Presented below is a chart of PS ratio across Australia Market, constructed using the Individual Company Information on Damodaran Online. As presented, the majority of the PS ratios of firms lie between 0 – 3 and over 10. Except firms from mining, metal and biotechnology industries which have PS ratio over 10, most of the firm in the sample have PS ratio from 0 – 3. WOW has a PS ratio of 1. 1359, which, we believe, is a comparable figure representing that WOW is correctly valued.
Since WOW does not fall into the mining, metal and biotechnology industry, thus it is reasonable to ignore the firms with 10+ PS ratios. As a result, the graph is skewed to the left. This chart below presents the PS ratios of firms outside the Australian market. The median for US market is 1. 36; 0. 93 for Europe market; 0. 51 for Japan market; 1. 74 for emerging markets. As illustrated below, most of the firms in these markets have PS ratio of 0 -3. Similar to other firms outside Australia, WOW has PS ratio of 1.1359, which lies between 0 -3.
In the section of the report, we will conduct analytical tests for WOW to identify sensitivity of PS ratio to changes in specific variables. In this part, we are assuming that WOW is a stable growth firm. The formula of PS ratio for a stable growth firm is: Price0Sales0= Net Profit Margin ? Payout ratio? (1+g) ke-g The first chart identifies a positive relationship between PS ratio and growth rate, and a negative relationship between risk free rate and PS ratio.
At a certain risk free rate, PS ratio increases at an increasing rate as the expected growth rate increases; and the PS ratio decreases as risk free rate increases, given a certain expected growth rate. Also, it is obvious that a lower risk free rate gives a higher increasing rate. The second chart describes the relationship between PS ratio, growth rate and net profit margin. As shown in the chart, there is a positive linear relationship between PS ratio and net profit margin, being that PS ratio increases as net profit margin increases.
Also, PS ratio increases as the growth rate increases. Moreover, for firms with higher growth rate, their PS ratios tend to increase faster as net profit margin increases. As shown above, the PS ratio is primarily driven by the firm’s Net Profit Margin. This is shown by a high t-stat and a low P-value, which explains Net Profit Margin is the most correlated and related fundamental variable to PS ratio compared to the rest. However, it is believed that WOW is relatively undervalued. Read which statement correctly explains the chart
This is showed by an adjusted R Square of 69.86% which suggested that the fundamental variables do not explain well, and hence lead to an incorrect prediction of the PS ratio and share price. Besides adjusted R Square, there are a few more causes for the unreliable results. First of all, a small sample size and not random samples will lead to a biased result. Next, high P-value and low t-stat for some fundamental variables proves that the result is not accurate. Besides that, standard error is also not considered low. Lastly, we believed that the expected residual value might not equal to zero, which will further lead to an unreliable and inaccurate result.
The stock of Woolworth is currently trading at $24. 63 per share, and according to our discounted cash flow model, we have estimated the share’s value of $22. 30 per share. This is implying that Woolworth’s stock is overvalued in the market at the moment. Therefore, we strongly recommend that investors should invest in Woolworth’s stock because the price is going to increase in the future. For those who are holding WOW’s stock should not try to sell it now, but rather hold on to it for a while and wait for it to appreciate.
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