1、CHAPTER SIXMcGraw-Hill/IrwinCopyright 2013 by The McGraw-Hill Companies,Inc.All rights reserved.Prepared by:Stephen H.Penman Columbia UniversityWith contributions byNir Yehuda Northwestern UniversityMingcherng Deng University of MinnesotaPeter D.Easton and Gregory A.Sommers Notre Dame and Southern M
2、ethodist UniversitiesLuis Palencia University of Navarra,IESE Business SchoolWhat You Will Learn From This ChapterWhat a P/E ratio meansWhat“abnormal earnings growth”isHow forecasting abnormal earnings growth yields the intrinsic P/E ratioWhat is meant by a normal P/E ratioThe difference between ex-
3、dividend earnings growth and cum-dividend earnings growthThe difference between a Case 1 and Case 2 abnormal earnings growth valuationHow abnormal earnings growth valuation protects the investor from paying too much for earnings growthThe advantages and disadvantages of using an abnormal earnings gr
4、owth valuation and how the valuation compares with residual earnings valuationThat abnormal earnings growth is equal to the change in residual earningsHow abnormal earnings growth valuation protects the investor from paying for growthWhat a PEG ratio isThe Big Picture for this Chapter To price earni
5、ngs,one thinks of earnings growth:more growth,higher P/E But:Beware of paying for growthOnly pay for growth that adds valueGrowth is risky:Beware of paying for risky growth Abnormal earnings growth is the metric that protects from paying too much for growthThe Concept Behind the P/E RatioPrice in nu
6、merator of P/E is based on expected future earningsEarnings in denominator is current(or forward)earningsP/E is thus based on expected growth in earnings:for trailing P/E,growth from current earnings onwards for forward P/E,growth from one-year-ahead earnings onwardsBut growth is risky,so the P/E ra
7、tio also involves a discount for risk expected earning growth increases the P/E ratio risk reduces the P/E ratioBeware of Paying Too Much for Earnings Growth Investment creates growth but does not necessarily add value Earnings growth can be created by the accounting We need a valuation method that
8、protects us from paying too much for earnings growthReminder:Residual Earnings Valuation Protects You From Paying Too Much For Earnings Earnings from new investment is charged with the required return on investmentResidual earnings before new investment:10%hurdle rate RE=12 (0.10 x 100)=2 (ROCE=12%)
9、Residual earnings after new investment of$20 million earning at 10%RE=14 (0.10 x 120)=2 No value added from new investment Creating earnings by accounting methods also increases residual earnings but reduces book value.The net effect is zero.See Chapter 5.A P/E model must also protect you from payin
10、g too much for earnings growth.P/B Valuation for Nike,Inc.(Ch.5)From P/B Valuation to P/E ValuationThe residual earnings pro forma for Nike,Inc:Change in Residual Earnings and Abnormal Earnings Growth Equivalent valuations:V=Book Value+PV of Residual Earnings =Capitalized forward earnings+PV of Chan
11、ges in Residual Earnings Equivalent measures:Change in Residual Earnings=Abnormal Earnings GrowthAbnormal Earnings Growth(AEG)is growth in earnings over the required growth rateAEG is the focus for P/E valuationThe Prototype Savings Account2005.01return required1 P/E Forward100$05.05$return required
12、earnings forward account savings of ValueThe Trailing P/E and Forward P/E1P/E Trailing NormalP/E Forward Normalreturn requiredreturn required 1 P/E Trailing Normalreturn required1 P/E Forward Normalearningscurrent not but price,current reduce DividendsEarningsDividend Price P/E TrailingEarningsPrice
