Assume company ABC is having having FY15 profit of 100Cr, and the average P/E of industry in which business operates is 10 and current market cap is 1000Cr.
Given that you know and the company will have 10Cr profit in FY16, 200Cr in FY17, 10Cr in FY18 and 200Cr in FY19 and after that profit will be somewhere in range of 40-60 Cr for next 10 years which cannot be predicted exactly now but will be range bound.
How do someone value such business or on what earnings should multiple be applied? Most of the times market assign a value based on forward year earnings.
Now because each year earnings are so fluctuating what should be the base earnings which should be considered Current year? Next year? Average of 4 to 5 years?
Views please.
If this case study doesn’t makes sense please flag the post so that it gets deleted.
In my limited and flawed view this is too hypothetical a scenario :).
Need to get into the specifics of the business the company is in (Business model, Competitive advantage, pricing power, relationship with suppliers etc). you would have to take a qualitative call on the nature of the business.
Purely from a valuation perspective, i have not been in favor of using earnings to arrive at a intrinsic value range (especially given the fact that Profits are so inconsistent across the years). For example what would explain a drop in profits from 200 cr to 10 cr the next year.
Maybe a safer way would be to determine the growth in book value factoring in future investments to be made and the dividend expected to be paid out. (Playing it safe assuming the company was to be liquidated what would the investors get out). In addition you should also look at Enterprise value of the company (which takes care of Cash balance and debt levels).
Also would be important to look at Cash Flow patterns (Free cash flows, Op cash flow and how much of the business is self funded for future growth without needing additional capital).
Is it due to the business model, the company is generating – 10Cr profit in FY16, 200Cr in FY17, 10Cr in FY18 and 200Cr in FY19. If yes, then comparable valuation will be the best i think.
If not due to business model, then is it due to other one time expenses – like impairment, litigation charges etc. In that case, we can remove the one time expenses and use the proper multiples. Is it correct.
