Let’s Learn Stock Valuation With Various Methods

3. Stock Valuation with Market Ratios Method

Another approach to calculating stock valuations is to use Market Ratios, namely Price to Book Value (PBV), Liquidation Value and Price/Earnings Multiple.

Let’s peel them off one by one:

3.1. Price to Book Value (PBV)

Book value per share is the value that shareholders will acquire (common stock) if the Company’s assets are sold at exactly the same price as its book value (the value listed on the balance sheet), after all liabilities (liabilities, including preferred stock) of the company are paid.

Book Value per share is defined as follows:

While Price to Book Value (PBV) is obtained by dividing the market price of the company’s shares (Market price) with its Book Value per share.

Common Stock Equity can be obtained from The Balance Sheet, or it can be obtained by subtracting the value of Total Assets with Total Liabilities and Preferred Stock

Example:

From the Company Balance Sheet “danieel.id Bersaudara” in 2020 known the following data:

• • • Total Assets = Rp 4.51 trillion,
    • Total Liabilities = Rp 2.25 trillion
    • Preferred Stock = Rp 300 Billion
    • Number of shares of common stock outstanding is 600 million shares

So the Book value per share of the Company “danieel.id Bersaudara” is:

(Rp 4.510.000.000.000 – Rp 2.250.000.000.000 – Rp 300.000.000.000) / 600.000.000 

= Rp 3.267 per share

If the stock market price of the Company “danieel.id Bersaudara” at that time was Rp 4,125 per share

Then The Price to Book Value (PBV) is Rp 4,125 / Rp 3,267 = 1.26

This could mean the market valuing the Company’s “danieel.id Bersaudara” more than its book value.

A company that is healthy and has good business prospects, usually has a valuation that is higher than its book value.

Investors will assess the company’s price from more than just a pile of assets, but the value of the business and the prospects for profits that can be generated by the company in the future.

Like if you buy a restaurant business, for example, 

If the restaurant already has a good brand and reputation, the cuisine is famously good, the number of customers continues to grow. 

Then the valuation of the restaurant if sold will certainly be more than just the price of pots, stoves, plates and all the assets of the restaurant minus its debt.

Vice versa, the Price to Book Value (PBV) of a company can be worth less than 1. 

If the company is reviewed from its financial statements it is not in good condition, its growth is negative, or an investor assesses that its assets are overvalued or its liabilities are understated.

The company’s price to book value (PBV) is also an indicator of whether the company’s stock price is expensive or cheap.

The greater the value, the more expensive the company’s shares, and vice versa.

To make the assessment of the ratio more meaningful, it can also be compared to The Price to Book Value (PBV) of similar companies.  

3.2 Liquidation Value

Liquidation value per share is the actual value per common stock if all of the company’s assets are sold at market value, after all liabilities (including preferred stock) of the company are met.

Here the key point of difference with book value is the assumption of the selling price of the company’s assets. 

In Liquidation value, the value of the asset is adjusted to the price to be absorbed by the market (which could be lower than the book price).

This approach is considered more realistic than book value, because it estimates the actual value that shareholders will receive if the company is liquidated.

Example :

Continuing the case example in the book value discussion earlier,

After re-valuation, from the Total Assets listed on The Balance Sheet of the company “danieel.id Bersaudara” amounting to Rp 4.51 trillion. If it is sold, it will only be obtained a sales value of 4.3 trillion.

The liquidation value per share is:

(Rp 4.300.000.000.000 – Rp 2.250.000.000.000 – Rp 300.000.000.000) / 600.000.000 

= Rp 2.917 per share

This value is smaller than the book value per share.

Liquidation value is the minimum value (price) of a Company. 

If a company’s valuation (derived from one of the other methods, for example from the constant growth dividend model, free cash flow valuation model, or multiple price earnings) is smaller than liquidation value, then the company can be said to be in a condition “worth more dead than alive“.

In these conditions the Company does not have sufficient power to generate profit to justify its existence, and may be considered for liquidation.

3.3. Price / Earnings (P/E) Multiples

Price Earnings Ratio (PER) reflects the price that investors are willing to pay against every dollar of profit (earnings) earned by the Company.

