Nicole Cordingley

Financial Management
Professor Schozer
May 5, 2015
Equity Valuation
Equity valuations are used to objectively value a firm. There are three majors groups of
equity valuations comparable multiples, discounted cash flows, and asset-based valuation
models. Using equity valuation allows an investor to determine a companys intrinsic value.
From the intrinsic value, it can be determined whether the company is undervalued, fairly
valued, or overvalued. The most investment opportunity lies within companies that are
undervalued, while overvalued companies offer the best opportunity to sell. Equity valuations
are very useful for an investor looking to profit.
Comparable multiples are an equity valuation tool that is useful when comparing
companies within the same industry. These are helpful in identifying which companies are most
opportune to invest in and which are not. Comparable multiples use share price and enterprise
value multiples. Some examples of share price multiples are price/earnings and price/sales.
Examples of enterprise value multiples are enterprise value/EBITDA and enterprise value/sales.
Discounted cash flows, also known as present value models, value a firm based on the
present value of its expected future cash flows. The dividend discount model presents an
intrinsic value based on expected future cash flows to shareholders. The free-cash-flow-toequity model provides a value based on cash flows available to shareholders after current
liabilities and working capital needs are met. There are a number of models based on this
method, but two of the most commonly used are the Gordon growth model and the two-stage
dividend discount model. The Gordon growth model is based on a firms constant rate of growth
and constant rate of return. This method is best used with mature companies that pay a dividend
and are insensitive to fluctuations in the economy. The two-stage dividend discount model is
appropriate for companies that are growing rapidly or have expected changes in growth. This

method considers the likely fact that a company will grow quickly at its outset, as it expands, but
will eventually reach maturity and a constant growth rate.
Asset based valuation models use the estimated value of a firms assets minus the value
of its liabilities and preferred shares to find the intrinsic value of its common shares. This
method assumes that the value of a company is equal to the sum of the value of the businesss
assets.
To exemplify equity valuations, I will be valuing and comparing Nike, Under Armour,
and Lulu Lemon. These three companies are all well known sports apparel manufacturers based
in North America. Nike and Under Armour both trade on the NYSE, while Lulu Lemon trades
on the NASDAQ. For the purposes of this paper, differences in these exchanges should be
insignificant.
Using the current market price of a stock and numbers of outstanding shares and bonds,
the market value of an entity can be determined. Shares of Nike currently trade at $100.53.
There are 682.19 million shares outstanding. This means that the market value of Nikes
common stock is $68.58 billion. Nike has three bond issues outstanding. The first is for $500
million, currently selling at 98.5. Another is for $500 million, currently selling at 96.7. The last
is for $100 million, currently selling for 102.1. The market value of Nikes debt is $1.078
billion. The sum of market value of Nikes debt and equity is $69.66 billion, which is Nikes
market value.
I used the same methodology to find the market value of both Under Armour and Lulu
Lemon. Under Armour currently trades at $77.05. The market value of UAs equity is $13.82
billion, and they have no outstanding bonds, which puts UAs market value at $13.82 billion.
Lulu Lemon currently trades at $64.44. The market value of LULUs equity is $8.71
billion, and the company has no debt, therefore, LULUs market value is $8.71 billion.
Using present value models, the values of these companies can be ascertained via the
Gordon growth model or the Free Cash Flows to Equity model. The Gordon growth model is a

discounted cash flow approach to valuation. This method uses dividends as the metric, and
assumes a constant perpetual growth rate. This method is best used for companies that pay
dividends, are at the mature growth phase, and are insensitive to economy cycles. This method
can be used for Nike, but not for Under Armour or Lulu Lemon, as neither pays dividends.
To estimate Nikes value using the Gordon growth model, we first start with the formula:
(Dividend most recently paid*(1-dividend growth rate))/(rate of return dividend growth rate).
For the dividend growth rate, we can use the companys estimated growth rate over the next five
years of 12.15%. We could also use the formula of earnings retention rate * return on equity to
find the dividend growth rate. The earnings retention rate is equal to 1 dividend payout ratio.
For Nike, the dividend growth rate = (1 30%)*26.43% = 18.50%. To compute the required
rate of return, I will use CAPM. The CAPM rate is equal to the risk-free rate + (beta*market risk
premium). For the CAPM, we will use the market risk premium calculated by NYU Stern of
5.78% and the current rate on a 10 year treasury bond of 2.19% for the risk free rate. Nikes beta
is .51, therefore the companys CAPM is 5.138%. Now we would estimate Nikes value using
the Gordon growth model: ($1.12*(1 - .1850))/(.05138 - .1850). Because the required rate of
return is less than the dividend growth rate, the Gordon growth model cannot be used for Nike.
Neither Under Armour nor Lulu Lemon distributes dividends, so we cannot use the
Gordon growth model to estimate their values. However, there is value in comparing each of
these companys required rates of return. Nikes CAPM is 5.138%. We will use the same market
risk premium and risk free rate for Under Armour and Lulu Lemon. UAs beta is -.04%,
therefore, their CAPM is 1.959%. LULUs beta is .35, which puts their CAPM at 4.213%. Of
these three companies, Nike has the highest required rate of return, which means that it has the
highest cost of capital. We can use the residual income method of value which equals
income/discount rate to value these firms. Nikes EBITDA is $4.80 billion. The companys

