We’ve gotten many questions about how to account for the impact of the ongoing Coronavirus Global Economy Shutdown in company valuation and how to use PE when earnings are highly volatile or negative. Today, we’ll take a stab at it.
How to value a company when earnings are highly volatile or negative
Investors find it difficult to value a company when earnings are highly volatile or even negative. The current Coronavirus Global Economy Shutdown makes it especially hard as earnings of companies are likely to be a wipeout for the next couple of quarters.
Let Buffett and Shiller help shift your focus on the long-term
One way to solve this problem is to switch the focus away from a company’s quarterly earnings and instead try to estimate the long-term damage caused by the Coronavirus Global Economy Shutdown. We have constructed a simplified way of doing this across companies.
We start by averaging the long-term earnings and PE ratios of a company. Let’s use Warren Buffett and Robert Shiller’s method, by calculating a 10-year EPS. Next, we calculate the market-implied impact of Coronavirus on EPS growth. We do this by considering the price today relative to the long-term EPS and PE.
From the current price and assuming no change in the long-term PE, we can estimate the implied future EPS. We then compare that with the long-term EPS to get the market’s expectation of the EPS growth.
The market implies 56% damage to Minor International’s EPS and no impact on HomePro EPS
Minor International (MINT): Price of Bt19.3 divided by long-term PE of 37.2x, minus long-term EPS of Bt1.6, all divided by the long-term EPS of Bt1.6. The result of negative 56% tells us that, based on past long-term EPS and PE, the market is factoring in a 56% reduction of future earnings.
HomePro (HMPRO): Price of Bt13.9 divided by long-term PE of 30x, minus long-term EPS of Bt0.5, all divided by the long-term EPS of Bt0.5. The result of negative 1.3% tells us that, based on past long-term EPS and PE, the market is factoring in a 1.3% decrease in its future earnings.
Plugin your own numbers to reflect your assumptions
If you think that the market is being overly pessimistic about MINT and you believe that the future damage to EPS will be only 20% rather than 56%, you can plug that in to find that it implies a price of Bt34.8, which is nearly 44.5% above the current price of Bt19.3.
If you think that the market is being overly optimistic about HMPRO and you believe that the long-term damage to EPS will be minus 30% rather than a 1.3% increase, this would imply a price of Bt9.9, which is nearly 41% below the current price of Bt13.9.
This is a simplified model; other factors should be considered
Of course, there are many other factors to consider, such as whether PE ratios will end up being different than the long-term past. Also, whether that specific company is facing other challenges in addition to the Coronavirus outbreak. But this gives one methodology that is related to the long-term impact on EPS.
Companies where the market is factoring in significant damage to long-term EPS
PTT Exploration and Production (PTTEP) -84%, True Corporation (TRUE) -72%, Indorama Ventures (IVL) -69%, Osotspa (OSP) -61%, Banpu (BANPU) -56%, TMB Bank (TMB) -56%, Kasikornbank (KBANK) -52%, Minor International (MINT) -52%, Bangkok Bank (BBL) -46%, and Krung Thai Bank (KTB) -45%.
Companies where the market is factoring in improving long-term EPS
B.Grimm Power (BGRIM) 54%, Global Power Synergy (GPSC) 40%, Bangkok Expressway and Metro (BEM) 23%, Krungthai Card (KTC) 20%, Central Retail (CRC) 19%, Carabao Group (CBG) 18%, RATCH Group (RATCH) 15%, VGI Global Media (VGI) 14%, BTS Group (BTS) 10%, Advanced Info Service (ADVANC) 7%.
DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article.