13、 P/E Forward00010Cum-Dividend Earnings Cum-dividend earnings is earnings with the prior years dividend reinvested:For the full-payout account:Earnings for 2014$5.00Earnings from reinvesting prior years dividend 0.25 Cum-dividend earnings$5.25For zero-payout account:Earnings for 2014$5.00Earnings fro
14、m reinvesting prior years dividend 0.00 Cum-dividend earnings$5.25The two savings accounts have the same cum-dividend earnings!Normal Earnings(2001)Earnings 1.05 (2014)Earnings Normal:account savings For theEarnings Earnings Normal:return of rate required at the growing earnings is 1ttEingsNormalEar
15、n=1.05 x 5.00=5.25Abnormal Earnings Growth(AEG)Abnormal Earnings Growth is growth over normal earnings growth(in dollars):AEG=Cum-dividend earnings Normal earnings For the Savings account:025.525.52014AEGLessons from the Savings Account1.An asset is worth capitalized forward earnings if abnormal ear
16、nings growth is expected to be zero.2.An asset has a normal P/E ratio if abnormal earnings growth is expected to be zero.3.Earnings comes from two sources:earnings from the asset earnings from reinvesting dividends4.Dividends do not affect cum-dividend earnings.5.Dividend payout does not affect valu
17、e.An Anchoring Principle If one forecasts that cum-dividend earnings will grow at a rate equal to the required rate of return,the assets value must be equal to its earnings capitalized Or,equivalently:If one forecasts that abnormal earnings growth will be zero,the assets value must be equal to its e
18、arnings capitalizedA Bad P/E ModelDoes not work for a savings account!g-Earn Value105.1g A Model of the Forward P/EValue of savings account=Capitalized forward earnings+No extra valueExtra value is added if abnormal earnings growth is forecastedThe model:Value of equity=Capitalized forward earnings+
19、Extra value for abnormal earnings growth3423210111EEEEEEAEGAEGAEGEarnV34232111EEEEAEGAEGAEGEarnThe intrinsic P/E 1E0EarnVis given by dividing through by Earn1Measuring Abnormal Earnings Growth for Equities:Dell and Nike,2010Abnormal earnings growtht (AEGt)=Cum-dividend earnt -Normal earnt =Earnt+(E
20、1)dt-1 Earnt-1Dell:Required return=9%Eps 2009=$1.25Nike:Required return=9%Eps 2009=$3.07Dell Inc.Nike,Inc.Eps 2010Dps 2009Earnings on reinvested 2009 dividends Cum-dividend earnings 2010Normal earnings from 2009:Dell:1.25 x 1.09;Nike:3.07 x 1.09Abnormal earnings growth(AEG)2010$0.00$0.73$0.00 0.73 1
21、.363-$0.633$0.98$3.93 0.088 4.018 3.346$0.672Cum-dividend Earnings Growth Rate Cum-dividend earnings growth rate(plus one):Note:This is not 1tttEarningsearningsdividendCumG1ttearningsdividendCumearningsdividedCumAlternative Calculation of AEGAbnormal earnings growtht=Gt E x Earningst-1Where Gt=Cum-d
22、ividend earnings growth rate(plus one)For Nike:G2010=4.018/3.07=1.3088(a 30.88%growth rate)AEG2010=1.3088 1.09 x 3.07 =$0.672Steps in Applying the Model1.Forecast earnings and dividends up to a forecast horizon.2.Calculate AEG after the forward year from the forecasts of earnings and dividends.3.Dis
23、count the AEG to present value at the end of the forward year.4.Calculate a continuing value at the forecast horizon.5.Discount the continuing value to present value at the end of the forward year.6.Add 3,5,and forward earnings7.Capitalize this total at the required rate of return.)(11113423210gAEGA
24、EGAEGAEGEarnVTTEEEEEApplying the ModelCum dividend earnings2 Normal earnings2 Cum dividend earnings3 Normal earnings2 Cum dividend earnings4 Normal earnings4 Year 4 aheadYear 3 aheadYear 2 aheadAbnormal Earnings2Abnormal Earnings3Abnormal Earnings4Forward Earnings1 Year 1 aheadPV of AEG2Total earnin
