The valuation performance of mathematically-optimised, equity-based composite multiples
Keywords:
Emerging markets, Composite multiples, Equity multiples, Equity valuations, Valuation precisionAbstract
Purpose. This paper aims to examine the valuation precision of composite models in each of six key industries in South Africa. The objective is to ascertain whether equity-based composite multiples models produce more accurate equity valuations than optimal equity-based, single-factor multiples models.
Design/methodology/approach. This study applied principal component regression and various mathematical optimisation methods to test the valuation precision of equity-based composite multiples models vis-à-vis equity-based, single-factor multiples models.
Findings. The findings confirmed that equity-based composite multiples models consistently produced valuations that were substantially more accurate than those of single-factor multiples models for the period between 2001 and 2010. The research results indicated that composite models produced up to 67 per cent more accurate valuations than single-factor multiples models for the period between 2001 and 2010, which represents a substantial gain in valuation precision.
Research implications. The evidence, therefore, suggests that equity-based composite modelling may offer substantial gains in valuation precision over single-factor multiples modelling.
Practical implications. In light of the fact that analysts’ reports typically contain various different multiples, it seems prudent to consider the inclusion of composite models as a more accurate alternative.
Originality/value. This study adds to the existing body of knowledge on the multiples-based approach to equity valuations by presenting composite modelling as a more accurate alternative to the conventional single-factor, multiples-based modelling approach.
Downloads
References
Abukari, K., Jog, V. and McConomy, B.J. (2000), “The role and the relative importance of financial statements in equity valuation”, Working Paper, Wilfred Laurier University, Ontario, ON, pp. 1-36.
Alford, A. (1992), “The effect of the set of comparable companies on the accuracy of the price-earnings valuation method”, Journal of Accounting Research, Vol. 30 No. 1, pp. 94-108.
Asquith, P., Mikhail, M.B. and Au, A.S. (2005), “Information content of equity analyst reports”, Journal of Financial Economics, Vol. 75 No. 2, pp. 245-282.
Barker, R.G. (1999), “Survey and market-based evidence of sector-dependence in analysts’ preferences between the dividend yield and price-earnings ratio valuation models”, Journal of Business Finance and Accounting, Vol. 26 Nos 3/4, pp. 393-418.
Berkman, H., Bradbury, M.E. and Ferguson, J. (2000), “The accuracy of price earnings and discounted cash flow methods of IPO equity valuations”, Journal of International Financial Management and Accounting, Vol. 11 No. 2, pp. 71-83.
Chan, K. (2009), “Accounting-based composite market multiples and equity valuation”, Working Paper, University of Technology, Sydney, pp. 1-70.
Cheng, C.S.A. and McNamara, R. (2000), “The valuation accuracy of the price-earnings and price-book benchmark valuation methods”, Review of Quantitative Finance and Accounting, Vol. 15 No. 4, pp. 349-370.
Damodaran, A. (2006a), Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, 2nd ed., John Wiley & Sons, New Jersey.
Damodaran, A. (2006b), Valuation Approaches and Metrics: A Survey of the Theory and Evidence, 2nd ed., Now Publishers, Hanover.
Damodaran, A. (2009), The Dark Side of Valuations, 2nd ed., Pearson Education, New Jersey.
Dittmann, I. and Weiner, C. (2005), “Selecting comparable companies for the valuation of European firms”, Working paper, Erasmus University, Rotterdam, pp. 1-25.
Efthimios, G.D., Strong, N.C. and Walker, M. (2004), “What valuation models do analysts use?”, Accounting Horizons, Vol. 18 No. 4, pp. 221-240.
Fama, E.F. and French, K.R. (1996), “Multifactor explanations of asset pricing anomalies”, Journal of Finance, Vol. 51 No. 1, pp. 55-84.
Fernández, P. (2001), “Valuation using multiples: how do analysts reach their conclusions?”, Working Paper, IESE Business School, Madrid, pp. 1-13.
Fernández, P. (2002), Valuation Methods and Shareholders’ Value Creation, 1st ed., Academic press, San Diego, CA.
Gilson, S.C., Hotchkiss, E.S. and Ruback, R.S. (2000), “Valuation of bankrupt firms”, Review of Financial Studies, Vol. 13 No. 1, pp. 43-74.
Goedhart, M., Koller, T. and Wessels, D. (2005), “The right role for multiples in valuation”, The McKinsey Quarterly, McKinsey & Company, New York, NY, (March), pp. 7-11.
Gower, J., Lubbe, S. and Le Roux, N. (2011), Understanding Biplots, 1st ed., John Wiley & Sons, Chichester.
Henschke, S. and Homburg, C. (2009), “Equity valuation using multiples: controlling for differences between firms”, Working Paper, University of Cologne, Cologne, pp. 1-38.
Kaplan, S.N. and Ruback, R.S. (1995), “The valuation of cash flow forecasts: an empirical analysis”, Journal of Finance, Vol. 50 No. 4, pp. 1059-1093.
Le Roux, N.J., Nel, W.S. and Bruwer, B.W. (2014d), “Market-based valuations in an emerging market from a biplot perspective”, International Conference on Computational Statistics Proceedings, 19-22 August, Geneva.
