AZN Investment in Enterprise Value
The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value (EV) is the present value of the entire company. Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash. The formula is given below:
Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
The market capitalization of AZN was stable at an average of $62.8 billion. The total debt represented 15.3 percent, while cash and cash equivalent were 15.5 percent. Therefore, the total debt was offset by cash and cash equivalent, since this valuation factors the balance sheet account. Digging into results, if an investor decided to buy the entire business of AZN, he/she will be paying 100 percent of its equity.
The purchase price of AstraZeneca plc (ADR) to date, January 16, 2013, would be $59.3 billion at $46.26 per share. The market price to date was $59.08 per share.
The Net Current Asset Value (NCAV) Method
The net current asset value approach tells us that AZN’s stock price was overvalued from 2007 to the trailing twelve months because the market price was greater than the 66 percent ratio. The 66 percent ratio represents only 6 percent of the market price average, therefore the price was overvalued.
What does it mean? It indicates that the stock of AZN traded above the liquidation value of the company.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
By calculating market capitalization over the net current asset value of the company, we can determine if the stock is trading over or undervalued.
For AZN, the result of MC/NCAV valuation shows that the stock was at an overvalued price because the ratio of MC/NCAV exceeded the 1.2 ratios, therefore the price was expensive.
The margin of Safety (MOS)
The table shows that the margin of safety was 81 percent average. There was the margin of safety from 2007 to the trailing twelve months. The enterprise value represents only 17 percent of the intrinsic value, therefore the intrinsic value was over 600 percent of the enterprise value.
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
The explanation in the calculation of intrinsic value was as follows:
EPS or the company’s last 12-month earnings per share; G is the company’s long-term (five years) sustainable growth estimate; 9 as the constant representing the appropriate P-E ratio for a no-growth company as proposed; and 2 for the average yield of high-grade corporate bonds.
The earning per share was average 5, while the sustainable growth rate was average 21. The annual growth rate was 51 average. On the other hand, the intrinsic value was $267 average.
The earnings per share (EPS) and the sustainable growth rate (SGR) factor intrinsic value.
Earnings per Share (EPS)
Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate you need to know the 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 = ROE x (1 – dividend-payout ratio)
Return on Equity (ROE) is an indicator of company’s profitability by measuring how much profit the company generates with the money invested by common stock owners.
Return on Equity shows how many dollars of earnings result from each dollar of equity. According to Cris, there are two approaches to calculating the sustainable growth rate. These are the relative ratio approach and the average ratio approach. I have summarized the difference between these two approaches in the table given below:
It shows that the average approach shows a greater result than by applying the relative approach. The margin of safety was greater by 1 percent, so as with the growth and the return on equity.
I want you to understand more clearly the relationship between the price and the intrinsic value in getting the margin of safety. Please follow me, I will explain to you what does the graph mean.
The intrinsic value (IV) is the true value of the stock and the EV line is the market price. The stock of AZN is trading below the true value of the stock or in other words, the stock price of AZN is cheap.
Further, the space between the two lines is the margin of safety. The margin of safety is the difference between the enterprise value and the intrinsic value. So, if we get the difference, the average would be 81 percent. This is the average margin of safety for AZN. The requirement of Benjamin Graham in buying the stock is at least 40-50 percent margin of safety, so this means, the stock of AZN is cheap and is a candidate for buying.
Price to Earnings/Earning Per Share (P/E*EPS)
This approach will help us 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. This will give us an idea about the status of the stock price.
The P/E*EPS valuation above shows that the stock was trading overvalued in 2007 and 2008. While during 2009 to the trailing twelve months, the stock was trading at an undervalued price. Because the price was lesser than the P/E*EPS ratio. Overall, the stock price is considered undervalued.
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 represents the price (P/E) and the difference represents the earnings (EPS).
The EV/EPS valuation, tells us how much is the price and the earnings in the enterprise value. It shows that the average price (P/E) was 20 percent and the earnings (EPS) was 80 percent average.
However, what important here is it separate the P/E and the EPS from the price. This is the price that the investor is willing to pay.
Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)
The EV/EBITDA tells us that it will take 5 years to cover the costs of buying the entire business. In other words, it will take 5 times the cash earnings of the company to cover the purchase price.
This valuation also indicates the profitability of the company considering the cash earnings of the company. Exclusive of the non-cash expenses against the market price, net of total debt and cash and cash equivalent. The average net margin of AZN is 23 percent.
The market capitalization of AstraZeneca plc (ADR) was stable at $62.8 billion average. The total debt represents 15.3 percent. An investor would be buying 100 percent equity in buying the entire business. The purchase price of the entire business to date, January 16, 2013, is $59.3 billion at $46.26 per share. While the market price to date was $59.08 per share.
The net current asset value approach tells us that the stock was overvalued and expensive. Because the ratio was greater than the 1.2 ratios. Therefore the stock of AZN was expensive.
The margin of Safety (MOS)
On the other hand, the margin of safety was 81 percent average. There was a margin of safety from 2007 to the trailing twelve months. The intrinsic value was $267 average and the earning per share was 5 average. On the other hand, the sustainable growth rate was 21 average. While the annual growth rate was 51 average.
Moreover, in the EV/EPS valuation, it shows that the price (P/E) 20 percent. Moreover, the earnings (EPS) was 80 percent average.
Furthermore, the EV/EBITDA valuation shows that it will take 5 years to cover the cost of buying AZN. In other words, it will take 5 times the cash earnings to cover the purchase price. The net margins of the company were 23 percent average.
There is a margin of safety at 81 percent in buying the stock of AZN. Therefore, I recommend a Buy in the stock of AstraZeneca plc (ADR).
Research and Written by Cris