25、gs plus growthCurrent ValueCapitalizeDiscount by Discount by 2Discount by 3ForecastsPV of AEG3PV of AEG4+-+Applying the Model:A Simple Example and a Simple ModelForecast for a firm with expected earnings growth of 3 percent per year(in dollars).Required return is 10%per year.Residual earnings valuat
26、ion:71.13303.110.136.2100VE2000AEG valuation:71.13303.110.1071.036.1210.012000EVA Case 1 Valuation:General ElectricRequired return is 10%In this case,abnormal earnings growth is expected to be zero after 2004 13.07 0.017 1.29 1001 V1999.ESame as residual earnings valuationA Case 2 Valuation:Nike,Inc
27、.Required return is 9%In this case,abnormal earnings growth is expected to grow at a 4.5 percent rate after 201218.53495.1332.096.209.012006EVSame as residual earnings valuationConverting Analysts Forecasts to a Valuation:Google Inc.,2010 Price,early 2011=$624 Required return =11%Consensus eps forec
28、asts:2011$33.832012$39.475-year growth rate forecasted=17.4%Abnormal Earnings Growth is Equal to the Change in Residual EarningsAEGt=earnt+(E 1)dt-1-Eearnt-1 By the stocks and flows equation for accounting for the book value of equity(Chapter 2),Bt-1=Bt-2+earnt-1 dt-1,so earnt-1 dt-1=Bt-1 Bt-2.Thus,
29、AEGt=earnt earnt-1-(E 1)Bt-1 Bt-2 =earnt-(E 1)Bt-1-earnt-1-(E 1)Bt-2 =REt REt-1 d1)earn(earnearn1t1tE1tt.RE RE RE Earn 1 VEEE2EE3423101So,the AEG model can be written as:Protection From Earnings Created by Accounting:A Restructuring Charge71.13310.103.110.1073.010.1729.836.2010.012000EVAbnormal Earn
30、ings Growth Analysis:Advantages and DisadvantagesAdvantages Easy to understand:Investors think in terms of future earnings;investors buy earnings.Focuses directly on the most common multiple used,the P/E ratio.Uses Accrual accounting:embeds the properties of accrual accounting by which revenues are
31、matched with expenses to measure value added from selling products.Versatility:Can be used under a variety of accounting principles(Chapter 17).Aligned with what people forecast:Analysts forecast earnings and earnings growth.Disadvantages Accounting complexity:Requires an understanding of how accrua
32、l accounting works.Concept complexity:Requires an appreciation of the concept of cum-dividend earnings;that is,value is based on earnings to be earned within the firm and from earnings from the reinvestment of dividends.Application to strategy:Does not give an insight into the drivers of earnings gr
33、owth,particularly balance sheet items,so is not suited to strategy analysis.Suspect accounting:Relies on earnings numbers that can be suspect(Chapter 18).The Fed ModelIf Earnings Yield is less than 10-year treasury note yield,stocks are overpricedIn Greenspan 1998:“irrational exuberance”speechTreasu
34、ry yield=5.60%(P/E=17.86)Earnings yield=4.75%(P/E=21.05)A good model?Different risk for bonds and stocks P/E should be higher for bonds(and earnings yields lower)Stocks deliver AEG,bonds do notP/E can be higher for stocks(and earnings yields lower)But:growth may be risky.The Fed Model says that grow
35、th=risk,So the two cancel in the price.P/E Forward1Priceearnings Forward yield EarningsP/E Ratios and Interest Rates:1963 2003Median P/E ratios and interest rates(in percentages)on one-year Treasury billsThe PEG RatioPEG RATIO=P/E 1-year ahead percentage earnings growthDoes it work as a screen for buy and sell?Three points:1.One-year-ahead growth does not capture long-term growth:Use an average 5-year growth rate in denominator?2.A 1.0 cutoff applies only for a required return of 10%.3.Growth rate should be the cum-dividend growth rate.
