market-to-book patterns and the logic of valuation (in a not always logical world ) by carlos de...
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Market-to-Book Patterns and the Market-to-Book Patterns and the Logic of Valuation Logic of Valuation
(in a not always logical world(in a not always logical world))
byby Carlos De Mello e Souza Carlos De Mello e Souza
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Stocks have reached what looks like a permanently high plateau. ~ Irving Fisher, 1929 ~
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Measuring value
• Method 1: discounted cash flow model
1 1
t
e
e tt
FCFEVr
Where:
e M ff er r rr
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Measuring value
• Method 2: residual income model (RIM)
1
0
1 1
t e t
e
e tt
NI BErV BEr
Note that:
1 1 t t t e teNI BE ROE r BEr
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Measuring value
• Method 2: residual income
1
0 1
11
t e t
e
et
t
NI BEV rBE r
Note that:
1 1 t t t e teNI BE ROE r BEr
PB ratio
Zero expected RI “Perfect Accounting”
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Value drivers (Advanced Dupont):
ROEROE
pmpm atoato
ROAROA
D/SED/SE spread
leverageleverage
cogscogs
sg&asg&a
tax, etc...tax, etc...
surplussurplus
NWKNWK
NLTANLTA
ROAROA
- rd- rd
x x
+
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Market-to-Book Ratio (PB)
• With constant ROE and growth:
1
e
e
ROE rPB
r gre ROE g PB
10% 20% 5% 3.0
9% 15% 7.5% 5.0
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Price-to-Earnings Ratio (PE)
0
001
11
1
e t
e e
tt
r RI DPE
r NINIr
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Price-to-Earnings Ratio (PE)
0
001
11
1
e t
e e
tt
r RI DPE
r NINIr
• With zero growth:
0
0
1 e
e
r DPE
r NI
constant RI ∆RIt=0 (no growth!)
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Price-to-Earnings Ratio (PE)
0
001
11
1
e t
e e
tt
r RI DPE
r NINIr
• With re=10%, small dividend:
0
0
111
e
e
r DPE
r NI
constant RI ∆RIt=0 (no growth!)
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PB, PE and ROE:PB ROE PE
VALUE GROWTHPROFITABILITY
Value is driven by profitability and growth.
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NEXT:
How market returns to equity (and the ratios that explain these returns) behaved over the last 40 years (1969-2009).
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Holding Period Returns: 1970-2009
-1.0
-.5
.0
.5
1.0
1.5
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
Holding period returns
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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All Companies (aggregate figures, except holding returns)
.0
.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1970
1975
1980
1985
1990
1995
2000
2005
PB rat
io
(.60)
(.40)
(.20)
.00
.20
.40
.60
RO
E, M
kt.
Ret
urn
PB ROE Mkt. Return
PB, ROE, ex-post market returns
(**) Aggregate for all U.S. companies on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Price to Earnings Ratios: 1970-2009
.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
PE
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Evolution of PE Ratios By Industry: 1970-2009
-50.0
.0
50.0
100.0
150.0
200.0
1970
1975
1980
1985
1990
1995
2000
2005
PB rat
io
2 3 4 5 7
PE by Industry (1-digit SIC codes)
(**) Aggregate for all U.S. companies on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Price to Book Ratios: 1970-2009
.0
.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
PB
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Evolution of PB Ratios By Industry: 1970-2009
2
3
4
5
7
.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
1970
1975
1980
1985
1990
1995
2000
2005
PB rat
io
2 3 4 5 7
PB by Industry (1-digit SIC codes)
(**) Aggregate for all U.S. companies on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Sales Growth: 1970-2009
-.30
-.20
-.10
.00
.10
.20
.30
.40
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
Growth (sales)
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Return on Common Equity: 1970-2009
-.50
-.40
-.30
-.20
-.10
.00
.10
.20
.30
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
ROE
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Return on Assets: 1970-2009
-.50
-.40
-.30
-.20
-.10
.00
.10
.20
.30
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
ROA
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Asset Turnover: 1970-2009
.0
.5
1.0
1.5
2.0
2.5
3.0
3.5
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
ATO (Asset Turnover)
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Profit Margin on Sales: 1970-2009
-.35
-.30
-.25
-.20
-.15
-.10
-.05
.00
.05
.10
.15
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
PM (Profit Margin on Sales)
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Gross Margin: 1970-2009
.00
.10
.20
.30
.40
.50
.60
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
Gross Margin
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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Operating Margin: 1970-2009
-.05
.00
.05
.10
.15
.20
1970
1975
1980
1985
1990
1995
2000
2005
Q1 Median Q3
Operating Margin
(*) U.S. companies with data on COMPUSTAT, except financial intermediaries and SIC codes 9xxx.
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RNOA Decomposition (1979)
2
3
5
7
4
.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
.0 1.0 2.0 3.0 4.0
Asset Turnover
Pro
fit M
argi
n o
n S
ales
(%)
RNOA = PM x ATO (Year: 1979)
(**) Aggregates per 1-digit SIC (U.S. companies on COMPUSTAT, except financial intermediaries and SIC codes 9xxx).
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RNOA Decomposition (1989)
2
3
57
4
.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
.0 1.0 2.0 3.0 4.0
Asset Turnover
Pro
fit M
argi
n o
n S
ales
(%)
RNOA = PM x ATO (Year: 1989)
(**) Aggregates per 1-digit SIC (U.S. companies on COMPUSTAT, except financial intermediaries and SIC codes 9xxx).
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RNOA Decomposition (1999)
2
3
5
7
4
.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
.0 .5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Asset Turnover
Pro
fit M
argi
n o
n S
ales
(%)
RNOA = PM x ATO (Year: 1999)
(**) Aggregates per 1-digit SIC (U.S. companies on COMPUSTAT, except financial intermediaries and SIC codes 9xxx).
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RNOA Decomposition (2009)
23
5
7
4
.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
.0 .5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Asset Turnover
Pro
fit M
argi
n o
n S
ales
(%)
RNOA = PM x ATO (Year: 2009)
(**) Aggregates per 1-digit SIC (U.S. companies on COMPUSTAT, except financial intermediaries and SIC codes 9xxx).
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The amazing PB “effect” (Year: 1969)
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The amazing PB “effect” (Year: 2000)
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The amazing PB “effect” (Year: 2004)
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The amazing PB “effect” (Year: 2008)
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Valuation Ratios
Chevron MCD
COST
Earthlink
Expeditors
Sunlink Health
Integrated Security
Echostar
Briggs & Stratton
China Media
WMT
Biodelivery
NFLX
Colgate
Avon
BA
Riti Biologistics
0
5
10
15
20
25
30
35
40
.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5 20.0
PB Ratio
PE R
atio
Investment Strategies (Year: 2009)
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Valuation Ratios
Chevron MCD
COST
Earthlink
Expeditors
Sunlink Health
Integrated Security
Echostar
Briggs & Stratton
China Media
WMT
Biodelivery
NFLX
Colgate
Avon
BA
Riti Biologistics
0
5
10
15
20
25
30
35
40
.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5 20.0
PB Ratio
PE R
atio
GLAMOUR
HARVESTER
TURNAROUND
VALUE
Investment Strategies (Year: 2009)
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Les chiffres sont des éléments que l'homme, sous l'effet de la torture, fait dire tout ce qu'il veut."~ Leonardo Da Vinci ~