Earnings Multiples

Aswath Damodaran

Aswath Damodaran 1
 Price Earnings Ratio: Definition

PE = Market Price per Share / Earnings per Share

n There are a number of variants on the basic PE ratio in use. They are
based upon how the price and the earnings are defined.
n Price: is usually the current price
is sometimes the average price for the year
n EPS: earnings per share in most recent financial year
earnings per share in trailing 12 months (Trailing PE)
forecasted earnings per share next year (Forward PE)
forecasted earnings per share in future year

Aswath Damodaran 2
 PE Ratio: Descriptive Statistics

Distribution of PE Ratios - September 2001

1200

1000

800
Number of firms

Current PE
600 Trailing PE
Forward PE

400

200

0
0-4 4-6 6-8 8 - 10 10 - 15 15-20 20-25 25-30 30-35 35-40 40 - 45 45- 50 50 -75 75 - > 100
100
PE ratio

Aswath Damodaran 3
 PE: Deciphering the Distribution

Current PE Trailing PE Forward PE

Mean 30.93 30.33 21.13
Standard Error 2.70 2.74 0.73
Median 15.27 15.20 13.71
Mode 10 0 14
Standard Deviation 157.30 150.65 38.22
Kurtosis 795.82 1615.73 224.85
Skewness 26.28 36.04 12.97
Range 5370.00 7090.50 864.91
Maximum 5370.00 7090.50 865.00
Count 3387 3021 2737

Aswath Damodaran 4
 PE Ratio: Understanding the Fundamentals

n To understand the fundamentals, start with a basic equity discounted

cash flow model.
n With the dividend discount model,
DPS1
P0 =
r − gn

n Dividing both sides by the earnings per share,

P0 Payout Ratio *(1 + g n )
= PE =
EPS 0 r - gn

n If this had been a FCFE Model,

FCFE 1
P0 =
r − gn
P0 (FCFE/Earnings)*(1 + g n )
= PE =
EPS0 r-g n

Aswath Damodaran 5
 PE Ratio and Fundamentals

n Proposition: Other things held equal, higher growth firms will

have higher PE ratios than lower growth firms.
n Proposition: Other things held equal, higher risk firms will have
lower PE ratios than lower risk firms
n Proposition: Other things held equal, firms with lower
reinvestment needs will have higher PE ratios than firms with
higher reinvestment rates.
n Of course, other things are difficult to hold equal since high growth
firms, tend to have risk and high reinvestment rats.

Aswath Damodaran 6
 Using the Fundamental Model to Estimate PE For a
High Growth Firm

n The price-earnings ratio for a high growth firm can also be related to
fundamentals. In the special case of the two-stage dividend discount
model, this relationship can be made explicit fairly simply:
 ( 1 +g)n 
)* 1 −
EPS0 * P a y o u t R a t i o * ( 1g +
 ( 1 +r) n  EPS 0 *Payout Ration * ( 1 +g)n * ( 1 +g n )
P0 = +
r-g (r - gn )(1+r)n

• For a firm that does not pay what it can afford to in dividends, substitute
FCFE/Earnings for the payout ratio.
n Dividing both sides by the earnings per share:
 (1+ g )n 
Payout Ratio *(1 + g )*  1 − 
P0  (1+ r) n  Payout Ratio n * ( 1 + g )n *(1 + gn )
= +
EPS 0 r -g (r - g n )(1+ r) n

Aswath Damodaran 7
 Expanding the Model

n In this model, the PE ratio for a high growth firm is a function of

growth, risk and payout, exactly the same variables that it was a
function of for the stable growth firm.
n The only difference is that these inputs have to be estimated for two
phases - the high growth phase and the stable growth phase.
n Expanding to more than two phases, say the three stage model, will
mean that risk, growth and cash flow patterns in each stage.

Aswath Damodaran 8
 A Simple Example

n Assume that you have been asked to estimate the PE ratio for a firm
which has the following characteristics:
Variable High Growth Phase Stable Growth Phase
Expected Growth Rate 25% 8%
Payout Ratio 20% 50%
Beta 1.00 1.00
n Riskfree rate = T.Bond Rate = 6%
n Required rate of return = 6% + 1(5.5%)= 11.5%
 (1.25)5 
0 . 2 * (1.25) *  1− 5

 (1.115)  5
0.5 * (1.25) *(1.08)
PE = + = 28.75
(.115 - .25) (.115-.08) (1.115) 5

Aswath Damodaran 9
 PE and Growth: Firm grows at x% for 5 years, 8%
thereafter

PE Ratios and Expected Growth: Interest Rate Scenarios

180

160

140

120

100 r=4%
PE Ratio

r=6%
r=8%
80 r=10%

60

40

20

0
5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Expected Growth Rate

Aswath Damodaran 10
 PE Ratios and Length of High Growth: 25% growth
for n years; 8% thereafter

PE Ratios and Length of High Growth Period

60

50

40

g=25%
PE Ratio

g=20%
30
g=15%
g=10%

20

10

0
0 1 2 3 4 5 6 7 8 9 10
Length of High Growth Period

Aswath Damodaran 11
 PE and Risk: Effects of Changing Betas on PE
Ratio:
Firm with x% growth for 5 years; 8% thereafter

PE Ratios and Beta: Growth Scenarios

50

45

40

35

30
g=25%
PE Ratio

g=20%
25
g=15%
g=8%
20

15

10

0
0.75 1.00 1.25 1.50 1.75 2.00
Beta

Aswath Damodaran 12
 PE and Payout

PE Ratios and Payour Ratios: Growth Scenarios

35

30

25

20 g=25%
g=20%
PE

g=15%
15 g=10%

10

0
0% 20% 40% 60% 80% 100%
Payout Ratio

Aswath Damodaran 13
 PE: Emerging Markets

35

30

25

20

15

10

0
Mexico Malaysia Singapore Taiwan Hong Kong Venezuela Brazil Argentina Chile

Aswath Damodaran 14
 Comparisons across countries

n In July 2000, a market strategist is making the argument that Brazil

and Venezuela are cheap relative to Chile, because they have much
lower PE ratios. Would you agree?
o Yes
o No
n What are some of the factors that may cause one market’s PE ratios to
be lower than another market’s PE?

