The following was the result of a regression of PE ratios on growth rates, betas and payout ratios, for stocks listed on the Value Line Database, in April 1993.
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PE = 18.69 + 0.0695 GROWTH – 0.5082 BETA – 0.4262 PAYOUT R2 =0.35 |
Thus, a stock with an earnings growth rate of 20%, a beta of 1.15 and a payout ratio of 40%, would have had an expected PE ratio of:
PE = 18.69 + 0.0695 * 20 – 0.5082 (1.15) – 0.4262 * 0.40 = 19.33[NOTE: Is it 20 or 0.20?]
You are attempting to value a private firm, with the following characteristics:
(a) The firm had net profits of $10 million. It did not pay dividends, but had depreciation allowances of $5 million and capital expenditures of $12 million, in the most recent year. Working capital requirements were negligible.
(b) The earnings had grown 25% over the previous five years and are expected to grow at the same rate over the next five years.
(c) The average beta of publicly traded firms, in the same line of business, is 1.15, and the average debt/equity ratio of these firms is 25%. The tax rate is 40%. The private firm is an all-equity financed firm, with no debt.
a. Estimate the appropriate PE ratio for this private firm, using the regression.
b. What would some of your concerns be, in using this regression in valuation?