TITLE:
Predicting Accuracy of Valuation Multiples Using Value Drivers: Evidence from Indian Listed Firms
AUTHORS:
Vandana Gupta
KEYWORDS:
Equity, Valuations, Prediction, Earnings, Book Value, Enterprise Value
JOURNAL NAME:
Theoretical Economics Letters,
Vol.8 No.5,
March
19,
2018
ABSTRACT: The objective of this
research study is twofold: 1) to evaluate the prediction accuracy of four valuation multiples across three
sectors for Indian listed firms and 2) to identify the fundamental drivers for
these multiples. The valuation multiples identified for this study are: price
to earnings (P/E), price to book value (P/BV), price to sales (P/S) and
enterprise value to earnings before interest, depreciation, tax and
amortization (EV/EBIDTA) and the sectors taken are steel, banking and
automobile. Multiple regression methodology is followed with the valuation
multiple as dependent variable and the value drivers as independent variables,
to get predicted multiples on 470 firm observations. By regressing the
multiples on fundamental variables, the best suited multiple for each sector
and the key drivers of the multiple are obtained. The empirical findings based
on root mean square error (RMSE) and Theil coefficient reveal that least
prediction errors are observed in P/S and EV/EBIDTA for the automobile sector,
EV/EBIDTA for the steel sector and P/BV for the banking sector. It is also
observed that the significant variables that explain these multiples are beta,
return on equity (ROE), return on capital employed (ROC), dividend payout ratio
(D/P) and net profit margins (NPM). These findings are in line with the
derivation of fundamental drivers for each multiple as explained in Gordon
model. Damodaran: 2007 [1]. The present work contributes to emerging
market literature on equity valuations and attempts to compare valuations based
on market approach using value drivers. A comparison of forecasts with actuals
helps in recommendations to buy/sell/accumulate/hold for equity investors and
is also pertinent for market participants and financial regulators.