Question

7. Becker Products is a manufacturer and distributor of numerous food products. The company has a book value of $19.15 per share. Becker Products is part of the food processing industry which has an industry PB ratio of 3.15. Using industry information, estimate the intrinsic value of Becker Products’ equity per share?

Answer 1

Answer:

$60.32

Explanation:

The intrinsic value of a company is the theoretical value of any company and is essentially the price that investors would want to pay given the level of risk associated with an investment in the company. Intrinsic value is  calculated commonly from an investment appraisal standpoint whereby an investor may determine whether a stock is undervalued or overvalued or an investor may put a price on a stock that is not openly traded. There are multiple approaches towards calculating intrinsic value. The most comprehensive approaches are the ones that solely focus on "company centric" factors such as sales levels, cash flows, costs, discount rates and so on and so forth. This is commonly known as the discounted cash flow model in which you calculate the present value of all future cash flows of the company. Since this model is complicated to use, there are other approaches to calculate sort of a "back of the hand" intrinsic value. An example of such an approach is the relative/comparative valuation approach in which you calculate the price an investor would be willing to pay using examples of other similar instruments that an investor has made and assuming that a similar price would be paid for this investment as well.

The question at hand refers to a method known as the comparable company analysis in which an industry ratio is used to derive the price of Becker Products. So, the Price to Book value for the industry is given as 3.15 for the industry. Using comparative analysis we will assume that this ratio is the same for Becker (since it operates in the same industry and this is the industry average so the actual ratio should be close to the average). Formula for calculating PB is PB = Price per Share/Book Value per share. We have PB as 3.15 and Book Value per Share as 19.15. Re-arranging the formula becomes, Price per Share = PB x Book Value per Share = 3.15 x 19.15 = $60.32.

So we can estimate that, relative to the industry, the equity per share can be estimated as $60.32 per share which is the price investors would be willing to pay for the level of risk in the company.

Again, this is simply an estimation of the intrinsic value. Not the actual intrinsic value since the factors involved are external and industry specific. Discounted cash flows methods are better adopted to calculate the intrinsic value.