Hi everyone. As we discussed there are several common or widely used simpler basic valuation models, such as price to earnings, price to book price to sales, and enterprise value to EBITDA Multiple. Throughout this video ,will focus on the price to book valuation model. The price to book valuation model, is often used for mature companies that have similar capital allocation strategies. For example, sharer purchases, dividends, etc, as compared to their peers. Price to book ratio is calculated by dividing a company share price by their book value of equity per share. However, if amounts are not on a per share basis, you will need to convert them to a per share basis or simply divide their market value by their book value of equity, obtained from the equity section of the balance sheet. Both methods will yield the same result. Just that one is on a per share basis and the other is on a whole dollar basis. We'll use five steps to calculate our target company's valuation. Step 1, select the summary performance measure to use as the valuation basis. Step 2, select the comparable companies to determine the market multiple. Step 3, calculate the market multiple. Step 4, compute the target company's value, using its performance measure, and the market multiple from Step 3. And Step 5, calculate the equity value per share. For example purposes, we'll go through each of the five steps to execute the price to book valuation model. And Step 1, I've selected Walmart as our target company. Since we selected the price to book model, the book value of equity will be the summary performance metric. In Step 2, we need to select comparable or peer companies. Walmart operates in the retail industry with the combination of brick and mortar stores and online sales. Target and Costco have similar go to market approaches and also operate in the retail industry. As such, we've selected them as our peer companies. In Step 3, we obtain the applicable data for Target and Costco to calculate their price to book ratios. For simplicity, you can log in to Yahoo Finance to obtain the current share price and shares outstanding. Alternatively, you can also access the number of shares outstanding using each company's 10K. You also need to obtain each company's book value of equity from the balance sheet, as reported in their 10K. Since the current share price is on a per share basis and the book value of equity is in whole dollars, we'll need to either convert the share price to market value by multiplying share price by shares outstanding, or convert the book value of equity to a per share basis, by dividing by the number of shares outstanding. Either approach works what's important are both are on the same basis. For example, I calculate the market value of both companies by multiplying their share price by their applicable shares outstanding. To calculate a market value for Target of 114 billion and Costco 168 billion. Next, I calculated their price to book ratios by dividing their market values by the book value of equity. For Target, their price to book ratio was 7.9 and Costco 9.2. You'll notice there's a very wide range for peer companies. This is one of the limitations of using a simpler basic valuation model. No two companies are exactly alike and their valuations can vary widely. In order to take out some of the volatility, we calculate a simple average for the pair companies. The average of target and cost goes price to book is 8.55. And Step 4, we use the price to book ratio average for the pair companies and multiply by the book value of equity per share for Walmart. Note, the book value of equity per share for Walmart is obtained from their 10K, and is calculated by dividing the book value of equity by their shares outstanding. In order to calculate Walmart's equity value per share using the price to book model, we multiply Walmart's book value of equity per share of 28.42 by the comparable price to book ratio average for the peer companies of 8.55. This means that Walmart's estimated equity value per share equals $243.03 using the price to book model. If we compare our calculated equity value per share for Walmart, using the price to book model versus the current share price as of June the 17th 2021, you'll notice that this approach indicates that Walmart is undervalued. It's important than investor does not overreact based upon this simplistic analysis. It should be used as one of many data points when making investment decisions. Capital allocation strategies employed by a company can have a significant impact on their book value of equity balance. As such, the price to book ratio can be challenging, as peer companies often employ different approaches to capital allocation. It's also important to note that the price to book ratio should only be used as evaluation model for companies who have a positive book value of equity balance. Negative book value of equity balances would yield a negative share price estimate, which is not relevant. And finally in Step 5. We calculate the equity value per share. However, since the price to book model is already based upon share price. We've already calculated the equity value per share and do not need to execute any other steps. And in other examples such as the enterprise value to EBITDA, Step 5 will be necessary. As the EV to EBITDA model calculates enterprise value. And we'll need to subtract intrinsic debt to compute the equity value per share.
