Budi Frensidy: Valutation in the Times of Pandemic
Nino Eka Putra ~ FEB UI Public Relations Officer
DEPOK, Monday, 22/6/2020 – Kontan daily published an article written by Budi Frensidy, professor of finance and capital market at FEB UI, entitled Valuation in the Times of Pandemic in the Bourse – Wake Up Call column, page 3. Below is the article.
Valuation in the Times of Pandemic
The basic principle of investing for all assets is actually the same, namely comparing value and price. Value is what we get or worth, while price is what we pay or cost. This principle applies universally to anyone, anywhere, anytime. The problem is, unlike the price that lies ahead of us, value (called intrinsic value or textbook fair value) is unobservable and must be calculated, or estimated to be precise.
For stocks, we estimate their relative or absolute value and then compare them with ratios or prices in the market. To obtain relative value, we recognize the most popular price-to-earnings ratio (PER) multiplication methods, PBV, and EV/ EBITDA. We compare the justified PER (or other ratio) of a stock with its actual PER. Fair PER can be derived from the industry average within a country or across countries or from the Gordon equation (P0 = D1 / (k – g)) then divided by EPS. In other words, PER = P0 / EPS = (D1 / EPS) / (k – g) or dividend payout ratio divided by (k – g).
Investors are of course looking for stocks whose actual PER is below their fair PER and sell shares whose actual PER is already above their fair ratio. This approach has a weakness because it only uses EPS from one period, either in the past (trailing) or in the future (forward). In addition, the use of average PER also assumes that all issuers have the same payout ratio, a risk that is reflected by the same discount rate (k) and growth rate (g). If one of these three variables is not the same, then the fair PER of one stock will also be different from other stocks even in the same industry.
Using a trailing PER based on annualized annual PER of 2019 or quarter 1, 2020 (multiplied by four), we will find that the actual PER is much lower than the reasonable PER because the current stock price has generally declined significantly, while the 2019 and 2020 EPS until March were still normal because the large-scale social restrictions had yet to be imposed. Does this mean the stocks are cheap? Not necessarily. The figure obtained will change if we use forward PER, namely PER based on this year’s EPS projection.
We all know that nearly all sectors have been affected by Covid-19. It is easier to find industries that are not affected than those that are affected, namely telecommunications, consumer goods & groceries, e-commerce, and pharmaceuticals. The demand for products from these sectors has not decreased, while the supply is also relatively unhindered, except for the pharmaceutical industry because 90% of its raw materials are imported and there is fierce competition among countries for the raw materials.
For most other sectors, this year’s EPS will be 20%-40% below last year’s. This will make the actual PER increase by 25% to 67%, i.e. 1/80% to 1/60%, which makes stocks relatively inexpensive. Some issuers will even experience a decline of more than 40%, such as flights, hotels, tourist attractions, entertainment venues, and tours & travel.
We will get a similar result if we calculate absolute values. There are three methods used for this, namely accounting-based (residual income model), cash flow-based, and asset-based (replacement cost model). The model most commonly used is discounted cash flow, from simple dividends to the more complex FCFF (corporate net cash flow) and FCFE (equity net cash flow). The discounted dividend model will produce exactly the same result as the PER method above.
The discounted dividend model, FCFF, and FCFE share a similarity, in that they depend on four main variables, namely size, timing, uncertainty, and cash flow growth rate in the coming years. Let’s analyze them one by one.
Cash flow and timing are likely to decline this year and next year. The cash flow conditions will only become normal in 2022 or in 2023 at the lastest. This is in line with the assumption of a state budget deficit that widens by more than 3% to GDP in 2020-2022.
In terms of uncertainty, a variable that reflects risks, all agree that uncertainty increases and remains high as long as there is no cure or vaccine for Covid-19. This will raise the discount rate so that the valuation will decrease. The behavioral approach to asset pricing even encourages investors to add a proxy for market sentiment towards the discount rate based on the CAPM. This has the same implication, namely an increase in the discount rate.
For the last factor, namely the growth rate, most corporations will experience contraction in sales and net income this year and next year. Normal economic conditions such as before the pandemic may only occur in 2022 or even 2023. This only applies to those who can survive through two very difficult years, 2020 and 2021. Therefore, it is only natural that the sectors most affected by the pandemic will report impairments. Given that the JCI is the leading indicator of the economy, the index will move up significantly before 2022, perhaps in the middle of 2021.
Those are the points I presented as a panelist in a joint webinar by ACCA-IAI-AFA, which took Valuation and Impairment Consideration Post Covid-19 Era as its theme on 11 June 2020. The event was attended by around 200 accountants from Indonesia, Malaysia and Singapore. In conclusion, due to the current low valuation of most corporations, the JCI still needs 1.5 to 2 years to return to the figure of 6,300 recorded early this year. Hopefully, we and all issuers on the IDX can survive this pandemic. Stay healthy! (hjtp)
Source: Kontan daily, Monday, 22 June 2020 edition, Bourse– Wake Up Call column, page 3.
(lem)