Aswath Damodaran 15
 A Comparison across countries: June 2000

Country PE Dividend Yield 2-yr rate 10-yr rate 10yr - 2yr

UK 22.02 2.59% 5.93% 5.85% -0.08%
Germany 26.33 1.88% 5.06% 5.32% 0.26%
France 29.04 1.34% 5.11% 5.48% 0.37%
Switzerland 19.6 1.42% 3.62% 3.83% 0.21%
Belgium 14.74 2.66% 5.15% 5.70% 0.55%
Italy 28.23 1.76% 5.27% 5.70% 0.43%
Sweden 32.39 1.11% 4.67% 5.26% 0.59%
Netherlands 21.1 2.07% 5.10% 5.47% 0.37%
Australia 21.69 3.12% 6.29% 6.25% -0.04%
Japan 52.25 0.71% 0.58% 1.85% 1.27%
US 25.14 1.10% 6.05% 5.85% -0.20%
Canada 26.14 0.99% 5.70% 5.77% 0.07%

Aswath Damodaran 16
 Correlations and Regression of PE Ratios

n Correlations
• Correlation between PE ratio and long term interest rates = -0.733
• Correlation between PE ratio and yield spread = 0.706
n Regression Results
PE Ratio = 42.62 - 3.61 (10’yr rate) + 8.47 (10-yr - 2 yr rate) R2 = 59%
Input the interest rates as percent. For instance, the predicted PE ratio for
Japan with this regression would be:
PE: Japan = 42.62 - 3.61 (1.85) + 8.47 (1.27) = 46.70
At an actual PE ratio of 52.25, Japanese stocks are slightly overvalued.

Aswath Damodaran 17
 Predicted PE Ratios

Country Actual PE Predicted PE Under or Over Valued

UK 22.02 20.83 5.71%
Germany 26.33 25.62 2.76%
France 29.04 25.98 11.80%
Switzerland 19.6 30.58 -35.90%
Belgium 14.74 26.71 -44.81%
Italy 28.23 25.69 9.89%
Sweden 32.39 28.63 13.12%
Netherlands 21.1 26.01 -18.88%
Australia 21.69 19.73 9.96%
Japan 52.25 46.70 11.89%
United States 25.14 19.81 26.88%
Canada 26.14 22.39 16.75%

Aswath Damodaran 18
 An Example with Emerging Markets: June 2000

Country PE Ratio Interest GDP Real Country

Rates Growth Risk
Argentina 14 18.00% 2.50% 45
Brazil 21 14.00% 4.80% 35
Chile 25 9.50% 5.50% 15
Hong Kong 20 8.00% 6.00% 15
India 17 11.48% 4.20% 25
Indonesia 15 21.00% 4.00% 50
Malaysia 14 5.67% 3.00% 40
Mexico 19 11.50% 5.50% 30
Pakistan 14 19.00% 3.00% 45
Peru 15 18.00% 4.90% 50
Phillipines 15 17.00% 3.80% 45
Singapore 24 6.50% 5.20% 5
South Korea 21 10.00% 4.80% 25
Thailand 21 12.75% 5.50% 25
Turkey 12 25.00% 2.00% 35
Venezuela 20 15.00% 3.50% 45

Aswath Damodaran 19
 Regression Results

n The regression of PE ratios on these variables provides the following –

PE = 16.16 - 7.94 Interest Rates
+ 154.40 Growth in GDP
- 0.1116 Country Risk
R Squared = 73%

Aswath Damodaran 20
 Predicted PE Ratios

Country PE Ratio Interest GDP Real Country Predicted PE

Rates Growth Risk
Argentina 14 18.00% 2.50% 45 13.57
Brazil 21 14.00% 4.80% 35 18.55
Chile 25 9.50% 5.50% 15 22.22
Hong Kong 20 8.00% 6.00% 15 23.11
India 17 11.48% 4.20% 25 18.94
Indonesia 15 21.00% 4.00% 50 15.09
Malaysia 14 5.67% 3.00% 40 15.87
Mexico 19 11.50% 5.50% 30 20.39
Pakistan 14 19.00% 3.00% 45 14.26
Peru 15 18.00% 4.90% 50 16.71
Phillipines 15 17.00% 3.80% 45 15.65
Singapore 24 6.50% 5.20% 5 23.11
South Korea 21 10.00% 4.80% 25 19.98
Thailand 21 12.75% 5.50% 25 20.85
Turkey 12 25.00% 2.00% 35 13.35
Venezuela 20 15.00% 3.50% 45 15.35

Aswath Damodaran 21
 Comparisons of PE across time: PE Ratio for the
S&P 500

PE Ratio: 1960-2000

35.00

30.00

25.00

20.00

15.00

10.00

5.00

0.00
60

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00
19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

20
Aswath Damodaran 22
 Is low (high) PE cheap (expensive)?

n A market strategist argues that stocks are over priced because the PE
ratio today is too high relative to the average PE ratio across time. Do
you agree?
q Yes
q No
n If you do not agree, what factors might explain the higer PE ratio
today?

Aswath Damodaran 23
 E/P Ratios , T.Bond Rates and Term Structure

16.00%

14.00%

12.00%

10.00%

8.00%
Earnings Yield
T.Bond Rate
Bond-Bill
6.00%

4.00%

2.00%

0.00%
60

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00
19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

20
-2.00%

Aswath Damodaran 24
 Regression Results

n There is a strong positive relationship between E/P ratios and T.Bond

rates, as evidenced by the correlation of 0.685 between the two
variables.,
n In addition, there is evidence that the term structure also affects the PE
ratio.
n In the following regression, using 1960-2000 data, we regress E/P
ratios against the level of T.Bond rates and a term structure variable
(T.Bond - T.Bill rate)
E/P = 1 .88% + 0.776 T.Bond Rate - 0.407 (T.Bond Rate-T.Bill Rate)
(2.84) (6.08) (-2.37)
R squared = 50%

Aswath Damodaran 25
 Estimate the E/P Ratio Today

n T. Bond Rate =
n T.Bond Rate - T.Bill Rate =
n Expected E/P Ratio =
n Expected PE Ratio =

Aswath Damodaran 26
 Comparing PE ratios across firms

Company Name Trailing PE Expected Growth Standard Dev

Coca-Cola Bottling 29.18 9.50% 20.58%
Molson Inc. Ltd. 'A' 43.65 15.50% 21.88%
Anheuser-Busch 24.31 11.00% 22.92%
Corby Distilleries Ltd. 16.24 7.50% 23.66%
Chalone Wine Group Ltd. 21.76 14.00% 24.08%
Andres Wines Ltd. 'A' 8.96 3.50% 24.70%
Todhunter Int'l 8.94 3.00% 25.74%
Brown-Forman 'B' 10.07 11.50% 29.43%
Coors (Adolph) 'B' 23.02 10.00% 29.52%
PepsiCo, Inc. 33.00 10.50% 31.35%
Coca-Cola 44.33 19.00% 35.51%
Boston Beer 'A' 10.59 17.13% 39.58%
Whitman Corp. 25.19 11.50% 44.26%
Mondavi (Robert) 'A' 16.47 14.00% 45.84%
Coca-Cola Enterprises 37.14 27.00% 51.34%

Hansen Natural Corp 9.70 17.00% 62.45%

Aswath Damodaran 27
 A Question

You are reading an equity research report on this sector, and the analyst
claims that Andres Wine and Hansen Natural are under valued because
they have low PE ratios. Would you agree?
o Yes
o No
n Why or why not?