Liu, J., Nissim, D. and Thomas, J. (2002a), “Equity valuation using multiples”, Journal of Accounting Research, Vol. 40 No. 1, pp. 135-172.
Liu, J., Nissim, D. and Thomas, J. (2002b), “International equity valuation using multiples”, Working paper, University of California at Los Angeles (Anderson Graduate School of Management), Los Angeles, pp. 1-38.
Liu, J., Nissim, D. and Thomas, J. (2007), “Is cash flow king in valuations?”, Financial Analysts Journal, Vol. 63 No. 2, pp. 1-13.
Minjina, D.I. (2008), “Multiples and their use for equity valuation on European capital markets”, Theoretical and Applied Economics, Vol. 11 No. 11, pp. 22-28.
Nel, W.S. (2009a), “The use of multiples in the South African equity market: is the popularity of the price earnings ratio justifiable from a sector perspective?”, Meditari Accountancy Research, Vol. 17 No. 2, pp. 101-115.
Nel, W.S. (2009b), “Methods of choice in the valuation of ordinary shareholders’ equity”, Meditari Accountancy Research, Vol. 17 No. 2, pp. 117-135.
Nel, W.S., Bruwer, B.W. and Le Roux, N.J. (2013b), “Equity- and entity-based multiples in emerging markets: evidence from the JSE Securities Exchange”, Journal of Applied Business Research, Vol. 13 No. 3, pp. 829-852.
Nel, W.S., Bruwer, B.W. and Le Roux, N.J. (2013d), “The valuation performance of equity-based multiples in South African context”, Risk, Governance and Control: Financial Markets and Institutions, Vol. 3 No. 3, pp. 35-47.
Nel, W.S., Bruwer, B.W. and Le Roux, N.J. (2014a), “An emerging market perspective on peer group selection based on valuation fundamentals”, Applied Financial Economics, Vol. 24 No. 9, pp. 621-637.
Nel, W.S., Bruwer, B.W. and L. Roux, N.J. (2014b), “Precision, consistency and bias in the south african equity market”, Vol. 6 No. 5, pp. 386-399. Journal of Economics and Behavioral Studies.
Nel, W.S., Bruwer, B.W. and L. Roux, N.J. (2014e), “An emerging market perspective on key value drivers when valuing cross-border transactions into South Africa”, Economics, Management and Financial Markets, Vol. 9 No. 4, pp. 92-111.
Nel, S. (2014f), “The proper construction of multiples”, Reknuus, Vol. 18, pp. 1-43.
Nissim, D. (2011). “Ratio analysis and equity valuation: relative valuation of US insurance companies”, Working Paper, Columbia University, New York, NY, pp. 1-55.
Ohlson, J.A. (1995), “Earnings, book values, and dividends in equity valuation”, Contemporary Accounting Research, Vol. 11 No. 2, pp. 661-687.
Ohlson, J.A. and Juettner-Nauroth, B. (2005), “Expected EPS and EPS growth as determinants of value”, Review of Accounting Studies, Vol. 10 Nos 2/3, pp. 349-365.
Omran, M.F. (2003), “Equity valuation using multiples in the emerging market of the United Arab Emirates”, Review of Middle East Economics and Finance, Vol. 1 No. 3, pp. 267-283.
Penman, S. (1998), “Combining earnings and book value in equity valuation”, Contemporary Accounting Research, Vol. 15 No. 3, pp. 291-324.
PricewaterhouseCoopers (PwC) (2012), An African Perspective: Valuation Methodology Survey, 6th ed., PwC Corporate Finance, Johannesburg.
PricewaterhouseCoopers (PwC) (2015), An African Perspective: Valuation Methodology Survey, 7th ed., PwC Corporate Finance, Johannesburg.
R Core Team (2015), R: A Language and Environment for Statistical Computing, R Foundation for Statistical Computing, Vienna, available at: www.R-project.org/
Roosenboom, P. (2007), “How do underwriters value initial public offerings? An empirical analysis of the French IPO market”, Contemporary Accounting Research, Vol. 24 No. 4, pp. 1217-1243.
Ross, S.A. (1976), “The arbitrage theory of capital asset pricing”, Journal of Economic Theory, Vol. 13 No. 3, pp. 341-360.
Schreiner, A. (2007), “Equity valuations using multiples: an empirical investigation” PhD dissertation, University of St Gallen, Austria, pp. 1-169.
Sehgal, S. and Pandey, A. (2009), “The behavior of price multiples in India (1990-2007)”, Asian Academy of Management Journal of Finance and Accounting, Vol. 5 No. 1, pp. 31-65.
Sehgal, S. and Pandey, A. (2010), “Equity valuation using price multiples: a comparative study for BRICKS”, Asian Journal of Finance & Accounting, Vol. 2 No. 1, pp. 68-91.
Yee, K.K. (2005), “Aggregation, dividend irrelevancy, and earnings-value relations”, Contemporary Accounting Research, Vol. 22 No. 2, pp. 453-480
Yoo, Y.K. (2006), “The valuation accuracy of equity valuation using a combination of multiples”, Review of Accounting and Finance, Vol. 5 No. 2, pp. 108-123.
Downloads
Published
How to Cite
Issue
Section
License
Copyright (c) 2021 Journal of Economics, Finance and Administrative Science
This work is licensed under a Creative Commons Attribution 4.0 International License.
