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Aswath Damodaran 1

Book Value Multiples


Aswath Damodaran
Aswath Damodaran 2
Price-Book Value Ratio: Definition
n The price/book value ratio is the ratio of the market value of equity to
the book value of equity, i.e., the measure of shareholders equity in
the balance sheet.
n Price/Book Value = Market Value of Equity
Book Value of Equity
n Consistency Tests:
If the market value of equity refers to the market value of equity of
common stock outstanding, the book value of common equity should be
used in the denominator.
If there is more that one class of common stock outstanding, the market
values of all classes (even the non-traded classes) needs to be factored in.
Aswath Damodaran 3
Price to Book Value: Distribution
PBV Rat io
1000
800
600
400
200
0
St d. Dev = 2.36
Mean = 2.39
N = 4866.00
Aswath Damodaran 4
Price Book Value Ratio: Stable Growth Firm
n Going back to a simple dividend discount model,
n Defining the return on equity (ROE) = EPS
0
/ Book Value of Equity,
the value of equity can be written as:
n If the return on equity is based upon expected earnings in the next time
period, this can be simplified to,
P
0

DPS
1
r g
n
P
0

BV
0
*ROE*Payout Ratio *(1 + g
n
)
r - g
n
P
0
BV
0
PBV =
ROE*Payout Ratio*(1 + g
n
)
r-g
n
P
0
BV
0
PBV =
ROE*Payout Ratio
r-g
n
Aswath Damodaran 5
Price Book Value Ratio: Stable Growth Firm
Another Presentation
n This formulation can be simplified even further by relating growth to
the return on equity:
g = (1 - Payout ratio) * ROE
n Substituting back into the P/BV equation,
n The price-book value ratio of a stable firm is determined by the
differential between the return on equity and the required rate of return
on its projects.
P
0
BV
0
PBV =
ROE - g
n
r - g
n
Aswath Damodaran 6
Price Book Value Ratio for a Stable Growth Firm:
Example
n Jenapharm was the most respected pharmaceutical manufacturer in
East Germany.
n Jenapharm was expected to have revenues of 230 million DM and
earnings before interest and taxes of 30 million DM in 1991.
n The firm had a book value of assets of 110 million DM, and a book
value of equity of 58 million DM. The interest expenses in 1991 is
expected to be 15 million DM. The corporate tax rate is 40%.
n The firm was expected to maintain sales in its niche product, a
contraceptive pill, and grow at 5% a year in the long term, primarily by
expanding into the generic drug market.
n The average beta of pharmaceutical firms traded on the Frankfurt
Stock exchange was 1.05.
n The ten-year bond rate in Germany at the time of this valuation was
7%; the risk premium for stocks over bonds is assumed to be 5.5%.
Aswath Damodaran 7
Estimating a Price/Book Ratio for Jenapharm
n Expected Net Income = (EBIT - Interest Expense)*(1-t)* 1+g) = (30 -
15) *(1-0.4)* (1.05) = 9.45 mil DM
n Return on Equity = Expected Net Income / Book Value of Equity =
9.45 / 58 = 16.29%
n Cost on Equity = 7% + 1.05 (5.5%) = 12.775%
n Price/Book Value Ratio = (ROE - g) / (r - g) = (.1629 - .05) / (.12775 -
.05) = 1.46
n Estimated MV of equity = BV of Equity * Price/BV ratio = 58 * 1.46
= $ 84.50 mil DM
Aswath Damodaran 8
Price Book Value Ratio for High Growth Firm
n The Price-book ratio for a high-growth firm can be estimated
beginning with a 2-stage discounted cash flow model:
n Dividing both sides of the equation by the book value of equity:
where ROE = Return on Equity in high-growth period
ROE
n
= Return on Equity in stable growth period
P
0
=
EPS
0
*Payout Ratio *(1 +g)* 1
(1+ g)
n
( 1+r)
n



_
,

r - g
+
EPS
0
* Payout Ratio
n
* ( 1 + g )
n
* ( 1 + g
n
)
( r- g
n
)(1+ r)
n
P
0
BV
0
=
ROE* Payout Ratio*(1+ g) * 1
( 1+g)
n
( 1+r)
n



_
,
r - g
+
ROE
n
* Payout Ratio
n
* ( 1 +g)
n
* ( 1 +g
n
)
(r - g
n
)(1+r)
n





1
]
1
1
1
Aswath Damodaran 9
PBV Ratio for High Growth Firm: Example
n Assume that you have been asked to estimate the PBV ratio for a firm
which has the following characteristics:
High Growth Phase Stable Growth Phase
Length of Period 5 years Forever after year 5
Return on Equity 25% 15%
Payout Ratio 20% 60%
Growth Rate .80*.25=.20 .4*.15=.06
Beta 1.25 1.00
Cost of Equity 12.875% 11.50%
The riskfree rate is 6% and the risk premium used is 5.5%.
Aswath Damodaran 10
Estimating Price/Book Value Ratio
n The price/book value ratio for this firm is:
PBV =
0.25 * 0.2 * (1.20) * 1
(1.20)
5
(1.12875)
5



