- Objectives Budgeting
- To build a forcasted P&L for the next 3 years.
- To forecast the earnings per share for the next 3 years.
- To build 3 scenarios: Base / Optimistic / Pessimistic
- Methodology
Start with the Revenues
- Analyse the revenue growth in the last three years
- Identify the revenue guidance/strategy communicated by the company
- Compare the previous guidance provided by the company with the actual results and define if the guidance tend to be accurate, too optimistic or too pessimistic
- Identify revenue drivers (macro + micro)
- Build your main assumptions and explain them
Then budget the expenses
- Analyze the main expense items as a % of revenues in the last three years.
- Identify the cost/margin/EPS guidance communicated by the company
- Compare the previous guidance provided by the company with the actual results and define if the guidance tend to be accurate, too optimistic or too pessimistic
- Build your main assumptions (expenses as % of revenues) for each expense item over the next three years and explain your rationale.
Define the EPS and check the company’s valuation
- Divide the forecasted net income by the number of outstanding shares of the company to find your forecasted EPS.
- Do this for your 3 scenarios: base / optimistic / pessimistic
- Calculate the actual P/E (price/earning) ratio of the company = actual share price / last 12 months EPS
- Calculate the forecasted P/E = actual share price / your next 12 months forecasted EPS
- Compare (c.) and (d.) and conclude on whether the stock is a BUY or a SELL based on your assumptions.
Market pricing
- P/E ratios are commonly used by investors for relative valuation purposes.
- Everything else being equal, the lower the P/E the cheaper the stock.
- Relative valuation can be dangerous as it does not account for the specificities of the company.
- Weak balance sheet raise more risks
- Poor corporate governance may impair s/h value
Litigation, quality of products, lifecycle stage, degree of competitive advantage, etc