error result and examines the performance of models when their estimates are compared to the intrinsic value directly. Three alternative measures of the intrinsic value are chosen: i) linear fitted value, ii) moving average of prices for the next five years, and iii) return generation ability. A surprising result is, contrary to the theory and our expectation that the DBVMs would outperform the multiples in intrinsic value measurement, the multiples still outperform the DBVMs in all thre...
A GENERALIZED EARNINGS‐BASED STOCK VALUATION MODEL
2005
This paper provides a model for valuing stocks that takes into account the stochastic processes for earnings and interest rates. Our analysis differs from past research of this type in being applicable to stocks that have a positive probability of zero or negative earnings. By avoiding the singularity at the zero point, our earnings-based pricing model achieves improved pricing performance.
The Cross-Section of Stock Valuation Ratios
2010
Abstract What explains the cross-sectional variation of equity valuation ratios? The q-theory of investment implies that equity-to-capital equals marginal cost of investment minus debt-to-capital as well as the present value of marginal benefit of investment minus debt-to-capital. We estimate the two valuation equations using generalized methods of moments at the portfolio level.