_
,
(.12875 - .20)
+
0.15 * 0.6 * (1.20)
5
* (1.06)
(.115 - .06) (1.12875)
5





1
]
1
1
1
= 2.66
Aswath Damodaran 11
PBV and ROE: The Key
PBV and ROE: Ri sk Scenar i os
0
0.5
1
1.5
2
2.5
3
3.5
4
10% 15% 20% 25% 30%
ROE
P
r
i
c
e
/
B
o
o
k

V
a
l
u
e

R
a
t
i
o
s
Bet a=0.5
Bet a=1
Bet a=1.5
Aswath Damodaran 12
PBV/ROE: Oil Companies
Company Name Ticker Symbol PBV ROE
Crown Cent. Petr.'A' CNPA 0.29 -14.60%
Giant Industries GI 0.54 7.47%
Harken Energy Corp. HEC 0.64 -5.83%
Getty Petroleum Mktg. GPM 0.95 6.26%
Pennzoil-Quaker State PZL 0.95 3.99%
Ashland Inc. ASH 1.13 10.27%
Shell Transport SC 1.45 13.41%
USX-Marathon Group MRO 1.59 13.42%
Lakehead Pipe Line LHP 1.72 13.28%
Amerada Hess AHC 1.77 16.69%
Tosco Corp. TOS 1.95 15.44%
Occidental Petroleum OXY 2.15 16.68%
Royal Dutch Petr. RD 2.33 13.41%
Murphy Oil Corp. MUR 2.40 14.49%
Texaco Inc. TX 2.44 13.77%
Phillips Petroleum P 2.64 17.92%
Chevron Corp. CHV 3.03 15.69%
Repsol-YPF ADR REP 3.24 13.43%
Unocal Corp. UCL 3.53 10.67%
Kerr-McGee Corp. KMG 3.59 28.88%
Exxon Mobil Corp. XOM 4.22 11.20%
BP Amoco ADR BPA 4.66 14.34%
Clayton Williams Energy CWEI 5.57 31.02%
Average 2.30 12.23%
Aswath Damodaran 13
PBV versus ROE regression
n Regressing PBV ratios against ROE for oil companies yields the
following regression:
PBV = 1.04 + 10.24 (ROE) R
2
= 49%
n For every 1% increase in ROE, the PBV ratio should increase by
0.1024.
Aswath Damodaran 14
Valuing Pemex
n Assume that you have been asked to value a PEMEX for the Mexican
Government; All you know is that it has earned a return on equity of
10% last year. The appropriate P/BV ratio can be estimated
P/BV Ratio (based upon regression) = 1.04 + 10.24 * 0.1 = 2.06
Aswath Damodaran 15
Looking for undervalued securities - PBV Ratios
and ROE
n Given the relationship between price-book value ratios and returns on
equity, it is not surprising to see firms which have high returns on
equity selling for well above book value and firms which have low
returns on equity selling at or below book value.
n The firms which should draw attention from investors are those which
provide mismatches of price-book value ratios and returns on equity -
low P/BV ratios and high ROE or high P/BV ratios and low ROE.
Aswath Damodaran 16
The Valuation Matrix
MV/BV
ROE-r
High ROE
High MV/BV
Low ROE
Low MV/BV
Overvalued
Low ROE
High MV/BV
Undervalued
High ROE
Low MV/BV
Aswath Damodaran 17
Large Market Cap Firms: PBV vs ROE: January 2001
ROE
.5 .4 .3 .2 .1 0.0
12
10
8
6
4
2
0
XOM
C
CSCO
WMT
INTC
AIG
BP
SBC
IBM
VZ
JNJ
RD
HD
TYC
MWD
NT
DT
JPM
PG
T
WFC
BLS
TXN
BAC
FNM
SC
ERICY
TEF
PHA
SNE
BTY
PEP
ABT
DIS
AXP
HWP
WCOM
LU
AVE
QCOM
BA
AEG
GS
PHG
ENE
CHV
STD
MC
BBV
DD
F
MOT
ONE
JDSU
SLB
MMM
FRE
DCX
WAG
FBF
ADP
HMC
HON
AMAT
BUD
KMB
TOC.TO
DNA
UTX
TX
EMR
UN
KRB
FTU
TGT
CPQ
MMC
AA
GM
ALL
SWY FITB
CAH
WM DUK
TMX
EDS
A BAX
HI
AES
SLR
AHO
FSR
MEL
FDC
USB
UL
BCE
CVS
DOW
BBDB.TO
FON
MU
BNS.TO
AT
REP
PNC HCA
Aswath Damodaran 18
Company Symbols
Company Name Ticker Symbol Company Name Ticker Symbol Company Name Ticker Symbol Company Name Ticker Symbol
Mat sushit a Elec. ADR MC Brit ish Telecom ADR BTY Merrill Lynch & Co. MER Int ' l Business Mach. IBM
Compaq Comput er CPQ Amer. Int ' l Group AIG Fannie Mae FNM Abbot t Labs. ABT
News Corp. Lt d. ADR NWS Chevron Corp. CHV Tyco Int ' l Lt d. TYC Morgan S. Dean Wit t er MWD
