Ascertaining the Best Multiple to Value Pharmaceutical Company Stocks – An Empirical Study

Abstract

Valuation of shares is done using different models and methods. Predominantly used methods include Discounted Cash Flow valuation (DCF) and Relative valuation method. DCF method uses the projected cash flow, growth and risk characteristics of firm to arrive at the Equity value. Relative valuation method uses the current prices of equity of similar firms to arrive at the equity value of the firm.Relative valuation involves conversion of current prices of similar assets of firms into standard multiples using value drivers like earnings or revenue or value of assets. These multiples are adjusted to reflect the financial position of the firm to be valued and used to arrive at the value of shares of firm. In practice, different analysts use different multiples to value stocks of the same company. The objective of this paper is to use empirical data of companies and arrive at a set of multiples that are capable of explaining share value better than the others. Financial data of Pharmaceutical sector companies for the period 2005-2010 is used for this analysis. Only pharmaceutical sector companies are considered based on the assumption that the primary value drivers like growth, margins and risk characteristics of companies operating in the same sector are likely to be similar. Significant factors that determine the multiples are arrived using regression method. On the basis of regression results, the sample companies are segmented into two sets of peer comparable groups. Valuation of all companies is done. The results indicate that selecting comparable companies based on ROE and net profit margins gives less pricing errors. PE multiple, PBV multiple and EV_EBITDA multiple outperform others in valuation of pharmaceutical company stocks.