Aswath Damodaran 28
 Comparing PE Ratios across a Sector

Company Name PE Growth

PT Indosat ADR 7.8 0.06
Telebras ADR 8.9 0.075
Telecom Corporation of New Zealand ADR 11.2 0.11
Telecom Argentina Stet - France Telecom SA ADR B 12.5 0.08
Hellenic Telecommunication Organization SA ADR 12.8 0.12
Telecomunicaciones de Chile ADR 16.6 0.08
Swisscom AG ADR 18.3 0.11
Asia Satellite Telecom Holdings ADR 19.6 0.16
Portugal Telecom SA ADR 20.8 0.13
Telefonos de Mexico ADR L 21.1 0.14
Matav RT ADR 21.5 0.22
Telstra ADR 21.7 0.12
Gilat Communications 22.7 0.31
Deutsche Telekom AG ADR 24.6 0.11
British Telecommunications PLC ADR 25.7 0.07
Tele Danmark AS ADR 27 0.09
Telekomunikasi Indonesia ADR 28.4 0.32
Cable & Wireless PLC ADR 29.8 0.14
APT Satellite Holdings ADR 31 0.33
Telefonica SA ADR 32.5 0.18
Royal KPN NV ADR 35.7 0.13
Telecom Italia SPA ADR 42.2 0.14
Nippon Telegraph & Telephone ADR 44.3 0.2
France Telecom SA ADR 45.2 0.19
Korea Telecom ADR 71.3 0.44

Aswath Damodaran 29
 PE, Growth and Risk

Dependent variable is: PE

R squared = 66.2% R squared (adjusted) = 63.1%

Variable Coefficient SE t-ratio prob

Constant 13.1151 3.471 3.78 0.0010
Growth rate 121.223 19.27 6.29 ≤ 0.0001
Emerging Market -13.8531 3.606 -3.84 0.0009
Emerging Market is a dummy: 1 if emerging market
0 if not

Aswath Damodaran 30
 Is Telebras under valued?

n Predicted PE = 13.12 + 121.22 (.075) - 13.85 (1) = 8.35

n At an actual price to earnings ratio of 8.9, Telebras is slightly
overvalued.

Aswath Damodaran 31
 Using comparable firms- Pros and Cons

n The most common approach to estimating the PE ratio for a firm is

• to choose a group of comparable firms,
• to calculate the average PE ratio for this group and
• to subjectively adjust this average for differences between the firm being
valued and the comparable firms.
n Problems with this approach.
• The definition of a 'comparable' firm is essentially a subjective one.
• The use of other firms in the industry as the control group is often not a
solution because firms within the same industry can have very different
business mixes and risk and growth profiles.
• There is also plenty of potential for bias.
• Even when a legitimate group of comparable firms can be constructed,
differences will continue to persist in fundamentals between the firm
being valued and this group.

Aswath Damodaran 32
 Using the entire crosssection: A regression approach

n In contrast to the 'comparable firm' approach, the information in the

entire cross-section of firms can be used to predict PE ratios.
n The simplest way of summarizing this information is with a multiple
regression, with the PE ratio as the dependent variable, and proxies for
risk, growth and payout forming the independent variables.

Aswath Damodaran 33
 PE versus Growth

120

100

80

60

40

20

-20
-20 0 20 40 60 80 100

Expected Growth in EPS: next 5 years

Aswath Damodaran 34
 PE Ratio: Standard Regression

Model Summary

Adjusted R Std. Error of

Model R R Square Square the Estimate
1 .478a .229 .227 803.9541
a. Predictors: (Constant), Expected Growth in EPS: next 5 y,
PAYOUT1, Beta

Coefficients a,b

Standar
Unstandardized dized
Coefficients Coefficients
Model B Std. Error Beta t Sig.
1 (Constant) 13.090 1.164 11.242 .000
Beta -3.392 .908 -.089 -3.737 .000
PAYOUT1 4.938 1.190 .098 4.150 .000
Expected Growth
.880 .040 .527 22.115 .000
in EPS: next 5 y
a. Dependent Variable: Current PE
b. Weighted Least Squares Regression - Weighted by Market Cap

Aswath Damodaran 35
 Second Thoughts?

n Based on this regression, estimate the PE ratio for a firm with no

growth, no payout and no risk.

n Is there a problem with your prediction?

Aswath Damodaran 36
 PE Regression- No Intercept
Model Summary

Adjusted R Std. Error of

a
Model R R Square Square the Estimate
1 .912b .832 .832 833.0224
a. For regression through the origin (the no-intercept
model), R Square measures the proportion of the
variability in the dependent variable about the origin
explained by regression. This CANNOT be compared to R
Square for models which include an intercept.
b. Predictors: Expected Growth in EPS: next 5 y, PAYOUT1,
Beta

Coefficients a,b,c

Standar
Unstandardized dized
Coefficients Coefficients
Model B Std. Error Beta t Sig.
1 Beta 4.389 .609 .188 7.212 .000
PAYOUT1 13.299 .962 .189 13.823 .000
Expected Growth
1.014 .039 .608 25.786 .000
in EPS: next 5 y
a. Dependent Variable: Current PE
b. Linear Regression through the Origin
c. Weighted Least Squares Regression - Weighted by Market Cap

Aswath Damodaran 37
 Problems with the regression methodology

n The basic regression assumes a linear relationship between PE ratios

and the financial proxies, and that might not be appropriate.
n The basic relationship between PE ratios and financial variables itself
might not be stable, and if it shifts from year to year, the predictions
from the model may not be reliable.
n The independent variables are correlated with each other. For example,
high growth firms tend to have high risk. This multi-collinearity makes
the coefficients of the regressions unreliable and may explain the large
changes in these coefficients from period to period.

Aswath Damodaran 38
 The Multicollinearity Problem

Correlations

Expected
Growth in EPS:
Current PE next 5 y Beta Payout Ratio
Current PE Pearson Correlation 1.000 .342** .130** .009
Sig. (2-tailed) . .000 .000 .594
N 3303 2085 3027 3290
Expected Growth Pearson Correlation .342** 1.000 .397** -.078**
in EPS: next 5 y Sig. (2-tailed) .000 . .000 .000
N 2085 2675 2393 2143
Beta Pearson Correlation .130** .397** 1.000 -.213**
Sig. (2-tailed) .000 .000 . .000
N 3027 2393 4534 3114
Payout Ratio Pearson Correlation .009 -.078** -.213** 1.000
Sig. (2-tailed) .594 .000 .000 .
N 3290 2143 3114 3388
**. Correlation is significant at the 0.01 level (2-tailed).

