Explain momentum indicators and how they are used in valuation
The idea
Momentum indicators relate a price or a fundamental to its own history or to expectations, on the premise that trends persist. Unexpected earnings, or earnings surprise, is reported EPS less expected EPS, and dividing it by the standard deviation of analysts' forecasts gives a scaled earnings surprise. Standardised unexpected earnings, SUE, divides the surprise by the standard deviation of past surprises, so a given surprise counts for more at a company whose results are usually predictable. Relative strength compares a share's return with its own past or with a benchmark over a period. Although not grounded in valuation theory, these indicators are widely used to screen shares. The trap is comparing raw surprises across companies whose earnings differ greatly in volatility.
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- Contrast comparables with forecasted fundamentals as ways of applying price multiples when valuing, and set out the economic logic behind each
- Work out a justified price multiple and explain what it means
- Set out why one might value a stock with dividend yield or alternative price multiples and what can go wrong
- Work out dividend yield and alternative price multiples and explain what they mean
- Work out underlying earnings and explain them, set out ways to normalise earnings per share (EPS), and compute normalised EPS
- Explain earnings yield (E/P) and argue for its use
- Set out the fundamentals that drive dividend yield and alternative price multiples
- Use a cross-sectional regression on fundamentals to predict a P/E, explain the result, and explain where such regressions fall short
- From forecasted fundamentals, work out a stock's justified price-to-earnings (P/E), price-to-book (P/B) and price-to-sales (P/S) ratios and explain them
- Work out the PEG (P/E-to-growth) ratio, explain what it means and how it is used in relative valuation
- Work out terminal value for a DCF (discounted cash flow) model with several stages from price multiples and explain this use
- Judge from comparisons of multiples whether a stock is priced too high, too low or fairly
- Assess a stock with comparables and explain why fundamentals matter when applying that method
- Explain the various cash flow definitions used in multiples of price and of enterprise value (EV) and where each falls short
- Work out EV multiples, explain what they mean and assess how useful EV/EBITDA is
- Explain why valuation comparisons across borders can differ
- Explain how the median, arithmetic mean, harmonic mean and weighted harmonic mean summarise the typical level of a set of multiples