ValuePickr Forum

PE vs EPS Growth Rate - Thinking about valuations

I was trying to find a way to make sense of the valuations from a PE vs EPS growth rate basis. And below is the table I was looking to get some feedback on. The way to read it is as below.

  1. The vertical axis has the current PE ratio of the stock in analysis; the horizontal axis has the EPS growth rate/compounder assumed in valuations over the next X years.

  2. The table then calculates the number of years it would take for the future stock price to equal the current stock price should the exit PE get de-rated to 15.

I will walk through with an example. Say the current stock price of ABC corporation is Rs.100 today (selling at a PE of 20 and having an EPS of Rs.5). Should the stock be expected to grow at 10% over the next few years, then it would take 3 years (more or less) for the stock price to equal Rs.100 should the PE get derated to 15 from 20.

The other way to think about it is also to say, should we hold ABC corporation today at Rs.100 a stock (selling at a PE of 20 having an EPS of Rs.5) and our holding period is 3 years, then the company has to record an EPS growth rate of at least 10% and sell at an exit PE of at least 15 to ensure security of principle.

Why PE of 15? - It is a nice round number.

Much of my thinking around this is rooted on ensuring security of invested capital (even if it means I’ll have to go on a return holiday) and the fact that so many quality names have gotten significant PE re-rating over the last 3-4 years. Any thoughts/feedback is most appreciated.