Aswath Damodaran 39
 Using the PE ratio regression

n Assume that you were given the following information for Dell. The
firm has an expected growth rate of 10%, a beta of 1.40 and pays no
dividends. Based upon the regression, estimate the predicted PE ratio
for Dell.
Predicted PE =
(Work with absolute values in regression - 10 for 10% etc.)

n Dell is actually trading at 18 times earnings. What does the predicted

PE tell you?

Aswath Damodaran 40
 Investment Strategies that compare PE to the
expected growth rate

n If we assume that all firms within a sector have similar growth rates
and risk, a strategy of picking the lowest PE ratio stock in each sector
will yield undervalued stocks.
n Portfolio managers and analysts sometimes compare PE ratios to the
expected growth rate to identify under and overvalued stocks.
• In the simplest form of this approach, firms with PE ratios less than their
expected growth rate are viewed as undervalued.
• In its more general form, the ratio of PE ratio to growth is used as a
measure of relative value.

Aswath Damodaran 41
 Problems with comparing PE ratios to expected
growth

n In its simple form, there is no basis for believing that a firm is

undervalued just because it has a PE ratio less than expected growth.
n This relationship may be consistent with a fairly valued or even an
overvalued firm, if interest rates are high, or if a firm is high risk.
n As interest rate decrease (increase), fewer (more) stocks will emerge as
undervalued using this approach.

Aswath Damodaran 42
 PE Ratio versus Growth - The Effect of Interest
rates:
Average Risk firm with 25% growth for 5 years; 8% thereafter

Figure 14.2: PE Ratios and T.Bond Rates

45

40

35

30

25

20

15

10

0
5% 6% 7% 8% 9% 10%
T.Bond Rate

Aswath Damodaran 43
 PE Ratios Less Than The Expected Growth Rate

n In September 2001,
• 33% of firms had PE ratios lower than the expected 5-year growth rate
• 67% of firms had PE ratios higher than the expected 5-year growth rate
n In comparison,
• 38.1% of firms had PE ratios less than the expected 5-year growth rate in
September 1991
• 65.3% of firm had PE ratios less than the expected 5-year growth rate in
1981.

Aswath Damodaran 44
 PEG Ratio: Definition

n The PEG ratio is the ratio of price earnings to expected growth in

earnings per share.
PEG = PE / Expected Growth Rate in Earnings
n Definitional tests:
• Is the growth rate used to compute the PEG ratio
– on the same base? (base year EPS)
– over the same period?(2 years, 5 years)
– from the same source? (analyst projections, consensus estimates..)
• Is the earnings used to compute the PE ratio consistent with the growth
rate estimate?
– No double counting: If the estimate of growth in earnings per share is from the
current year, it would be a mistake to use forward EPS in computing PE
– If looking at foreign stocks or ADRs, is the earnings used for the PE ratio
consistent with the growth rate estimate? (US analysts use the ADR EPS)

Aswath Damodaran 45
 PEG Ratio: Distribution

400

300

200

100

Std. Dev = 1.05

Mean = 1.55

0 N = 2084.00

Price/ Expected Growth RAte

Aswath Damodaran 46
 PEG Ratios: The Beverage Sector

Company Name Trailing PE Growth Std Dev PEG

Coca-Cola Bottling 29.18 9.50% 20.58% 3.07
Molson Inc. Ltd. 'A' 43.65 15.50% 21.88% 2.82
Anheuser-Busch 24.31 11.00% 22.92% 2.21
Corby Distilleries Ltd. 16.24 7.50% 23.66% 2.16
Chalone Wine Group Ltd. 21.76 14.00% 24.08% 1.55
Andres Wines Ltd. 'A' 8.96 3.50% 24.70% 2.56
Todhunter Int'l 8.94 3.00% 25.74% 2.98
Brown-Forman 'B' 10.07 11.50% 29.43% 0.88
Coors (Adolph) 'B' 23.02 10.00% 29.52% 2.30
PepsiCo, Inc. 33.00 10.50% 31.35% 3.14
Coca-Cola 44.33 19.00% 35.51% 2.33
Boston Beer 'A' 10.59 17.13% 39.58% 0.62
Whitman Corp. 25.19 11.50% 44.26% 2.19
Mondavi (Robert) 'A' 16.47 14.00% 45.84% 1.18
Coca-Cola Enterprises 37.14 27.00% 51.34% 1.38
Hansen Natural Corp 9.70 17.00% 62.45% 0.57

Average
Aswath Damodaran 22.66 0.13 0.33 2.00 47
 PEG Ratio: Reading the Numbers

n The average PEG ratio for the beverage sector is 2.00. The lowest
PEG ratio in the group belongs to Hansen Natural, which has a PEG
ratio of 0.57. Using this measure of value, Hansen Natural is
o the most under valued stock in the group
o the most over valued stock in the group
n What other explanation could there be for Hansen’s low PEG ratio?

Aswath Damodaran 48
 PEG Ratio: Analysis

n To understand the fundamentals that determine PEG ratios, let us

return again to a 2-stage equity discounted cash flow model
 ( 1 +g)n 
) *1 −
EPS0 * P a y o u t R a t i o * ( 1g +
 ( 1 +r) n  EPS 0 *Payout Ration * ( 1 +g)n * ( 1 +g n )
P0 = +
r-g (r - gn )(1+r)n

n Dividing both sides of the equation by the earnings gives us the

equation for the PE ratio. Dividing it again by the expected growth ‘g’
 ( 1 +g)n 
Payout Ratio*(1+ g) * 1 −
 (1 + r) n  Payout Ratio n * ( 1 +g)n * ( 1 +g n )
PEG = +
g(r - g) g(r - gn )(1 + r)n

Aswath Damodaran 49
 PEG Ratios and Fundamentals

n Risk and payout, which affect PE ratios, continue to affect PEG ratios
as well.
• Implication: When comparing PEG ratios across companies, we are
making implicit or explicit assumptions about these variables.
n Dividing PE by expected growth does not neutralize the effects of
expected growth, since the relationship between growth and value is
not linear and fairly complex (even in a 2-stage model)

Aswath Damodaran 50
 A Simple Example

n Assume that you have been asked to estimate the PEG ratio for a firm
which has the following characteristics:
Variable High Growth Phase Stable Growth Phase
Expected Growth Rate 25% 8%
Payout Ratio 20% 50%
Beta 1.00 1.00
n Riskfree rate = T.Bond Rate = 6%
n Required rate of return = 6% + 1(5.5%)= 11.5%
n The PEG ratio for this firm can be estimated as follows:

 (1.25) 5 
0.2 * (1.25) * 1 −
 (1.115) 5  0.5 * (1.25)5 *(1.08)
PEG = + = .115 or 1.15
.25(.115 - .25) .25(.115-.08) (1.115)5

