market-to-book patterns and the logic of valuation (in a not always logical world ) by carlos de...

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

Stocks have reached what looks like a permanently high plateau. ~ Irving Fisher, 1929 ~

Measuring value

• Method 1: discounted cash flow model

1 1

t

e

e tt

FCFEVr

Where:

e M ff er r rr

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

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”

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

+

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

Price-to-Earnings Ratio (PE)

0

001

11

1

e t

e e

tt

r RI DPE

r NINIr

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!)

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!)

PB, PE and ROE:PB ROE PE

VALUE GROWTHPROFITABILITY

Value is driven by profitability and growth.

NEXT:

How market returns to equity (and the ratios that explain these returns) behaved over the last 40 years (1969-2009).

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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).

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).

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).

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).

The amazing PB “effect” (Year: 1969)

The amazing PB “effect” (Year: 2000)

The amazing PB “effect” (Year: 2004)

The amazing PB “effect” (Year: 2008)

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)

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)

Les chiffres sont des éléments que l'homme, sous l'effet de la torture, fait dire tout ce qu'il veut."~ Leonardo Da Vinci ~