Take the earnings of the company you are trying to value and multiply it by the average P/E ratio of their industry
Income based methods like this are best used when
When taking control of a company
When more interested in earnings than dividend policy
Price Earnings Ratio
It essentially tells us is how long it would take the earnings to repay the share priceOk so this is how it is calculated...
But what we are more concerned with here is how to use this to calculate the value of a business, again here is the formula to use to calculate the value of ONE share..
How to calculate the value of ONE share
How to calculate the value of the WHOLE business
Both of these give the value of the company as a whole..
HOWEVER, to value a target company you need to use THEIR earnings and our own P/E ratio or at least a P/E ratio from their industry
Also note: The PE can be adjusted down by 10 - 20%
If private company (as less liquid shares)
If risky company (fewer controls etc)
Share Capital (25c) $100,000
Profit before tax $260,000
Preference Dividend ($20,000)
Ordinary Dividend ($36,000)
PE (for similar company) = 12.5
What is the value of 200,000 shares?
Value of Company = PE x Earnings (PAT - Pref divs)
Total Earnings (of 200,000 shares)
140,000 - 20,000 = 120,000 x 200/400 = 60,000
60,000 x 12.5 = $750,000
Use of predator's P/E ratios
A predator company may use their higher P/E ratio to value a target company.
This use of a higher P/E ratio is known as bootstrapping
Cow Co. (Predator) is valuing a potential acquisition target, Calf Co. (Target), using a bootstrapping approach.
The following items will be used in a valuation calculation:
Drawbacks Of PE model
Finding a quoted company that is similar in activity (most have a wide range)
A single year’s PE ratio may not be representative
The quoted company used to get the PE ratio from may have a totally different capital structure