Aswath Damodaran 51
 PEG Ratios and Risk

PEG Ratios and Beta: Different Growth Rates

2.5

g =25%
PEG Ratio

g=20%
1.5
g=15%
g=8%

0.5

0
0.75 1.00 1.25 1.50 1.75 2.00
Beta

Aswath Damodaran 52
 PEG Ratios and Quality of Growth

PEG Ratios and Retention Ratios

1.4

1.2

0.8
PEG Ratio

PEG

0.6

0.4

0.2

0
1 0.8 0.6 0.4 0.2 0
Retention Ratio

Aswath Damodaran 53
 PE Ratios and Expected Growth

PEG Ratios, Expected Growth and Interest Rates

2.50

2.00

1.50
r=6%
PEG Ratio

r=8%
r=10%

1.00

0.50

0.00
5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Expected Growth Rate

Aswath Damodaran 54
 PEG Ratios and Fundamentals: Propositions

n Proposition 1: High risk companies will trade at much lower PEG

ratios than low risk companies with the same expected growth rate.
• Corollary 1: The company that looks most under valued on a PEG ratio
basis in a sector may be the riskiest firm in the sector
n Proposition 2: Companies that can attain growth more efficiently by
investing less in better return projects will have higher PEG ratios than
companies that grow at the same rate less efficiently.
• Corollary 2: Companies that look cheap on a PEG ratio basis may be
companies with high reinvestment rates and poor project returns.
n Proposition 3: Companies with very low or very high growth rates will
tend to have higher PEG ratios than firms with average growth rates.
This bias is worse for low growth stocks.
• Corollary 3: PEG ratios do not neutralize the growth effect.

Aswath Damodaran 55
 PE, PEG Ratios and Risk

45 2.5

40

2
35

30

1.5
25
PE
PEG Ratio
20
1

15

10
0.5

0 0
Lowest 2 3 4 Highest

Aswath Damodaran 56
 PEG Ratio: Returning to the Beverage Sector

Company Name Trailing PE Growth Std Dev PEG

Coca-Cola Bottling 29.18 9.50% 20.58% 3.07
Molson Inc. Ltd. 'A' 43.65 15.50% 21.88% 2.82
Anheuser-Busch 24.31 11.00% 22.92% 2.21
Corby Distilleries Ltd. 16.24 7.50% 23.66% 2.16
Chalone Wine Group Ltd. 21.76 14.00% 24.08% 1.55
Andres Wines Ltd. 'A' 8.96 3.50% 24.70% 2.56
Todhunter Int'l 8.94 3.00% 25.74% 2.98
Brown-Forman 'B' 10.07 11.50% 29.43% 0.88
Coors (Adolph) 'B' 23.02 10.00% 29.52% 2.30
PepsiCo, Inc. 33.00 10.50% 31.35% 3.14
Coca-Cola 44.33 19.00% 35.51% 2.33
Boston Beer 'A' 10.59 17.13% 39.58% 0.62
Whitman Corp. 25.19 11.50% 44.26% 2.19
Mondavi (Robert) 'A' 16.47 14.00% 45.84% 1.18
Coca-Cola Enterprises 37.14 27.00% 51.34% 1.38
Hansen Natural Corp 9.70 17.00% 62.45% 0.57

Average
Aswath Damodaran 22.66 0.13 0.33 2.00 57
 Analyzing PE/Growth

n Given that the PEG ratio is still determined by the expected growth
rates, risk and cash flow patterns, it is necessary that we control for
differences in these variables.
n Regressing PEG against risk and a measure of the growth dispersion,
we get:
PEG = 3.61 - 2.86 (Expected Growth) - 3.75 (Std Deviation in Prices)
R Squared = 44.75%
n In other words,
• PEG ratios will be lower for high growth companies
• PEG ratios will be lower for high risk companies
n We also ran the regression using the deviation of the actual growth rate
from the industry-average growth rate as the independent variable,
with mixed results.

Aswath Damodaran 58
 Estimating the PEG Ratio for Hansen

n Applying this regression to Hansen, the predicted PEG ratio for the
firm can be estimated using Hansen’s measures for the independent
variables:
• Expected Growth Rate = 17.00%
• Standard Deviation in Stock Prices = 62.45%
n Plugging in,
Expected PEG Ratio for Hansen = 3.61 - 2.86 (.17) - 3.75 (.6245)
= 0.78
n With its actual PEG ratio of 0.57, Hansen looks undervalued,
notwithstanding its high risk.

Aswath Damodaran 59
 Extending the Comparables

n This analysis, which is restricted to firms in the software sector, can be

expanded to include all firms in the firm, as long as we control for
differences in risk, growth and payout.
n To look at the cross sectional relationship, we first plotted PEG ratios
against expected growth rates.

Aswath Damodaran 60
 PEG versus Growth

-1
-20 0 20 40 60 80 100

Expected Growth in EPS: next 5 years

Aswath Damodaran 61
 Analyzing the Relationship

n The relationship in not linear. In fact, the smallest firms seem to have
the highest PEG ratios and PEG ratios become relatively stable at
higher growth rates.
n To make the relationship more linear, we converted the expected
growth rates in ln(expected growth rate). The relationship between
PEG ratios and ln(expected growth rate) was then plotted.

Aswath Damodaran 62
 PEG versus ln(Expected Growth)

-1
-1 0 1 2 3 4 5

Ln(Expected Growth)

Aswath Damodaran 63
 Market PEG Ratio Regression
Model Summary

Adjusted R Std. Error of

Model R R Square Square the Estimate
1 .587a .344 .343 56.7746
a. Predictors: (Constant), LNGROWTH, PAYOUT1, Beta

Coefficients a,b

Standar
Unstandardized dized
Coefficients Coefficients
Model B Std. Error Beta t Sig.
1 (Constant) 3.935 .112 35.175 .000
Beta -7.249E-02 .064 -.025 -1.140 .255
PAYOUT1 .575 .084 .149 6.873 .000
LNGROWTH -.867 .037 -.509 -23.522 .000
a. Dependent Variable: PEG1
b. Weighted Least Squares Regression - Weighted by Market Cap

Aswath Damodaran 64
 Applying the PEG ratio regression

n Consider Dell again. The stock has an expected growth rate of 10%, a
beta of 1.40 and pays out no dividends. What should its PEG ratio be?

n If the stock’s actual PE ratio is 18, what does this analysis tell you
about the stock?

