Workspace /D2 Justified Multiples
D2

Justified Multiples

Derive the P/E, P/B and P/S a company's fundamentals support, set each against the market, and test a predicted P/E and a terminal multiple.

Learning focus: A multiple is a compressed valuation model, so every multiple carries a view on payout, growth and risk that you can bring into the open.

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Fundamentals

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Predicted P/E
Terminal value from a multiple
yrs
×

Ostrell Industries's growth of 3.50% is below the sample's 4.63% to 6.86%; payout of 78.54% is above the sample's 34.10% to 58.00%; beta of 0.90 is below the sample's 0.97 to 1.31. A fitted line need not hold outside the data behind it, so treat the predicted P/E with caution. The peers' growth is expected earnings growth, which can run well above a long-run rate.

Justified leading P/E
17.45×
Market leading P/E
16.47×
Leading P/E verdict
Undervalued
market 5.6% below justified
Justified trailing P/E
18.07×
Market trailing P/E
17.05×
Trailing P/E verdict
Undervalued
market 5.6% below justified
Justified P/B
2.99×
Market P/B
2.89×
P/B verdict
Undervalued
market 3.5% below justified
Justified P/S
1.61×
Market P/S
1.51×
P/S verdict
Undervalued
market 5.8% below justified
PEG
4.71
market leading P/E over growth

How much of a P/E rests on growth still to come is the idea of PVGO, which the C1 DDM Lab works through.

Justified P/E as growth varies

Payout and the required return stay fixed along the line. The curve steepens as growth nears the required return, so the upper end stops short of it.

Predicted P/E
Predicted P/E
20.51×
Predicted P/E verdict
Undervalued
market 16.9% below predicted
Inputs outside the sample range
Growth, Payout, Beta
Intercept
13.281
t = 1.68
Growth coefficient
1.243
t = 3.10
Payout coefficient
0.116
t = 1.81
Beta coefficient
−6.952
t = −1.45
R²
0.955
Peers in the sample
6
Industrials
Growth sample range
4.63% to 6.86%
Payout sample range
34.10% to 58.00%
Beta sample range
0.97 to 1.31
Beta
0.90
PeerGrowthPayoutBetaP/E
Halvorne Engineering4.63%34.1%1.2513.47×
Brackwater Tools6.78%58.0%0.9721.58×
Selwick Controls6.86%35.6%1.0718.36×
Dunmarrow Industries6.74%47.3%1.1718.87×
Corwen Hydraulics4.63%41.2%1.1116.88×
Pellmark Industrial6.48%34.1%1.3116.71×

Six peers and three inputs leave only two degrees of freedom, so a high R² says less than it seems to, and a coefficient can take the wrong sign.

Terminal value from a multiple
Terminal value
$46.50
at the end of year 5
Present value of terminal value
$31.65
Horizon EPS
$3.10
year 5
Growth the multiple implies
2.63%
long-run growth 3.50%
Implied less long-run growth
−0.87 points
the multiple asks for less
Figures in use
Payout ratio
78.54%
Growth
3.50%
Required return
8.00%
ROE
16.96%
Net margin
8.89%
Latest EPS
$2.61
Next year's EPS
$2.70
Book value per share
$15.41
Sales per share
$29.41
Price
$44.50

Ostrell Industries's market trailing P/E of 17.05× is below the 18.07× these fundamentals justify. The predicted P/E of 20.51× is what the equation gives for its growth, payout and beta, and the market is below it. A trailing terminal multiple of 15.00× needs growth of 2.63% forever, below the 3.50% input. A gap is a question about the inputs before it is a view on the price.