Hi everyone, as we discussed there are several common or widely used simple or basic valuation models, such as Price to Earnings or P/E, Price to Book or P/B, Price to Sales or P/S and Enterprise Value to EBITDA Multiple. Throughout this video will focus on the Price to Earnings or P/E valuation model. Price to Earnings valuation model is frequently used for mature companies who have a consistent track record of generating stable levels of earnings per share. The price to earnings ratio is calculated by dividing a company's share price by their earnings per share. However, if amounts are not on a per share basis, you will need to convert them to a per share basis or simply divide their market value by their net income obtained from the income statement. Both methods will yield the same result. It just that one is on a per share basis and the other is on a whole dollar basis. We'll use five steps to calculate our target company's valuation. Step 1, select the summary performance measure to use as the valuation basis. Step 2, select the comparable companies to determine the market multiple. Step 3, calculate the market multiple. And Step 4, compute the target company's value using its performance measure, and the market multiple from Step 3. And finally, Step 5, calculate the equity value per share. For example purposes, we'll go through each of the five steps to execute the priced to earnings valuation model. And step one, I've selected Walmart, as our target company. Since we selected the P/E model, earnings per share, or the earnings component in the P/E model, we'll be the summary performance metric. In Step 2, we need to select comparable or peer companies. Walmart operates in the retail industry, with a combination of brick and mortar and online sales. Target and Costco have similar go to market approaches. And also operate in the retail industry. As such, we've selected them as our peer companies. And Step 3, we obtained the applicable data for Target and Costco to calculate their price earnings ratios. For simplicity, you can log into Yahoo Finance and obtain this information. Alternatively, you can also access this data using each company's 10k. I obtained the current share price and earnings per share for both Target and Costco from Yahoo Finance and calculated their price to earnings ratio. By dividing their share price by their earnings per share, for Target their P/E is 18.82 and Costco is 35.76. You'll notice there's a wide range for our peer companies. This is one of the limitations of using the simpler basic valuation model. Those two companies are exactly alike and their valuations can vary widely. In order to take out some of the volatility, we calculate the simple average for the peer companies. The average of Target and Costco P/E is 27.29. In Step 4, we use the P/E ratio average for the peer companies and multiply by the forecasted earnings per share for Walmart. It's important to note, the valuations are based upon the future earnings outlook. For example, you may notice that sometimes a company may report a blowout quarter. But lower their future forecast. And the result is usually a hit or reduction to their share price as valuations are based upon future performance, not historical results. In order to calculate Walmart's equity value per share using the P/E model. We multiply Walmart's EPS forecast of $4.32 by the comparable market multiple average for the peer companies selected of 27.29. This means that Walmart's estimated equity value per share equals 117.89, using the PE model. Now, if we compare our calculated equity value per share for Walmart using the P/E model, versus the current share price as of June the 17th, 2021. You'll notice that this approach indicates that Walmart is overvalued, it's important that investors do not overreact based upon this simplistic analysis. It should be used as one of many data points when making investment decisions. It's also important to know that the P/E ratio should only be used as evaluation model for companies who have positive earnings per share. Negative earnings per share would yield a negative share price, which is not relevant. And finally in Step 5, we calculate the equity value per share. However, since the P/E model is already based upon share price, we've already calculated the equity value per share and do not need to execute any other steps. And other examples such as enterprise value to EBITDA, step five will be necessary. As the EVE to EBITDA model calculates enterprise value and will need to subtract intrinsic debt to compute the equity value per share.
