Equity Valuation【Reading 41】Sample average, selling, industry

anshultongia

Shares of TKR Construction (TKR) are selling for $50. Earnings for the last 12 months were $4.00 per share. The average trailing P/E ratio for firms in TKR’s industry is 15. The appropriate WACC is 12%, and the risk-free rate is 8%. Assume a growth rate of 0%. Using the method of comparables, what price is indicated for TKR?

A) $33.33.

B) $50.00.

C) $60.00.

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Using the method of comparables, TKR should be priced as (15 × 4) = $60.00.

luckygiftvn

An analyst is preparing a presentation on “Interpreting PE ratios” and has the following data:

	Portfolio %	Stock PE
Stock AAA	60%	10
Stock BBB	40%	15

Which of the following is closest to the weighted harmonic mean of these two PE ratios?

A) 12.49.

B) 11.98.

C) 11.54.

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The weighted harmonic mean of the two PE ratios is a harmonic mean which is weighted by the portfolio weights.
1/[(0.60 × 1/10) + (0.40 × 1/15)] = 11.54

luckygiftvn

An analyst is calculating the weighted harmonic mean P/E ratio of a 2-stock portfolio. Stocks AAA and BBB have prices of $12 and $15, respectively, and EPS of $1 and $2, respectively. Which of the following is the weighted harmonic mean P/E of the portfolio closest to?

A) 9.00

B) 9.23

C) 9.75

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The weighted harmonic mean is 1/[(12/27)(1/12) + (15/27)(2/15)] = 27/3 = 9.00 The weighted harmonic mean of the individual stocks P/Es is the best measure of the P/E for a portfolio of stocks.

luckygiftvn

An analyst is preparing a presentation on “Interpreting PE ratios” and has the following data:

	Portfolio %	Stock PE
Stock AAA	60%	10
Stock BBB	40%	15

Which of the following is the most appropriate measure for calculating the portfolio P/E?

A) Geometric mean of the P/E’s.

B) Arithmetic average of the P/E’s.

C) Weighted harmonic mean of the P/E’s.

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The weighted harmonic mean of the 10 and 15 will give the result closest to the portfolio earnings divided by the portfolio value.

luckygiftvn

Herb McClain tells Cammy Oren that Kline Industries’ expected dividend growth rate is 4.0%, ROE is 14%, and required return on equity (r) is 10%. Based on a justified P/B ratio compared to a P/B ratio (based on market price per share) of 1.55, Kline Industries is most likely:

A) undervalued.

B) overvalued.

C) correctly valued.

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Justified P/B = (ROE − g) / (r − g). When the expected dividend growth is 4.0%, the justified P/B = (0.14 − 0.04) / (0.10 − 0.04) = 1.67. This is greater than the P/B (at market) of 1.55.

luckygiftvn

Leslie Singer comments to Robert Chan that Dreamtime Industries’ expected dividend growth rate is 5.0%, ROE is 14%, and required return on equity (r) is 10%. Based on a justified P/B ratio compared to a P/B ratio (based on market price per share) of 1.60, Dreamtime Industries is most likely:

A) overvalued.

B) undervalued.

C) correctly valued.

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Justified P/B = (ROE − g) / (r − g). When the expected dividend growth is 5.0%, the justified P/B = (0.14 − 0.05) / (0.10 − 0.05) = 1.80. This is greater than the market P/B of 1.60.

luckygiftvn

At a CFA society function, Robert Chan comments to Li Chiao that Xanedu Industries’ expected dividend growth rate is 5.5%, dividend payout ratio (g) is 40%, and required return on equity (r) is 12%. Based on a justified leading P/E ratio compared to a market P/E ratio of 8.0, Xanedu Industries is most likely:

A) undervalued.

B) overvalued.

C) correctly valued.

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Justified Leading P/E = payout ratio / (r − g). When the expected dividend growth is 5.5%, the justified leading P/E = 0.40 / (0.12 − 0.055) = 6.15. This is less than the market P/E of 8.0.

luckygiftvn

Robert Chan comments to Leslie Singer that Converted Industries’ expected dividend growth rate is 5.0%, dividend payout ratio (g) is 45%, and required return on equity (r) is 10%. Based on a justified trailing P/E ratio compared to the stock's trailing P/E ratio at market of 9.0, Converted Industries is most likely:

A) overvalued.

B) correctly valued.

C) undervalued.

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Justified trailing P/E = payout ratio * (1 + g) / (r − g). When the expected dividend growth is 5.0%, the justified trailing P/E = 0.45 * (1 + 0.05) / (0.10 − 0.05) = 9.45. This is greater than the market P/E of 9.0.

luckygiftvn

In interpreting the standardized unexpected earnings (SUE) momentum measure, it can be concluded that a given size forecast error is:

A) scaled by the earnings surprise.

B) more meaningful the smaller the historical size of forecast errors.

C) more meaningful the larger the historical size of forecast errors.

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A given size forecast error is more (less) meaningful the smaller (larger) the historical size of forecast errors.

luckygiftvn

Which of the following is NOT a common momentum valuation indicator?

A) Earnings surprise.

B) Dividend yield.

C) Relative strength.

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Dividend yield is not generally considered a momentum valuation indicator.