Page 166 - DMGT553_RETAIL_STORE_MANAGEMENT

Unit 9: Store Finance and Controls

The Nerbrand Z is therefore expressed as Notes

where H [P/E] = normalised P/E, e.g. a 5 year historical average of 12 month forward P/E ratios.
E12 = mean 12 month forward earnings estimates
St. dev.(E12) = standard deviation of 12 month forward earnings estimates.

A negative number indicates that earnings can be downgraded before valuations normalise.
As such, a negative number indicate a valuation adjusted earnings buffer. For example, if the
12 month forward means EPS forecast is $10, the price of the equity is $100, the historical average
P/E ratio is 15, the standard deviation of EPS forecast is 2 then the Nerbrand Z is -1.67. That is,
12 month forward consensus earnings estimates could be downgraded by 1.67 standard deviation
before P/E ratio would go back to 15.
Return on Invested Capital (ROIC): This valuation technique measures how much money the
company makes each year per dollar of invested capital. Invested Capital is the amount of
money invested in the company by both stockholders and debtors. The ratio is expressed as a
percent and you should look for a percent that approximates the level of growth that you expect.
In its simplest definition, this ratio measures the investment return that management is able to
get for its capital. The higher the number, the better is the return.
To compute the ratio, take the pro forma net income (same one used in the EPS figure mentioned
above) and divide it by the invested capital. Invested capital can be estimated by adding together
the stockholders equity, the total long and short term debt and accounts payable, and then
subtracting accounts receivable and cash (all of these numbers can be found on the company’s
latest quarterly balance sheet). This ratio is much more useful when you compare it to other
companies that you are valuing.
Return on Assets (ROA): Similar to ROIC, ROA, expressed as a percent, measures the company’s
ability to make money from its assets. To measure the ROA, take the pro forma net income
divided by the total assets. However, because of very common irregularities in balance sheets
(due to things like Goodwill, write-offs, discontinuations, etc.) this ratio is not always a good
indicator of the company’s potential. If the ratio is higher or lower than you expected, be sure to
look closely at the assets to see what could be over or understating the figure.
Price to Sales (P/S): This figure is useful because it compares the current stock price to the annual
sales. In other words, it tells you how much the stock costs per dollar of sales earned. To compute
it, take the current stock price divided by the annual sales per share. The annual sales per share
should be calculated by taking the net sales for the last four quarters divided by the fully diluted
shares outstanding (both of these figures can be found by looking at the press releases or
quarterly reports). The price to sales ratio is useful, but it does not take into account any debt the
company has. For example, if a company is heavily financed by debt instead of equity, then the
sales per share will seem high (the P/S will be lower). All things equal, a lower P/S ratio is
better. However, this ratio is best looked at when comparing more than one company.
Market Cap: Market Cap, which is short for Market Capitalization, is the value of all of the
company’s stock. To measure it, multiply the current stock price by the fully diluted shares
outstanding. Remember, the market cap is only the value of the stock. To get a more complete
picture, you’ll want to look at the Enterprise Value.
Enterprise Value (EV): Enterprise Value is equal to the total value of the company, as it is trading
for on the stock market. To compute it, add the market cap (see above) and the total net debt of
the company. The total net debt is equal to total long and short term debt plus accounts payable,
minus accounts receivable, minus cash. The Enterprise Value is the best approximation of what

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