Exit PE : 15

Current PE vs Profit Compounder 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24% 25% 26% 27% 28% 29% 30%
16 0.7 0.6 0.6 0.5 0.5 0.5 0.4 0.4 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.2
17 1.3 1.2 1.1 1.0 1.0 0.9 0.8 0.8 0.8 0.7 0.7 0.7 0.6 0.6 0.6 0.6 0.5 0.5 0.5 0.5 0.5
18 1.9 1.7 1.6 1.5 1.4 1.3 1.2 1.2 1.1 1.0 1.0 1.0 0.9 0.9 0.8 0.8 0.8 0.8 0.7 0.7 0.7
19 2.5 2.3 2.1 1.9 1.8 1.7 1.6 1.5 1.4 1.4 1.3 1.2 1.2 1.1 1.1 1.1 1.0 1.0 1.0 0.9 0.9
20 3.0 2.8 2.5 2.4 2.2 2.1 1.9 1.8 1.7 1.7 1.6 1.5 1.4 1.4 1.3 1.3 1.2 1.2 1.2 1.1 1.1
21 3.5 3.2 3.0 2.8 2.6 2.4 2.3 2.1 2.0 1.9 1.8 1.8 1.7 1.6 1.6 1.5 1.5 1.4 1.4 1.3 1.3
22 4.0 3.7 3.4 3.1 2.9 2.7 2.6 2.4 2.3 2.2 2.1 2.0 1.9 1.9 1.8 1.7 1.7 1.6 1.6 1.5 1.5
23 4.5 4.1 3.8 3.5 3.3 3.1 2.9 2.7 2.6 2.5 2.3 2.2 2.1 2.1 2.0 1.9 1.8 1.8 1.7 1.7 1.6
24 4.9 4.5 4.1 3.8 3.6 3.4 3.2 3.0 2.8 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.0 2.0 1.9 1.8 1.8
25 5.4 4.9 4.5 4.2 3.9 3.7 3.4 3.3 3.1 2.9 2.8 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.1 2.0 1.9
26 5.8 5.3 4.9 4.5 4.2 3.9 3.7 3.5 3.3 3.2 3.0 2.9 2.8 2.7 2.6 2.5 2.4 2.3 2.2 2.2 2.1
27 6.2 5.6 5.2 4.8 4.5 4.2 4.0 3.7 3.6 3.4 3.2 3.1 3.0 2.8 2.7 2.6 2.5 2.5 2.4 2.3 2.2
28 6.5 6.0 5.5 5.1 4.8 4.5 4.2 4.0 3.8 3.6 3.4 3.3 3.1 3.0 2.9 2.8 2.7 2.6 2.5 2.5 2.4
29 6.9 6.3 5.8 5.4 5.0 4.7 4.4 4.2 4.0 3.8 3.6 3.5 3.3 3.2 3.1 3.0 2.9 2.8 2.7 2.6 2.5
30 7.3 6.6 6.1 5.7 5.3 5.0 4.7 4.4 4.2 4.0 3.8 3.6 3.5 3.3 3.2 3.1 3.0 2.9 2.8 2.7 2.6
31 7.6 7.0 6.4 5.9 5.5 5.2 4.9 4.6 4.4 4.2 4.0 3.8 3.7 3.5 3.4 3.3 3.1 3.0 2.9 2.9 2.8
32 7.9 7.3 6.7 6.2 5.8 5.4 5.1 4.8 4.6 4.4 4.2 4.0 3.8 3.7 3.5 3.4 3.3 3.2 3.1 3.0 2.9
33 8.3 7.6 7.0 6.5 6.0 5.6 5.3 5.0 4.8 4.5 4.3 4.1 4.0 3.8 3.7 3.5 3.4 3.3 3.2 3.1 3.0
34 8.6 7.8 7.2 6.7 6.2 5.9 5.5 5.2 4.9 4.7 4.5 4.3 4.1 4.0 3.8 3.7 3.5 3.4 3.3 3.2 3.1
35 8.9 8.1 7.5 6.9 6.5 6.1 5.7 5.4 5.1 4.9 4.6 4.4 4.3 4.1 3.9 3.8 3.7 3.5 3.4 3.3 3.2
36 9.2 8.4 7.7 7.2 6.7 6.3 5.9 5.6 5.3 5.0 4.8 4.6 4.4 4.2 4.1 3.9 3.8 3.7 3.5 3.4 3.3
37 9.5 8.7 8.0 7.4 6.9 6.5 6.1 5.8 5.5 5.2 5.0 4.7 4.5 4.4 4.2 4.0 3.9 3.8 3.7 3.5 3.4
38 9.8 8.9 8.2 7.6 7.1 6.7 6.3 5.9 5.6 5.3 5.1 4.9 4.7 4.5 4.3 4.2 4.0 3.9 3.8 3.7 3.5
39 10.0 9.2 8.4 7.8 7.3 6.8 6.4 6.1 5.8 5.5 5.2 5.0 4.8 4.6 4.4 4.3 4.1 4.0 3.9 3.8 3.6
40 10.3 9.4 8.7 8.0 7.5 7.0 6.6 6.2 5.9 5.6 5.4 5.1 4.9 4.7 4.6 4.4 4.2 4.1 4.0 3.9 3.7
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Isn’t PEG giving the same concept to you and then you adjust it to the industry and sector? And, a lot of sites will show you stocks with PEG and you can then filter on it. Sorry did not read your entire logic and table, but PE and EPS relationships is really with PE and Growth Rate. Growth Rate can be TTM or FWD looking. I do not believe in Forward Growth Rates, so take the TTM and FWD both to find some logic.

KKP

Discounted Cash Flow valuation essentially does the same thing that you have done, but in a much more refined way. It uses Cash Flows instead of EPS and a Residual Value based on a Terminal Growth Rate instead of the conservative 15 P/E used here.

But estimated growth rate is not the only thing that affects valuation. Your methodology does not account for factors like certainty of income (risk) or varying reinvestment needs (whether the earnings can be taken out of the business or need to be put back in). The methodology cannot explain why some companies consistently get higher valuation than others, despite same or lower growth rate.

In DCF, these factors are considered separately. For example, Warren Buffet uses a very low discounting factor equivalent to risk free rate because (he says) the companies he values have a high certainty of income ( “moat” ). In general, you will also find that companies having higher re-investment needs get a low discounting than those with lower re-investment needs.

Hence it is better to use DCF that this one-metric-fits-all approach.

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