residual income value is $4.80 billion/.05138 = $93.42 billion. Under Armours residual income
value is $437.15 million/.01959 = $22.31 billion. Lulu Lemons residual income value is
$428.02 million/.04213 = $10.16 billion. Nikes residual income value is highest because its
EBITDA is much higher than that of the other two companies. Compared to its EBITDA, Under
Armour is most highly valued using this method because its required rate of return is so low, due
to its near-zero beta coefficient. This beta means that this stock carries basically no risk; it is
about equivalent to the risk of money in a savings or checking account. Of these companies,
Nike has the highest beta, and therefore carries the most risk of fluctuation. However, all of
these have betas of less than 1, which means that they carry less risk than the market as a whole.
Using the values given by the residual income method, we can determine an intrinsic
value per share for each company by dividing the value found by number of shares outstanding.
For Nike, each share should be worth $93.42 billion/682.19 million shares outstanding, which
equals $136.94. Under Armours shares should be worth $124.42. Lulu Lemons shares should
be worth $76.88. Using this methodology, all of these companies are undervalued. A share of
Under Armour would be undervalued by nearly $50.
To compare these companies values, we can also use comparable multiples. The
price/earnings ratio evaluates a company by comparing its share price to its per share earnings.
Nikes P/E ratio is 28.70, UAs P/E ratio is 82.17, and LULUs P/E ratio is 38.74. This value is
what it costs for $1 of current earnings. Comparing these ratios, it is clear that investors are most
willing to pay for Under Armours earnings, which suggests that there is expected growth in the
future, or it could suggest that Under Armour is overvalued.
Another comparable price multiple is price/sales. The price to sales ratio compares a
companys equity at market value with its total revenues. This can also be expressed as what
investors are paying for $1 of sales. Nikes price/sales ratio is 2.87, UAs is 5.10, and LULUs is

5.12. A lower price/sales ratio is generally preferable, as it means that the company is generating
more return on their equity.
The price/book ratio compares market value of a share to its book value. Nikes
price/book is 7.01, UAs price/book is 11.96, and LULUs price/book is 8.44. These high values
mean that all of these shares are trading at more than book value. One reason for this is that a
large part of the value of all of these companies is due to intellectual value the value of the
brand and its associated intellectual property. A company can also have a high price/book ratio
because it has been consistently earning a high return or because it is overvalued. We can
compare the price/book with the return on equity to evaluate the companys growth. Nikes ROE
is 26.43%, UAs ROE is 16.54%, and LULUs ROE is 21.87%. For comparison, the average
ROE for the S&P 500 is 18.15%. Under Armours growth is less than the average market
growth, but it has the highest price/book ratio. This is a sign that Under Armour is overvalued,
especially when compared to similar companies.
Enterprise value ratios can also be used to compare companies. The enterprise
value/revenue multiple compares a companys enterprise value to its revenues. Nikes enterprise
value/revenue multiple is 2.74, Under Armours is 5.64, and Lulu Lemons is 4.88. Nikes
enterprise value is most closely related to its revenues, while Under Armours enterprise value is
about 5.5 times its revenues.
The enterprise value to EBITDA multiple values a company by relating its enterprise
value as a multiple of its earnings. Nikes EV/EBITDA multiple is 17.26, Under Armours is
41.91, and Lulu Lemons is 20.50. A lower multiple means that a company may be undervalued
while a higher multiple means that a company may be overvalued.
Comparable multiples can be used to determine which stock or stocks within an industry
are best to invest in. It is typically best to invest in an undervalued stock, unless a stock is
undervalued because the company is failing. Multiples can also be used to find which stocks are

overvalued. Sometimes a stock is simply overvalued, and sometimes it has a high value because
it is expected to have high growth in the future. After considering the comparable multiples of
Nike, Under Armour, and Lulu Lemon, it seems that Nike offers the best value, and that Under
Armour is somewhat overvalued. It is important to note that Nike does not offer the best value
because it is the most valuable in terms of sheer assets, but rather because generates the highest
return on its assets and has a lower stock price as a multiple of earnings. On the other hand,
Under Armour seems like a poor investment currently, because its stock price is much higher as a
multiple of its earnings. This may be because investors deem that it is poised for growth in the
future. For someone who already owns Under Armour, this may be a good time to sell because
the value of the company is high compared to its current returns and the current returns in the
industry.
In conclusion, there are a number of methods for valuing a company based on its equity.
A companys gross market value can be determined easily by combining the market value of its
debt and equity. An intrinsic value of the companys equity can be determined using dividend
discount models which consider the present value of the companys expected cash flows. To get
an idea of a companys value compared to its peers, comparable multiples are very useful.
Comparable multiples also give insight to how fairly a company is valued, and are a very reliable
measure due to their simplicity. No matter the method used, equity valuations are an important
measure because they allow an investor to objectively consider the value of an investment.

Works Cited:
1. Implied Equity Risk Premiums for US Market. (2015, January 5). Retrieved May
3, 2015, from
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/implpr.html
2. Daily Treasury Yield Curve Rates. (2015, May 5). Retrieved May 5, 2015, from
http://www.treasury.gov/resource-center/data-chart-center/interestrates/Pages/TextView.aspx?data=yield

3. (n.d.). Retrieved May 3, 2015, from http://finance.yahoo.com/

4. Nagorniak, J., & Wilcox, S. (n.d.). Equity Valuation: Concepts and Basic Tools.
In Investments: Principles of Portfolio and Investment Analysis.