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Lecture: Multiples Analysis Objectives What is a multiple? How is a multiple calculated? How is a multiple used? How do you evaluate a multiple?
Accounting in 2 minutes Revenue -Cost of Goods Sold Gross Profit -Operating Expenses Operating Profit -Taxes Earnings Price per unit x units sold Cost of the inputs associated with the product Literally the cost of the goods you sell Cost of input per unit x units sold Costs not associated with producing the good Ex.) salaries paid to accountants or executives The final residual profit after all expenses and taxes have been taken out Also known as net income, net profit
Stock Price AAPL $467.41 per share LNKD $243.90 per share If we want to invest in cheap stocks (buy-low-sell-high), which would you invest in?
Stock price is arbitrary! A company wants to sell a bunch of stock onto a stock exchange to raise money (IPO) The company needs to raise $100 million The company gets to choose the stock price it wants to issue the stock at 1 million shares @ $100 each 10 million shares @ $10 each 100 million shares @ $1 each 1 billion shares @ $0.10 each Price is only used to gauge how much you make off a buy-and-sell trade. It is NOT a determinant of value
Back to multiples We want to figure out if an investment is cheap
Relative Valuation Example Your exotic friend asks you to go buy this fruit youve never seen for him, but to not spend too much for him. The fruit is only sold by one vendor and costs $5 each, but you have no idea if thats a good price. What do you do? You compare it to other things that are like it, namely, other fruit! You can refine your search further by comparing to other fruit that look and taste like it.
Relative Valuation Example You look around and find a vendor who has a similar looking, but slightly larger fruit. You look around and find a vendor who has a similar looking, but larger fruit, selling for $10 each. $5 each $10 each In order to standardize the price and eliminate the factor of size, we can calculate the price per pound
Relative Valuation Much in the way price is arbitrary for fruit until you standardize it per unit of weight, stock price can be standardized per unit of earnings Price per share Earnings per share Total earnings / total shares = Tells you how much you pay per dollar of earnings Investors tend to want to pay less for a dollar of earnings like paying less per pound of fruit =
Price to Earnings Example AAPL =11.7x LNKD $243.90 $476.41 $40.82 $.37 =676.6x
Interpreting a P/E Multiple Lower isnt always better –For better, safer, growing companies, investors are willing to pay a higher multiple –Sometimes a higher multiple indicates expectation the company will grow into it Cheap has two meanings –You can get a good price –But that also means you could be getting bad quality
Questioning a Multiple Low Multiple + Quality Company = Good investment –If its so great, why is it cheap? Exaggerated Bad News Small Company- not regularly covered by Wall Street Analysts Quality is being incorrectly perceived Future of the company is going to result in multiple expansion
Multiples Used Price per share Earnings per share Price per share Book value per share How much you pay per dollar of earnings How much you pay per dollar of resources of the business Price per share Cash Flow per share Like P/E, but using cash flow (different from earnings) Enterprise Value EBITDA Like P/E, but using better measurements of price and a proxy for cash flow/earnings. Most popular multiple
Derivation of Stock Price P/E Industry = P/E Target Company We know: P/E Industry (average of P/E of similar companies) Earnings Per Share company (10-K) We want to solve for price P/E Industry As long as the stock is trading below the industry multiple, its implied price will be higher than its current price. = Price EPS 10.2x $3 Price 10.2x * $3
Price to earnings below competitors and industry average Comparables
Vertical Integration High growth in tablet market share Over 90% market share in server chips Risks/Mitigations PC Revenue Declines Vertical integration is capital intensive Competition between Apple and Samsung
Tech/Market Developments Shifts to Tablets Strong Company Brand Intel Core Risks/Mitigations Changes in Market Mix Consistent since 1970s Leader in microprocessor technology Tomorrow Project
Important Dates Thursday, Sept. 26, 6-8PM- Investment Banking Workshop -UTC3.102 Saturday, October 12: Last day to register for TXSP www.usiteam.org/events Saturday, October 19: Texas Stock Pitch Competition