Question #35

The price-to-sales multiple based on market data is 44.56 / 32.44 = 1.37 The price-to-book multiple based on market data is 44.56 / 15.69 = 2.84. The formula for justified price-to-sales ratio based on forecasted fundamentals is: The profit margin (PM) is 20X3 EPS / sales per share = 1.89 / 32.44 = 5.8% The dividend-payout-ratio (1 – b) is 0.76 / 1.89 = 40%. The retention rate (b) is 60%. The sustainable growth rate is ROE × b = 12% × 60% = 7.2% The cost of equity from CAPM is 2.5% + 1.4 × 5% = 9.5% Thus, the justified price-to-sales ratio is: Comparing the justified multiple of 1.09 to the market based multiple of 1.37 the company appears overvalued. The formula for justified price-to-book ratio based on forecasted fundamentals is: Comparing the justified multiple of 2.11 to the market based multiple of 2.84 the company, again, appears overvalued. Please, note that the value of each ratio is not required in the solution. Therefore, realizing that justified ratios are derivable from the Gordon Growth Model (GGM), one could simply proceed and value the company as follow: The company is overvalued as its market price of £44.56 exceeds its intrinsic value of £35.42. As a result, any ratio that divides this intrinsic value by a value driver (e.g., P/B, P/S, etc.) will also be higher than the market multiple resulting in the same conclusion.