Question #123
Reading: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples
PDF File: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples.pdf
Page: 43
Status: Unattempted
Question
Glad Tidings Gifts (GTG) recently reported annual earnings per share (EPS) of $2.25, which included an extraordinary loss of $0.17 and an expense of $0.12 related to acquisition costs during the accounting period, neither of which are expected to recur. Given that the most recent share price is $50.00, what is a useful GTG's trailing price to earnings (P/E) for valuation purposes?
Answer Choices:
A. 22.22
B. 19.69
C. 25.51. Victoria Banks is a senior analyst working for a large firm of portfolio managers. Her manager, David Alan, has asked her to report on a company called Retro Inc. as he believes it might offer a potentially good investment. The accounts for Retro Inc. are given below. Retro prepares its accounts using U.S. GAAP. Exhibit 1: Retro Inc. Balance Sheet as at 31 December 20x9 $m 20x8 $m Assets Cash 150 100 Accounts receivable 1,700 1,620 Inventory 1,810 1,800 Total current assets 3,660 3,520 Property, plant, and equipment 1,430 1,000 Intangibles 100 150 Total assets 5,190 4,670 Liabilities and Capital
Explanation
Using an underlying earnings concept, an analyst would add back the temporary charges
against earnings: $2.25 + $0.17 + $0.12 = $2.54. The resulting trailing P/E = 50.00 / 2.54 =
19.69.
(Module 22.4, LOS 22.e)
Victoria Banks is a senior analyst working for a large firm of portfolio managers. Her manager, David Alan,
has asked her to report on a company called Retro Inc. as he believes it might offer a potentially good
investment. The accounts for Retro Inc. are given below.
Retro prepares its accounts using U.S. GAAP.
Exhibit 1: Retro Inc. Balance Sheet as at 31 December
20x9
$m
20x8
$m
Assets
Cash
150
100
Accounts receivable
1,700
1,620
Inventory
1,810
1,800
Total current assets
3,660 3,520
Property, plant, and equipment
1,430
1,000
Intangibles
100
150
Total assets
5,190 4,670
Liabilities and Capital
Notes payable to banks
200
220
Accounts payable
1,330
1,200
Interest payable
130
100
Total current liabilities
1,660 1,520
Long-term debt
770
680
Deferred tax
820
790
Common stock
1,300
1,300
Retained earnings
640
380
Total liabilities and capital
5,190 4,670
Exhibit 2: Retro Inc. Income Statement for the Year Ended 31 December 20x9
$m
Sales
3,000
Cost of goods sold
(1,800)
Gross profit
1,200
Depreciation
(150)
Amortization
(50)
SG&A
(280)
Gain on disposal
30
Restructuring charge reversal
20
Interest expense
(190)
Income tax expense
(223)
Net income
357
Retro disposed of PPE in the year that had a cost of $150m and accumulated depreciation at the time of
disposal of $90m. No intangibles were disposed of during the year. Deferred tax liabilities are not expected to
reverse for the foreseeable future.
Banks is also concerned that the net income looks relatively high when compared to previous years and
therefore wants to measure the quality of earnings. She has heard that the lower the accruals ratio the
higher the quality of earnings.
Banks calculates that Retro Inc. has a leading P/E ratio of 4.29 and a five-year consensus growth rate forecast
at 14.85%. The median PEG, based on leading P/E, for a group of companies comparable in risk to Retro Inc.
is 0.82. Based on this Banks wants to determine whether the stock is correctly priced.
One of Banks's colleagues, Jennifer Cery, comments that P/E multiples are not always that useful and that
sometimes enterprise value multiples are better. She makes the following comments:
Comment 1: Enterprise value multiples are useful when comparing firms with different degrees of financial
leverage and when EPS is negative.
Comment 2: As EBITDA can be used as a proxy for free cash flow to the firm providing depreciation is close
to capital expenditure and the firms levels of working capital is relatively constant.