The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit (Little Books. Big Profits)

by Aswath Damodaran

Notwithstanding the fact that each multiple is determined by many variables, there is a single variable that dominates when it comes to explaining each multiple (and it is not the same variable for every multiple). This variable is called the companion variable and is key to finding undervalued stocks. In Table 4.4, the companion variables and mismatches are identified for six multiples. Table 4.4 Valuation Mismatches Multiple Companion Variable Mismatch Indicator for Undervalued Company PE ratio Expected growth Low PE ratio with high expected growth rate in earnings per share P/BV ratio ROE Low P/BV ratio with high ROE P/S ratio Net margin Low P/S ratio with high net profit margin EV/EBITDA Reinvestment rate Low EV/EBITDA ratio with low reinvestment needs EV/Capital Return on capital Low EV/Capital ratio with high return on capital EV/Sales After-tax operating margin Low EV/Sales ratio with high after-tax operating margin