Aswath Damodaran 65
 A Variant on PEG Ratio: The PEGY ratio

n The PEG ratio is biased against low growth firms because the
relationship between value and growth is non-linear. One variant that
has been devised to consolidate the growth rate and the expected
dividend yield:
PEGY = PE / (Expected Growth Rate + Dividend Yield)
n As an example, Con Ed has a PE ratio of 16, an expected growth rate
of 5% in earnings and a dividend yield of 4.5%.
• PEG = 16/ 5 = 3.2
• PEGY = 16/(5+4.5) = 1.7

Aswath Damodaran 66
 Relative PE: Definition

n The relative PE ratio of a firm is the ratio of the PE of the firm to the
PE of the market.
Relative PE = PE of Firm / PE of Market
n While the PE can be defined in terms of current earnings, trailing
earnings or forward earnings, consistency requires that it be estimated
using the same measure of earnings for both the firm and the market.
n Relative PE ratios are usually compared over time. Thus, a firm or
sector which has historically traded at half the market PE (Relative PE
= 0.5) is considered over valued if it is trading at a relative PE of 0.7.

Aswath Damodaran 67
 Relative PE: Cross Sectional Distribution

1000

800

600

400

200
Std. Dev = .77
Mean = 1.00

0 N = 3303.00

Relative PE

Aswath Damodaran 68
 Relative PE: Distributional Statistics

n The average relative PE is always one.

n The median relative PE is much lower, since PE ratios are skewed
towards higher values. Thus, more companies trade at PE ratios less
than the market PE and have relative PE ratios less than one.

Aswath Damodaran 69
 Relative PE: Determinants

n To analyze the determinants of the relative PE ratios, let us revisit the

discounted cash flow model we developed for the PE ratio. Using the
2-stage DDM model as our basis (replacing the payout ratio with the
FCFE/Earnings Ratio, if necessary), we get
 ( 1 +g j ) 
n

Payout Ratio j * ( 1+ g j ) * 1 − 
 
n n
( 1 +r j ) Payout Ratio j,n * ( 1+ g j ) * ( 1+ g j,n )
+ n
rj - g j (rj - g j,n )(1 + rj )
Relative PE j =
 ( 1 +g m ) n 

Payout Ratio m * ( 1 +g m ) * 1 − 
 ( 1 +rm ) 
n
Payout Ratio m,n * ( 1 +g m )n * ( 1+ gm,n )
+ n
rm - gm (rm - gm,n ) ( 1 +rm )

where Payoutj, gj, rj = Payout, growth and risk of the firm

Payoutm, gm, rm = Payout, growth and risk of the market
Aswath Damodaran 70
 Relative PE: A Simple Example

n Consider the following example of a firm growing at twice the rate as

the market, while having the same growth and risk characteristics of
the market:
Firm Market
Expected growth rate 20% 10%
Length of Growth Period 5 years 5 years
Payout Ratio: first 5 yrs 30% 30%
Growth Rate after yr 5 6% 6%
Payout Ratio after yr 5 50% 50%
Beta 1.00 1.00
Riskfree Rate = 6%

Aswath Damodaran 71
 Estimating Relative PE

n The relative PE ratio for this firm can be estimated in two steps. First,
we compute the PE ratio for the firm and the market separately:
 (1.20) 
5
0 . 3 * (1.20) * 1−
 (1.115) 5  0.5 * (1.20)5 * (1.06)
PE firm = + 5 = 15.79
(.115 - .20) (.115 -.06) (1.115)

 (1.10) 
5
0 . 3 * (1.10) *  1−
 (1.115)5  0.5 * (1.10) 5 *(1.06)
PE market = + 5 = 10.45
(.115 - .10) (.115-.06) (1.115)

n Relative PE Ratio = 15.79/10.45 = 1.51

Aswath Damodaran 72
 Relative PE and Relative Growth

Relative PE and Relative Growth Rates: Market Growth Scenarios

3.50

3.00

2.50

2.00
Relative PE

Market g=5%
Market g=10%
Market g=15%
1.50

1.00

0.50

0.00
0% 50% 100% 150% 200% 250% 300%
Firm's Growth Rate/Market Growth Rate

Aswath Damodaran 73
 Relative PE: Another Example

n In this example, consider a firm with twice the risk as the market,
while having the same growth and payout characteristics as the firm:
Firm Market
Expected growth rate 10% 10%
Length of Growth Period 5 years 5 years
Payout Ratio: first 5 yrs 30% 30%
Growth Rate after yr 5 6% 6%
Payout Ratio after yr 5 50% 50%
Beta in first 5 years 2.00 1.00
Beta after year 5 1.00 1.00
Riskfree Rate = 6%

Aswath Damodaran 74
 Estimating Relative PE

n The relative PE ratio for this firm can be estimated in two steps. First,
we compute the PE ratio for the firm and the market separately:
 (1.10) 5 
0.3 * (1.10)* 1 −
 (1.17) 5  0 . 5 * (1.10)5 * (1.06)
PE firm = + = 8.33
(.17 - . 1 0 ) (.115-.06) (1.17)5

 (1.10) 
5
0 . 3 * (1.10) *  1−
 (1.115)5  0.5 * (1.10) 5 *(1.06)
PE market = + 5 = 10.45
(.115 - .10) (.115-.06) (1.115)

n Relative PE Ratio = 8.33/10.45 = 0.80

Aswath Damodaran 75
 Relative PE and Relative Risk

Relative PE and Relative Risk: Stable Beta Scenarios

4.5

3.5

2.5
Beta stays at current level
Beta drops to 1 in stable phase
2

1.5

0.5

0
0.25 0.5 0.75 1 1.25 1.5 1.75 2

Aswath Damodaran 76
 Relative PE: Summary of Determinants

n The relative PE ratio of a firm is determined by two variables. In

particular, it will
• increase as the firm’s growth rate relative to the market increases. The rate
of change in the relative PE will itself be a function of the market growth
rate, with much greater changes when the market growth rate is higher. In
other words, a firm or sector with a growth rate twice that of the market
will have a much higher relative PE when the market growth rate is 10%
than when it is 5%.
• decrease as the firm’s risk relative to the market increases. The extent of
the decrease depends upon how long the firm is expected to stay at this
level of relative risk. If the different is permanent, the effect is much
greater.
n Relative PE ratios seem to be unaffected by the level of rates, which
might give them a decided advantage over PE ratios.

Aswath Damodaran 77
 Relative PE Ratios: The Auto Sector

Relative PE Ratios: Auto Stocks

1.20

1.00

0.80

Ford
0.60 Chrysler
GM

0.40

0.20

0.00
1993 1994 1995 1996 1997 1998 1999 2000

Aswath Damodaran 78
 Using Relative PE ratios

n On a relative PE basis, all of the automobile stocks look cheap because

they are trading at their lowest relative PE ratios in five years. Why
might the relative PE ratio be lower today than it was 5 years ago?

Aswath Damodaran 79
 Relative PEs: Why do they change?

n Historically, GM has traded at the highest relative PE ratio of the three

auto companies, and Chrysler has traded at the lowest. In the last two
or three years, this historical relationship has been upended with Ford
and Chrysler now trading at the higher ratios than GM. Analyst
projections for earnings growth at the three companies are about the
same. How would you explain the shift?

