How to use PSR with the key fundamental factor to value companies

Key fundamental factors in intrinsic multiples

Among the fundamental factors that make up each intrinsic (or theoretical) multiple in relative valuation, the key critical factor is as follows.

 Multiples Main Fundamental Factor PER Expected growth rate in EPS EV/EBITDA Reinvestment rate PBR ROE PSR Net margin EVSR After-tax operating margin

Analysing a multiple with the key fundamental factor together helps to determine whether the stock price in the market is overvalued or undervalued. For example, suppose that the PER of company A and B, which have a similar business, are 10 and 15 respectively. We might judge that A is undervalued just when looking at the multiple alone. However, if you predict the growth rate of A and B to be 5% and 15%, the PEGs are 2 and 1 respectively. Therefore, it is highly likely that the stock price of B, which has a lower PEG, is undervalued than A.

Let’s see the PSRs with the fundamentals to evaluate the stock prices of other companies.

PSR comparison between Just Eat and Delivery Hero

Just Eat (Just) and Delivery Hero (Hero) are large European food delivery service companies. Just is headquartered in London, UK, operating in 13 countries. It went public on the London Stock Exchange in February 2020.

Hero is headquartered in Berlin, Germany, and operates in 40 countries, including Asia and the Middle East. It also operates Yogiyo and Beadal-Tong in South Korea. Besides, it has recently taken over one more business, Beadal Minjok, the largest one in South Korea. Hero is listed on the German Stock Exchange.

The primary market data and fundamentals of the two companies are as follows:

Source: Yahoo Finance

The market caps of Just and Hero are £12.5 billion and €18.3 billion respectively as of September 2020. Hero is slightly higher in it. PSR is 10 and 11 respectively, which are similar, and EVSR is 13.8 and 10.4, where Just is higher.

Let’s look at the key fundamentals, net margin and operating margin, to compare those multiples. Yahoo Finance did not disclose the timing of the margins, but it seems the middle of 2020. The net margin is in the red for both companies, but Just has a smaller deficit with -15.5% than Hero’s -55.8%. As for operating margin, Just is 0%, and Hero is -51.4%. Just’s margin is better than Hero’s.

The PSR multiples of Just and Hero are similar. From the perspective of the fundamentals, however, Just’s stock price seems to be undervalued than Hero’s.

Even in the EVSR multiple, it is not easy to decide that Just is overvalued than Hero. Let’s estimate whether the margins of the two companies could improve in the future with only the past income statements.

Source: Yahoo Finance

Total revenues of Just and Hero have grown at a similar level with four times over the last four years. For that period, Just’s operating margin has been on the decline. Even more so considering that it is 0% in 2020. Hero’s operating margin also seemed to improve, but when considering -51.4% in 2020, it is difficult to predict the direction. Net profit turned to the black in 2019. It seems to be from non-recurring items, however, given that the operating profit was in the red while net profit was in the black. Moreover, since it has gotten down to -56% in 2020, it is still challenging to predict the turn to a surplus.

When judging from those, Hero’s stock price seems more overvalued than Just.

Don’t forget that this analysis is a comparison of two companies’ stock price. It is not an absolute stock valuation for one company.

Case: Valuation of Deliveroo using PSR

By using PSR or EVSR multiples, you could estimate the stock value or the enterprise value of a company having a high sales growth rate and a likely improvement in operating margin.

For example, you predict sales after five years for the target company. Then, you evaluate its stock or enterprise value using the PSR or EVSR of the peers. Finally, you convert the corresponding value into the present value.

Case: London-based Deliveroo is a food delivery service company founded in 2013. It operates in 200 cities in the UK, as well as Europe, the Middle East, Australia, Singapore and Hong Kong. Deliveroo’s sales had grown from £277 million in 2017 to £476 million in 2019, 72% totally or 31% annually. Based on that, let’s assume that sales over the next five years would grow at an average 15% annually, reaching about £951 million in 2024. Deliveroo’s equity cost is 5.05% (= 0.19% + 0.65 x 7.47%). Also, the average PSR of Just Eat and Delivery Hero is 10.46 as its peer group. Now, you can value Deliveroo’s stock as follows.

Share value after 5 years = £951 M x 10.46 = £9,947 M

Current Share Value = £9,947 M / 1.05055 = £7,775 M

Deliveroo stock is estimated at £7,775 million, around £7.8 billion. In this case, the reason for using the expected future sales rather than the current one is we admit that the value of a company with apparent growth increases. When using the current sales, Deliveroo’s stock value is £5.0 billion (£476 million x 10.46). For investors, it is advantageous to invest in Deliveroo at this value of £5.0 billion. However, if the trend of growth is evident, Deliveroo’s owner would never accept the valuation based on current sales.