This is Hilton, another hotel company. This exhibit three comes directly from the case and it's carry information about Hilton and a few competitors, including Marriott, but also including Four Seasons, Starwood and the industry as a whole. And so there's a couple things that I would like to do with Hilton just to change companies and to go back to a couple of important points. One is, at the time that the case is set, and again, it doesn't really matter if we could be using numbers of today, and it wouldn't change anything of the analysis that we're going to make. The numbers would be different, but the idea of the analysis would be the same. At that point in time, Hilton is priced at 10.5, a little bit less than 10.5. now. The earnings per share of Hilton at that point in time is almost 75% per share, 0.74 to be exact. And if we divide, those are trailing earnings, by the way, and if we divide the price by the earnings per share, we get the PE ratio and the PE ratio, let's round it up to 14, 14.2, let's call it 14 just for the sake of brevity. Now we can go back and look at Hilton in two ways. First, we choose the benchmarks an we can do as we did with Marriot. That is, we can look at Hilton over the previous 5 and 10 years, that's a previous 5 and 10 beginning from January 2001, and over the previous 5 years it was 23.7 and over the previous 10, it was almost identical 23.4. So the comparison, the historical comparison is a benchmark between 23 and 24 to be approximate compared to 14, which is what Hilton had at that particular point in time. Now, again, don't do what we said before with Mariott that you shouldn't do, which is, well, jump to the conclusion that Hilton is cheap because you have to pay less for Hilton at this point in time, than you have to pay 5 years ago and 10 years ago or during the last 5 and 10 years. If we look at some of the competitors, the sector as a whole has a PE ratio of 23, and two of the competitors, Marriott has 23.7, Starwood has 18.5. And so if we look at either two of the competitors or the sector as a whole, once again, the PE ratio of Hilton happens to be lower. And once again, resist the temptation of concluding that because Hilton, excuse me, yes, Hilton is price cheaper than Mariott and Starwood and just about the average competitor, then Hilton happens to be cheap. We didn't do that with Mariott, we're not going to do that with Hilton. Now, with all that said, here we could go into the PEG ratio, here we could go into the expected growth, into the risk of Hilton and compare that to Hilton in the past, or Hilton the competitors, that's what I really want to stress in this session. A multiples analysis doesn't stop in comparing two numbers, you really have to go into the fundamentals. Now we have to be able to explain why 14 is lower than 23, 24, or why 14 is lower than 22 or 23 or 19, which is what the competitors have. Maybe you can explain it with fundamentals, in which case that, going back to what we said before, there's no trading opportunity. Hilton is cheaper because it deserves to be cheaper. Maybe be because it's not going to grow as fast as it did in the past, or as their competitors are expected to grow, or maybe because its riskier than it was in the past, or that the competitors are at this particular point in time. But that's where step two really comes in. You can't stop just by the comparison between the multiple that we're looking at and the benchmark. So it is really, really important that if you learn one thing in this session, make it this one that when you do valuation by multiples, you never stop in comparing two numbers. That is actually the beginning of the inquire. That's when you say, well, let me see if I can explain this difference with fundamentals or not. Maybe you can, maybe you cannot, but then and only then, you can reach the conclusion whether these company's properly price or over price or under price. I don't want to go through a discussion of multiples without emphasizing a very widely way of using multiples. And once again, let me remind you that PE star means whatever benchmark you're using, but let me in this case be a little bit more concrete, meaning let's use as a benchmark the cross sectional comparison. So we have the PE ratio of the company, we have the PE ratio of the competitors, that's the benchmark, that's the PE star. And one thing we could do, and one thing that a lot of people do in practice is to use that expression, and let me explain that notation. So PE star, once again, it's the benchmark that you're using for the evaluation. And let's say that this is a cross sectional benchmark. E are the earnings of the company you're dealing with, the earnings of the company that you're valuing, and P star is what you think is the appropriate valuation of the company given the valuation that the competitors have. So notice what we're doing there, were taking the earnings of the company were interested in, and would apply in the multiple of the competitors. So implicitly we're saying, if we apply to this company the same multiple that the competitors have, the price should be this one. So let's go to a concrete case, back to Hilton. So we know that the sector PE is roughly 23, that'll be the PE star. We know that the earnings of Hilton, our 0.74, so now let's apply our little formula. We multiply 0.74, the earnings of Hilton, by the benchmark that we're using, which is almost 23, and then we get a P star of 16.9, let's call it 17. What is 17? 17 is what Hilton should be valued if we apply to Hilton, the same multiple that the competitors have. In other words, given the earnings of Hilton, and given the motives of the competitors, given how much people are willing to pay for the competitors, Hilton should be trading at 17. But we know that Hilton is trading at a lot less than that, so a possible conclusion is that Hilton is undervalued and I stress the word, possible, because again, we would have to go into the fundamentals and try to explain why 16.9 is higher than the actual price of Hilton at this point in time. So we know that Hilton is trading at 10.5, we have a model, if you will, that says that it should be trading at 17 and then comes the why, once again. Why is this difference? Why does this happen? That's when we need to go back to the fundamentals, to the growth, to the risk and try to explain that particular difference.