Aswath Damodaran 80
 Relative PE Ratios: Market Analysis

Model Summary

Adjusted R Std. Error of

Model R R Square Square the Estimate
1 .478a .229 .227 41.4196
a. Predictors: (Constant), Beta, RELPYT, RELGR

Coefficients a,b

Standar
Unstandardized dized
Coefficients Coefficients
Model B Std. Error Beta t Sig.
1 (Constant) .674 .060 11.242 .000
RELGR .835 .038 .527 22.115 .000
RELPYT 4.431E-02 .011 .098 4.150 .000
Beta -.175 .047 -.089 -3.737 .000
a. Dependent Variable: RELPE
b. Weighted Least Squares Regression - Weighted by Market Cap

Aswath Damodaran 81
 Value/Earnings and Value/Cashflow Ratios

n While Price earnings ratios look at the market value of equity relative to
earnings to equity investors, Value earnings ratios look at the market value of
the firm relative to operating earnings. Value to cash flow ratios modify the
earnings number to make it a cash flow number.
n The form of value to cash flow ratios that has the closest parallels in DCF
valuation is the value to Free Cash Flow to the Firm, which is defined as:
Value/FCFF = (Market Value of Equity + Market Value of Debt-Cash)
EBIT (1-t) - (Cap Ex - Deprecn) - Chg in WC
n Consistency Tests:
• If the numerator is net of cash (or if net debt is used, then the interest income from
the cash should not be in denominator
• The interest expenses added back to get to EBIT should correspond to the debt in
the numerator. If only long term debt is considered, only long term interest should
be added back.

Aswath Damodaran 82
 Value/FCFF Distribution

800

600

400

200

Std. Dev = 21.77

Mean = 20.6

0 N = 3063.00

Enterprise Value/FCFF

Aswath Damodaran 83
 Value of Firm/FCFF: Determinants

n Reverting back to a two-stage FCFF DCF model, we get:

 (1 + g)n 
FCFF (1 + g) 1 -  n ( 1 +g )
0  ( 1 +WACC)  n FCFF ( 1 +g)
V0 = + 0 n
WACC - g (WACC - g )(1 + WACC)n
n

• V0 = Value of the firm (today)

• FCFF0 = Free Cashflow to the firm in current year
• g = Expected growth rate in FCFF in extraordinary growth period (first
n years)
• WACC = Weighted average cost of capital
• gn = Expected growth rate in FCFF in stable growth period (after n
years)

Aswath Damodaran 84
 Value Multiples

n Dividing both sides by the FCFF yields,

 (1 + g)n 
(1 + g) 1 -
V0  (1 + WACC)n  ( 1 +g)n ( 1 +gn )
= +
FCFF0 WACC - g (WACC - gn )(1 + WACC)n

n The value/FCFF multiples is a function of

• the cost of capital
• the expected growth

Aswath Damodaran 85
 Alternatives to FCFF - EBIT and EBITDA

n Most analysts find FCFF to complex or messy to use in multiples

(partly because capital expenditures and working capital have to be
estimated). They use modified versions of the multiple with the
following alternative denominator:
• after-tax operating income or EBIT(1-t)
• pre-tax operating income or EBIT
• net operating income (NOI), a slightly modified version of operating
income, where any non-operating expenses and income is removed from
the EBIT
• EBITDA, which is earnings before interest, taxes, depreciation and
amortization.

Aswath Damodaran 86
 Value/FCFF Multiples and the Alternatives

n Assume that you have computed the value of a firm, using discounted
cash flow models. Rank the following multiples in the order of
magnitude from lowest to highest?
o Value/EBIT
o Value/EBIT(1-t)
o Value/FCFF
o Value/EBITDA
n What assumption(s) would you need to make for the Value/EBIT(1-t)
ratio to be equal to the Value/FCFF multiple?

Aswath Damodaran 87
 Illustration: Using Value/FCFF Approaches to value
a firm: MCI Communications

n MCI Communications had earnings before interest and taxes of $3356

million in 1994 (Its net income after taxes was $855 million).
n It had capital expenditures of $2500 million in 1994 and depreciation
of $1100 million; Working capital increased by $250 million.
n It expects free cashflows to the firm to grow 15% a year for the next
five years and 5% a year after that.
n The cost of capital is 10.50% for the next five years and 10% after
that.
n The company faces a tax rate of 36%.
 (1.15)5 
(1.15)  1-
V0 (1.105)5  (1.15) 5 (1.05)
= + 5
= 31.28
FCFF0 .105 -.15 (.10 - .05)(1.105)

Aswath Damodaran 88
 Multiple Magic

n In this case of MCI there is a big difference between the FCFF and
short cut measures. For instance the following table illustrates the
appropriate multiple using short cut measures, and the amount you
would overpay by if you used the FCFF multiple.
Free Cash Flow to the Firm
= EBIT (1-t) - Net Cap Ex - Change in Working Capital
= 3356 (1 - 0.36) + 1100 - 2500 - 250 = $ 498 million
$ Value Correct Multiple
FCFF $498 31.28382355
EBIT (1-t) $2,148 7.251163362
EBIT $ 3,356 4.640744552
EBITDA $4,456 3.49513885

Aswath Damodaran 89
 Reasons for Increased Use of Value/EBITDA

1. The multiple can be computed even for firms that are reporting net
losses, since earnings before interest, taxes and depreciation are
usually positive.
2. For firms in certain industries, such as cellular, which require a
substantial investment in infrastructure and long gestation periods, this
multiple seems to be more appropriate than the price/earnings ratio.
3. In leveraged buyouts, where the key factor is cash generated by the firm
prior to all discretionary expenditures, the EBITDA is the measure of
cash flows from operations that can be used to support debt payment at
least in the short term.
4. By looking at cashflows prior to capital expenditures, it may provide a
better estimate of “optimal value”, especially if the capital
expenditures are unwise or earn substandard returns.
5. By looking at the value of the firm and cashflows to the firm it allows
for comparisons across firms with different financial leverage.
Aswath Damodaran 90
 Value/EBITDA Multiple

n The Classic Definition

Value Market Value of Equity + Market Value of Debt
=
EBITDA Earnings before Interest, Taxes and Depreciation

n The No-Cash Version

Enterprise Value Market Value of Equity + Market Value of Debt - Cash
=
EBITDA Earnings before Interest, Taxes and Depreciation

n When cash and marketable securities are netted out of value, none of
the income from the cash and securities should be reflected in the
denominator.