AT&T Corp. T AEGON Ins. Group AEG Amer. Express AXP Amgen AMGN
Schlumberger Lt d. SLB Sprint Corp. FON Corning Inc. GLW Dell Comput er DELL
Disney ( Walt ) DIS Boeing BA EMC Corp. EMC Amer. Home Product s AHP
Koninklij ke Philips NV PHG Hewlet t -Packard HWP Gen' l Elect ric GE Proct er & Gamble PG
Time Warner TWX Banco Bilbao Vis. ADR BBV Int el Corp. INTC Pf izer, Inc. PFE
Deut sche Telekom ADR DT Wells Fargo WFC Ford Mot or F Schering-Plough SGP
WorldCom Inc. WCOM Ericsson ADR ERICY BellSout h Corp. BLS Merck & Co. MRK
Mot orola, Inc. MOT Texas Inst rument s TXN Johnson & Johnson JNJ Brist ol-Myers Squibb BMY
Telef onica SA ADR TEF Micron Technology MU Lucent Technologies LU Philip Morris MO
Banco Sant ander ADR STD Bank of America BAC PepsiCo, Inc. PEP Lilly ( Eli) LLY
Sony Corp. ADR SNE Home Depot HD Cisco Syst ems CSCO Oracle Corp. ORCL
Exxon Mobil Corp. XOM McDonald' s Corp. MCD Goldman Sachs GS
Avent is ADR AVE SBC Communicat ions SBC Medt ronic, Inc. MDT
Enron Corp. ENE Wal-Mart St ores WMT Sun Microsyst ems SUNW
Pharmacia Corp. PHA Du Pont DD Applied Mat erials AMAT
Shell Transport SC Cit igroup Inc. C Schwab ( Charles) SCH
Royal Dut ch Pet r. RD Qualcomm Inc. QCOM Microsof t Corp. MSFT
DaimlerChrysler AG DCX Smit hKline Beecham SBH Nokia Corp. ADR NOK
BP Amoco ADR BPA Chase Manhat t an Corp. CMB Coca-Cola KO
Aswath Damodaran 19
PBV Matrix: Telecom Companies
TelAzt eca
TelNZ Vimple
Carlt on
Cable&W
Teleglobe FranceTel
Deut scheTel
Brit Tel
TelIt alia
AsiaSat Port ugal
HongKong
Royal BCE Hellenic
ChinaTel Nippon
Danmark
Espana
Indast
Televisas Telmex
TelArgFrance PhilTel
TelArgent ina
TelIndo
TelPeru
GrupoCent ro APT CallNet
Anonima
ROE
60 50 40 30 20 10 0
12
10
8
6
4
2
0
Aswath Damodaran 20
WABC
OV
NBAK
BWE
HU
PFGI
BOH
CBC
TRMK
SKYF
WL
VLY
CBH
CFR
FULT
FVB
CYN
MRBK
CBSS
BPOP
FSCO
UB
ZION
UPC
SOTR
RGBK
SNV
ASO
KEY
BBT
WB
PNC
STI
MEL
FTU
FBF
CMB
WFC
BAC
1.25
2.50
3.75
5.00
0.12 0.16 0.20 0.24
ROE
P
B
V
U.S. Banks: Market Cap > $ 1 billion
Aswath Damodaran 21
Company Name Ticker Symbol Company Name Ticker Symbol Company Name Ticker Symbol
West america Bancorp WABC Fult on Fin' l FULT Regions Financial RGBK
Keyst one Fin' l KSTN First Va. Banks FVB Synovus Financial SNV
Colonial BncGrp. ' A' CNB Cit y Nat ional Corp. CYN AmSout h Bancorp. ASO
One Valley Bancorp OV Hibernia Corp. ` A' HIB KeyCorp KEY
Nat ional BanCorp. of Alaska,In NBAK Silicon Valley Bncsh SIVB BB&T Corp. BBT
BancWest Corp. BWE Mercant ile Bankshares MRBK Wachovia Corp. WB
Hudson Unit ed Bancorp HU Compass Bancshares CBSS PNC Financial Serv. PNC
Provident Finl Group PFGI Popular Inc BPOP SunTrust Banks STI
Pacif ic Cent ury Fin' l BOH First Securit y FSCO St at e St reet Corp. STT
Cent ura Banks CBC No. Fork Bancorp NFB Mellon Financial Corp. MEL
Trust mark Corp. TRMK Nat l Commerce Bancrp NCBC Morgan ( J.P.) & Co JPM
Sky Finl Group Inc SKYF UnionBancal Corp UB First Union Corp. FTU
Wilmingt on Trust WL M&T Bank Corp. MTB Fleet Bost on Fin' l FBF
Valley Nat l Bancp NJ VLY Zions Bancorp. ZION Bank of New York BK
Commerce Bancorp NJ CBH Union Plant ers UPC Chase Manhat t an Corp. CMB
Cullen/ Frost Bankers CFR Sout hTrust Corp. SOTR Wells Fargo WFC
Summit Bancorp SUB Bank of America BAC
Aswath Damodaran 22
IBM: The Rise and Fall and Rise Again
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year
P
r
i
c
e

