Valuation using Return On Equity

This method values a business as an investment opportunity. It uses the company’s return on equity to project earnings and dividends 5 to 10 years into the future to get the future value of the company. This value is then discounted back to present value to get the value of the business.

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Valuing "WPP WPP PLC"

Valuation Assumptions

Latest quoted share price	£
Number of ordinary shares

Number of years to project
Required annual rate of return	%

Latest reporting financial year
Total cash & cash equivalents	£
Total interest-bearing debts	£

Shareholders' equity	£
Return on equity	%
Dividend payout	%
P/E	x

Valuation Results

£1.73 Highest price you can pay to get 10% annual return	-19.7% Your annual return if you pay at market price £8.33
0% Your annual return if you pay at intrinsic value £-1.79	-121.5% Value Vs Price variation

Projection Horizon

Year	Growth	Shareholders' Equity	Net Earnings	Dividend
2024	-2%	£3,307,821,680	£115,773,759	£182,575,218
2025	-2%	£3,241,020,221	£113,435,708	£178,888,111
2026	-2%	£3,175,567,818	£111,144,874	£175,275,466
2027	-2%	£3,111,437,226	£108,900,303	£171,735,778
2028	-2%	£3,048,601,751	£106,701,061	£168,267,574

Calculations

Net profit in year 2028	£106,701,061
Market value in year 2028 (£106,701,061 x 19.8)	£2,112,681,013
Total dividends received over the period	£876,742,146
Expected total return in year 2028 (£2,112,681,013 + £876,742,146)	£2,989,423,159
Value of company operations (£2,989,423,159 discounted at 10%)	£1,856,196,583
+ Add cash & cash equivalents	£2,218,000,000
- Less total interest-bearing debts	£5,995,000,000
Business intrinsic value	£-1,920,803,417
Business intrinsic value per share	£-1.79

+Tips & Advice

Return on equity (ROE) measures the rate of return that was delivered to the company’s shareholders. ROE is a key driver of company value. It is a fundamental indication of a company’s ability to increase its earnings per share and thus the quality of its stock. It reveals how well a business is using its money to generate additional earnings and is applicable to most industries. ROE also allows investors to compare a company’s use of their equity with other investments and to compare the performance of companies in the same industry. Businesses that generate high ROE with minimal debts employed can pay off their shareholders handsomely and create substantial assets for each pound invested. A ROE of 15% is very satisfactory. Beware where shareholders’ funds have been depressed by unusual factors such as write-offs, this ratio can send a false positive signal.
Shareholders' funds increase as a company retains some or all of its earnings each year but can be diluted because of new issues of shares; conversion of debt instruments and share options.
Companies adopt dividend policies to suit their business needs. The dividend pay-out percentage is usually related to the sectors they operate and business strategies they adopt. Stable low-growth companies often pay out high percentage of earnings. Too high dividend pay-out ratio can affect earnings growth as the company reserves less cash to re-invest in the business for future growth.
Theoretically the faster a company is expected to grow, the higher the price to earnings (P/E) ratio that investors would award it. It is one measure of how cheap or expensive a share appears. P/E ratios vary widely from the sector average even though the constituent companies may all be engaged in broadly similar businesses. This is because one company may be more efficient and profitable than the other and so the market might recognise this by awarding the more profitable share a higher P/E. Beware, many high P/E shares have in the past been the most awful long-term investments when the promise of future rapid growth failed to materialised. In contrast many low P/E companies operate in perceived dull industries have proved over time to be outstanding investments. For businesses that operate in a cyclical industry with unstable earnings you should use the weighted average of earnings for a more reliable reflection of the company’s earnings power.
The ROE method works well with companies that have relatively straightforward balance sheets and a steadily growing business. Asset-based or income-orientated investment do not fit well with this approach.