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Market-based Valuation (Valuation Indicators (Price Multiples (Ratios of…
Market-based Valuation
Valuation Indicators
Price Multiples
- Ratios of stock’s market price to some measure of fundamental value per share
- Price multiples are used to evaluate the price of a share of stocks to judge whether the share is undervalued, fairly priced, or overvalued in term per share earnings, net assets, cash flows and some other measures.
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Momentum Indicator
- Ratios of price or other fundamentals to the time series of their past values,/ in some cases, their expected value
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Justified P/E
- P/E can also be calculated using the DCF/DDM approach
- where P/E of a share of stock can be related to the value of a stock as calculated under the constant growth model.
- P/E can be treated as a function of two fundamentals: the required rate of return, r, and the expected (stable) dividend growth rate, g.
- Linking P/Es to a DCF model helps us address what value the market should place on a dollar of EPS when we are given a particular set of expectations about the company’s profitability, growth, and cost of capital
Drawbacks
- Zero, negative, or very small earnings
- Permanent (recurring) vs. transitory (nonrecurring) components of earnings are difficult to be differentiated.
- Management discretion for earnings may distort the EPS from being an accurate reflection of economic performance.
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