Aswath Damodaran 91
 Value/EBITDA Distribution

1200

1000

800

600

400

200 Std. Dev = 8.06

Mean = 8.0

0 N = 3630.00

EV/EBITDA

Aswath Damodaran 92
 The Determinants of Value/EBITDA Multiples:
Linkage to DCF Valuation

n Firm value can be written as:

FCFF1
V0 =
WACC - g

n The numerator can be written as follows:

FCFF = EBIT (1-t) - (Cex - Depr) - ∆ Working Capital
= (EBITDA - Depr) (1-t) - (Cex - Depr) - ∆ Working Capital
= EBITDA (1-t) + Depr (t) - Cex - ∆ Working Capital

Aswath Damodaran 93
 From Firm Value to EBITDA Multiples

n Now the Value of the firm can be rewritten as,

EBITDA (1-t) + Depr (t) - Cex - ∆ Working Capital
Value =
WACC - g

n Dividing both sides of the equation by EBITDA,

Value (1- t) Depr (t)/EBITDA CEx/EBITDA ∆ Working Capital/EBITDA
= + - -
EBITDA WACC-g WACC - g WACC - g WACC - g

Aswath Damodaran 94
 A Simple Example

n Consider a firm with the following characteristics:

• Tax Rate = 36%
• Capital Expenditures/EBITDA = 30%
• Depreciation/EBITDA = 20%
• Cost of Capital = 10%
• The firm has no working capital requirements
• The firm is in stable growth and is expected to grow 5% a year forever.

Aswath Damodaran 95
 Calculating Value/EBITDA Multiple

n In this case, the Value/EBITDA multiple for this firm can be estimated
as follows:
Value ( 1 -.36) (0.2)(.36) 0.3 0
= + - - = 8.24
EBITDA .10 - . 0 5 .10 - . 0 5 .10 - .05 .10 - .05

Aswath Damodaran 96
 Value/EBITDA Multiples and Taxes

VEBITDA Multiples and Tax Rates

16

14

12

10
Value/EBITDA

0
0% 10% 20% 30% 40% 50%
Tax Rate

Aswath Damodaran 97
 Value/EBITDA and Net Cap Ex

Value/EBITDA and Net Cap Ex Ratios

12

10

8
Value/EBITDA

0
0% 5% 10% 15% 20% 25% 30%
Net Cap Ex/EBITDA

Aswath Damodaran 98
 Value/EBITDA Multiples and Return on Capital

Value/EBITDA and Return on Capital

12

10

8
Value/EBITDA

WACC=10%
6 WACC=9%
WACC=8%

0
6% 7% 8% 9% 10% 11% 12% 13% 14% 15%
Return on Capital

Aswath Damodaran 99
 Value/EBITDA Multiple: Trucking Companies

Company Name Value EBITDA Value/EBITDA

KLLM Trans. Svcs. $ 114.32 $ 48.81 2.34
Ryder System $ 5,158.04 $ 1,838.26 2.81
Rollins Truck Leasing $ 1,368.35 $ 447.67 3.06
Cannon Express Inc. $ 83.57 $ 27.05 3.09
Hunt (J.B.) $ 982.67 $ 310.22 3.17
Yellow Corp. $ 931.47 $ 292.82 3.18
Roadway Express $ 554.96 $ 169.38 3.28
Marten Transport Ltd. $ 116.93 $ 35.62 3.28
Kenan Transport Co. $ 67.66 $ 19.44 3.48
M.S. Carriers $ 344.93 $ 97.85 3.53
Old Dominion Freight $ 170.42 $ 45.13 3.78
Trimac Ltd $ 661.18 $ 174.28 3.79
Matlack Systems $ 112.42 $ 28.94 3.88
XTRA Corp. $ 1,708.57 $ 427.30 4.00
Covenant Transport Inc $ 259.16 $ 64.35 4.03
Builders Transport $ 221.09 $ 51.44 4.30
Werner Enterprises $ 844.39 $ 196.15 4.30
Landstar Sys. $ 422.79 $ 95.20 4.44
AMERCO $ 1,632.30 $ 345.78 4.72
USA Truck $ 141.77 $ 29.93 4.74
Frozen Food Express $ 164.17 $ 34.10 4.81
Arnold Inds. $ 472.27 $ 96.88 4.87
Greyhound Lines Inc. $ 437.71 $ 89.61 4.88
USFreightways $ 983.86 $ 198.91 4.95
Golden Eagle Group Inc. $ 12.50 $ 2.33 5.37
Arkansas Best $ 578.78 $ 107.15 5.40
Airlease Ltd. $ 73.64 $ 13.48 5.46
Celadon Group $ 182.30 $ 32.72 5.57
Amer. Freightways $ 716.15 $ 120.94 5.92
Transfinancial Holdings $ 56.92 $ 8.79 6.47
Vitran Corp. 'A' $ 140.68 $ 21.51 6.54
Interpool Inc. $ 1,002.20 $ 151.18 6.63
Intrenet Inc. $ 70.23 $ 10.38 6.77
Swift Transportation $ 835.58 $ 121.34 6.89
Landair Services $ 212.95 $ 30.38 7.01
CNF Transportation $ 2,700.69 $ 366.99 7.36
Budget Group Inc $ 1,247.30 $ 166.71 7.48
Caliber System $ 2,514.99 $ 333.13 7.55
Knight Transportation Inc $ 269.01 $ 28.20 9.54
Heartland Express $ 727.50 $ 64.62 11.26
Greyhound CDA Transn Corp $ 83.25 $ 6.99 11.91
Mark VII $ 160.45 $ 12.96 12.38
Coach USA Inc $ 678.38 $ 51.76 13.11
US 1 Inds Inc. $ 5.60 $ (0.17) NA
Average 5.61

Aswath Damodaran 100

 A Test on EBITDA

n Ryder System looks very cheap on a Value/EBITDA multiple basis,

relative to the rest of the sector. What explanation (other than
misvaluation) might there be for this difference?

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 Analyzing the Value/EBITDA Multiple

n While low value/EBITDA multiples may be a symptom of

undervaluation, a few questions need to be answered:
• Is the operating income next year expected to be significantly lower than
the EBITDA for the most recent period? (Price may have dropped)
• Does the firm have significant capital expenditures coming up? (In the
trucking business, the life of the trucking fleet would be a good indicator)
• Does the firm have a much higher cost of capital than other firms in the
sector?
• Does the firm face a much higher tax rate than other firms in the sector?

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 Value/EBITDA Multiples: Market

n The multiple of value to EBITDA varies widely across firms in the

market, depending upon:
• how capital intensive the firm is (high capital intensity firms will tend to
have lower value/EBITDA ratios), and how much reinvestment is needed
to keep the business going and create growth
• how high or low the cost of capital is (higher costs of capital will lead to
lower Value/EBITDA multiples)
• how high or low expected growth is in the sector (high growth sectors will
tend to have higher Value/EBITDA multiples)

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