Stock Valuation
Principles of Finance
Show how to value stocks using multiples - Chapter 5
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Stock Valuation Using Multiples
One challenge with valuing stocks based on dividends is that many companies don't pay them. If a company is profitable, you
can use the price-to-earnings (P/E) ratio. This ratio compares the stock's price per share to its earnings per share (EPS) over the
past year.
Price-Earnings (P/E) Ratio
The idea is to have some sort of benchmark PE ratio, which we then multiply by earnings to come up with a price. The benchmark
PE ratio could come from a variety of sources (for example, based on similar companies, based on a company's own historical
values). A PE ratio based on estimated future earnings is a forward PE ratio.
Jarir Bookstore's EPS Industry Benchmark P/E Ratio
4 SAR 15
Formula Calculation
Price-Sales (P/S) Ratio
The Price-Sales (P/S) Ratio is a valuation multiple that compares a company's market capitalization (its total equity value) to its
annual revenue. It gives you a sense of how much investors are willing to pay for every SAR 1 of sales generated by the company.
1 Ninja Delivery App's Sales per Share 2 Industry Benchmark P/S Ratio
10 SAR Jahiz P/S = 2
3 Formula 4 Calculation
Higher P/S Ratio: A higher P/S ratio suggests that investors are paying more for each SAR 1 of sales, indicating higher
expectations for future growth, strong brand value, or a competitive market position.
Lower P/S Ratio: A lower P/S ratio suggests that investors are paying less for each SAR 1 of sales, implying lower growth
potential or higher risk.
EV/EBITDA Ratio
Some companies do not pay dividends nor are they profitable. In this case, use the price-sales ratio, calculated as the price per
share on the stock divided by sales per share, or the EV/EBITDA ratio.
EV: Enterprise Value represents the total market value of a company, including equity and debt. It provides a broader picture of
a company's worth than market capitalization alone.
EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization measures a company's operating performance,
excluding certain non-operating expenses. It allows for comparison of profitability across industries and capital structures.
Maaden's EBITDA Industry Benchmark EV/EBITDA Ratio
500 million SAR 8
Formula Calculation
Sustainable Growth Rate
The Sustainable Growth Rate (SGR) is the maximum rate at which a company can grow its sales, earnings, and dividends without
needing to raise additional capital. It represents the growth rate that can be achieved while maintaining the company’s current
financial structure and risk profile.
The SGR can be calculated using the following formula:
Where:
ROE measures a company’s profitability in relation to shareholders’ equity. It indicates how effectively a company uses its
equity base to generate profits
The retention ratio, often denoted as (b), is the fraction of net income that is retained in the company instead of being paid out
as dividends.
Sustainble Growth Key Components:
1 Retention Ratio (b) 2 Return on Equity (ROE)
The retention ratio is the percentage of earnings kept ROE measures how effectively a company uses
by a company instead of paying out dividends. A higher shareholder's equity to generate profits. A higher ROE
retention ratio means more money is reinvested for indicates more efficient use of equity.
growth.
Key Takeaways
EV/EBITDA Ratio Sustainable Growth Rate
The EV/EBITDA ratio is an important metric to consider when The sustainable growth rate provides insight into a company's
valuing a company. A higher EV/EBITDA ratio indicates that the long-term growth potential. It represents the maximum rate at
market is willing to pay a premium for the company's future which a company can grow without needing to raise
earnings potential. additional capital.