t
o

B
o
o
k
-40.00%
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
R
e
t
u
r
n

o
n

E
q
u
i
t
y
PBV ROE
Aswath Damodaran 23
PBV Ratio Regression
Model Summar y
.686
a
.470 .469 167.8482
Model
1
R R Square
Adjust ed R
Square
St d. Error of
t he Est imat e
Predict ors: ( Const ant ) , Bet a, ROE1, Expect ed Growt h in
EPS: next 5 y
a.
Coef f i ci ent s
a, b
2.719 .199 13.678 .000
6.325E-02 .008 .159 8.302 .000
9.656 .253 .667 38.183 .000
-1.438 .183 -.150 -7.862 .000
( Const ant )
Expect ed Growt h
in EPS: next 5 y
ROE1
Bet a
Model
1
B St d. Er r or
Unst andardized
Coef f icient s
Bet a
St andar
dized
Coef f icient s
t Sig.
Dependent Variable: PBV Rat io a.
Weight ed Least Squares Regression - Weight ed by Market Cap
b.
Aswath Damodaran 24
PBV Ratio Regression: Brazil - September 2000
n Regressing PBV against ROE for 177 Brazilian firms (The betas are
missing for a lot of firms and meaningless for the rest, and there are no
expected growth rate estimates over the long term)
PBV = 0.77 + 3.78 (ROE) R squared = 17.3%
n To run this regression, we used
Only firms with positive returns on equity
Only firms with positive book values of equity
Aswath Damodaran 25
Cross Sectional Regression for Greece: May 2001
Coef f i ci ent s
a
2.106 .280 7.531 .000
11.631 1.535 .418 7.579 .000
( Const ant )
ROE
Model
1
B St d. Er r or
Unst andardized
Coef f icient s
Bet a
St andar
dized
Coef f icient s
t Sig.
Dependent Variable: PBV
a.
R squared = 22%
Number of firms in sample = 272
Aswath Damodaran 26
Value/Book Value Ratio: Definition
n While the price to book ratio is a equity multiple, both the market
value and the book value can be stated in terms of the firm.
n Value/Book Value = Market Value of Equity + Market Value of Debt
Book Value of Equity + Book Value of Debt
Aswath Damodaran 27
Value/Book Ratio: Description
Value/ BV of Capit al
1400
1200
1000
800
600
400
200
0
St d. Dev = 2.63
Mean = 2.53
N = 4813.00
Aswath Damodaran 28
Determinants of Value/Book Ratios
n To see the determinants of the value/book ratio, consider the simple
free cash flow to the firm model:
n Dividing both sides by the book value, we get:
n If we replace, FCFF = EBIT(1-t) - (g/ROC) EBIT(1-t),we get
V
0
=
FCFF
1

WACC- g

V
0
BV
=
FCFF
1
/BV
WACC- g

V
0
BV
=
ROC - g
WACC- g

Aswath Damodaran 29
Value/Book Ratio: An Example
n Consider a stable growth firm with the following characteristics:
Return on Capital = 12%
Cost of Capital = 10%
Expected Growth = 5%
n The value/BV ratio for this firm can be estimated as follows:
Value/BV = (.12 - .05)/(.10 - .05) = 1.40
n The effects of ROC on growth will increase if the firm has a high
growth phase, but the basic determinants will remain unchanged.
Aswath Damodaran 30
Value/Book and the Return Spread
Val ue/ BV Rat i os and Ret ur n Spr eads
-
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
-
2
%
-
1
%
0
%
1
%
2
%
3
%
4
%
5
%
6
%
7
%
8
%
9
%
1
0
%
ROC - WACC
V
a
l
u
e
/
B
V

R
a
t
i
o
WACC=8%
WACC=10%
WACC=12%

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