The Price Earnings Ratio is formulated as follows:

Meanwhile, the earnings per share (EPS) formula is as follows:

Example

From the Company’s Income Statement “danieel.id Bersaudara” in 2020 is known

• • • Earnings available for common stockholders = Rp 345 billion,
    • Number of shares of common stock outstanding is 600 million shares

So the earnings per share of the Company “danieel.id Bersaudara” is

Rp Rp 345.000.000.000) / 600.000.000 = Rp 575 per share

If the stock market price of the Company “danieel.id Bersaudara” at that time was Rp 4,125 per share

Then the Price Earnings Ratio (PER) is Rp 4,125 / Rp 575 = 7.2

Like the Price to Book Value (PBV), a company’s Price Earnings Ratio (PER) is also an indicator of whether the company’s stock price is expensive or cheap.

The greater the value, the more expensive the company’s shares, and vice versa.

Just like Price to Book Value (PBV), to make this assessment of the Price/Earnings ratio more meaningful, it can also be compared to the Price Earnings Ratio (PER) of similar industries.

This ratio can also be used as a multiple factor, to estimate the valuation of a company that has not entered the stock exchange market, by multiplying its earnings / net profit after taxes (NOPAT) by the average price earnings ratio (PER) of similar industries.

example case:

This time we suppose the Imaginer Company “danieel.id Bersaudara” engaged in textile, garment just entered the Stock Exchange Market (IPO). So that the company’s historical data available is still limited.

Fulan, an investor considers buying shares of this company, and analyzes its stock valuation based on the market ratio of similar industries.

Based on the latest available “danieel.id Bersaudara” financial statements, forecasts of future “textile” business conditions, economic growth and other factors, Fulan estimates that the Company can generate earnings per share of Rp 575 in the following years.

From the official website of The Indonesia Stock Exchange, Fulan obtained updated data on the average Price Earnings Ratio (PER) of the textile industry of 7,18

Based on this data, the valuation of “danieel.id Bersaudara” shares is:

Stock valuation = (expected) earnings per share x PER Similar industries

= Rp 575 per share x 7,18 =  Rp 4.129  

How to Obtain PBV and PER Industry Data

We can download the price to book value (PBV) and price earnings ratio (PER) data of companies listed on the Indonesia Stock Exchange on the official website of PT Bursa Efek Indonesia (https://www.idx.co.id/)

The following methods:

On the Website of PT Bursa Efek Indonesia, go to the menu “MARKET DATA“, then to the menu “Statistics“, as the picture below:

Then choose the desired period, whether daily, weekly, monthly, quarterly or yearly..

In this example I will download yearly period statistics (2020).

Dari berkas (pdf) yang di download, kita cari bagian “Financial Data & Ratios“. 

There is a table that presents Price to Book Value (PBV) and Price Earnings Ratio (PER) data both individually per company, and industry average.

please find an example for the type of Industrial Agriculture in the picture below:

From the picture above, we can see, the average Price to Book Value (PBV) of Agriculture Industry companies listed on the Indonesia Stock Exchange in 2020 is 1.31, 

And the average Price Earnings Ratio (PER) of the industry is 20.

You can search for PBV and other Industry type PER data on the data from the website of PT Bursa Efek Indonesia.  

Closing

Thus our discussion about sharing methods to do the valuation of the Company’s shares.

So, which method should be chosen?

There’s no right answer to this.  

How accurately we estimate the valuation of a company’s shares depends on the assumptions used and the completeness of the available data.

If the available data is quite a lot, it’s a good thing to use more than one valuation method to then compare.

For example, after using the constant growth method of dividends, we compare it with valuation techniques using free cash flow. Then we also compare the fairness of the valuation value obtained from these two methods with the market ratio of similar industries.

If you have any questions or suggestions, please submit them in the comments section below.

I hope this article is useful.  

Source :

• Lawrence J Gitman & Chad J.Zutter, “Principles of Managerial Finance” 13^th Edition
• Investopedia.com

This post is also available in: Indonesian