PE ratio

Earnings enhancement, earnings dilution and rights issues

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Although we generally prefer an enterprise value based approach, earnings and price earnings ratios remain an important and legitimate component of equity analysis and valuation. Earnings based analysis includes the earnings per share enhancement or dilutive effects of major transactions.

We discuss the value relevance of earnings enhancement or dilution arising from new capital bring raised and invested, with a focus on rights issues. In an earnings-based approach to analysis, it is important to correctly apply the rights issue adjustment factors to both historical and forecast earnings per share.

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Why you should ‘forward price’ valuation multiples

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The number of alternative valuation multiples can seem endless. Many different metrics, such as EBITDA and EPS, can be combined with different measures of value, such as the stock price and enterprise value. But there is a further variation that often seems to be overlooked – the pricing basis.

Valuation multiples can be based on a historical price (or EV), a current price, or the less commonly used forward price. We advocate greater use of forward priced multiples. They are more comparable and relevant for relative valuation comparisons and provide a better basis for terminal values in DCF analysis.

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Deferred tax fails to reflect economic value – Vodafone

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Most deferred tax adjustments in financial statements help investors – but not always. The ‘economic value’ of deferred tax assets arising from unused tax losses may be significantly less than the balance sheet figure. However, as a consequence, profit forecasts may be understated, potentially leading to an undervaluation by investors. 

We estimate that if the £24bn deferred tax asset of Vodafone were discounted to an economic value then it would instead be closer to £8bn, but forecast profit would rise by about £500m.

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Price earnings ratios – DCF in disguise

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Are you trying to identify what is ‘priced in’ to a current stock price or work out a terminal value in a DCF analysis? A target valuation multiple calculation may be the answer. We present a simple interactive model.

Many dismiss valuation multiples as being too simplistic; however, multiples are just DCF in disguise. You can derive a price earnings ratio with the same value drivers as you would use in a discounted equity cash flow model.

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