BYD Value Investing Approach
This Pricing Model was prepared for BYD in a very simple and easy way to value a company for business valuation. The essence of value investing according to Benjamin Graham is that investments should be worth less than its real value. This valuation style is to find out undervalued companies with a sound balance sheet.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
By calculating market capitalization over the net current asset value of the company, we will know if the stocks are trading over or undervalued. The result should be less than 1.2 ratios.
The formula was: Market Capitalization / NCAV = Result (must be lesser than 1.2)
The MC/NCAV valuation tells us that the stock was overvalued from 2008 up to the trailing twelve months because the ratio was greater than the 1.2 ratios. The net current asset value of BYD was negative because current liabilities were greater than its current assets. The ratio shows a -0. 16 against the 1.2 ratios. From there, we can say that the stock price was expensive.
BYD Margin of Safety (MOS)
The Margin of Safety is the difference between the market value and the real value. In other words, it is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies — the market price and the company’s business value or true value.
Formula: Margin of Safety = Enterprise Value – Intrinsic Value.
The table shows the historical calculation for the margin of safety.
The average margin of safety was 49 percent, more than the requirement of Benjamin Graham. The average enterprise value per share was $6.8 while the margin of safety was $10.33 per share.
In addition, the formula for the intrinsic value is:
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
The table below will show us the historical results of the calculations for the intrinsic value.
The average intrinsic value was $14.41 per share while the earnings per share were averaging $0.74 and the annual growth rate was 16.39 percent average.
The term earnings per share (EPS) represent the portion of a company’s earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock. The figure can be calculated simply by dividing net income earned in a given reporting period by the total number of shares outstanding during the same term.
The formula for earning per share is:
To calculate the sustainable -growth rate you need to know how profitable the company is as measured by its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio.
Sustainable Growth Rate
Sustainable growth rate = ROE x (1 – dividend-payout ratio)
The results of the calculation show that the BYD average sustainable growth rate was 3.7 percent and the return on equity was 3.7 as well because there was a zero payout ratio.
Return on Equity
Return on Equity (ROE), is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. It shows how many dollars of earnings result from each dollar of equity. For the formula, please refer below:
The other way of calculating the sustainable growth rate was by using the average approach.
As a result, the average approach produced a higher margin of safety because it takes into consideration the past performance.
Intrinsic Value Graph
Moving forward, I will show you the relationship of a price and value.
The intrinsic value is the true value of the stock while the enterprise value represents the market price. The intrinsic value soared up very high from 2008 to 2010 at a rate of 1224 percent. This means that there was a margin of safety from 2008 to 2011 because the intrinsic value line was higher than the EV line. The point of intersection at the year 2012 indicated a zero margin of safety until the trailing twelve months because the IV line is lower than the EV line. In other words, the price was higher than the true value of the stock.
Price to Earnings/Earning Per Share (P/E*EPS)
This valuation will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.
The table above indicates that in the P/E*EPS valuation the stock price was undervalued because the enterprise value was lesser than the P/E*EPS ratio. The enterprise value represents 20 percent of the ratio, thus, the stock price was cheap.
As shown in the table, the price to earnings ratio was so high during 2012 and the trailing twelve months, this is due to being net earnings of only 0.18 percent. Thus, the average P/E was so high.
The average approach takes into consideration the past period’s performance. The summary of the results of the calculations is in the table below:
The relative approach produced a higher result than by using the average approach. The average approach takes into consideration the company’s past performance.
The Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)
The use of this ratio is to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS), the result would then represents the price (P/E) and the difference represents the earnings (EPS).
This valuation is the separation of price and earnings from the enterprise value. The price represents 764 percent and the earnings were -664 percent. The earnings were negative because the EPS was very low during 2008, 2009, 2012 and the trailing twelve months.
Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)
This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.
The EV/EBITDA tells us that it will take 4 years to recover the cost of buying the entire business of BYD, in other words, it will take 4 times of the cash earnings of the company to recover the cost of buying the entire business. The EBITDA represents 25 percent of the enterprise value, it is the cash of the company against the enterprise value.
The market capitalization of BYD Company Ltd ADR was erratic in movement and during 2009 and 2010, the market capitalization was high. Total debt was 17 percent and its cash and cash equivalent represents 3 percent of the enterprise value. Purchasing the entire business, the investor would be paying 86 percent equity and 14 percent debt.
The purchasing price to date May 4, 2013, would be $11 billion at $9.45 per share. The market price to date was $7.36 per share.
Net Current Asset Value
The net current asset value tells us that the stock price of BYD was overvalued because the stock was trading above the liquidation value of the company.
The MC/NCAV approach shows that the stock was overvalued because the ratios exceeded the 1.2 ratios. Further, the margin of safety was 49 percent average. The average intrinsic value was $14.41 per share, while the earnings per share were averaging $0.74. Further, the annual growth rate was 16.39 percent average. The results of the calculation show that the average sustainable growth rate was 3.7 percent. And the return on equity was 3.7 as well because there was a zero payout ratio.
The relative method indicates that in the P/E*EPS valuation the stock price was undervalued. Because the enterprise value was lesser than the P/E*EPS ratio. The price represents 764 percent and the earnings were -664 percent.
EV/EBITDA tells us that it will take 4 times of the cash earnings to recover the costs of buying.