Price to earnings (P/E) determinants and the valuation of private firms
: a cross-country comparison

  • Ioannis Tsalkamas

    Student thesis: Doctoral Thesis


    Private firms are the predominant form of incorporation in both the developed and the developing world. They were, however until recently under-researched, mainly due to the lack of data availability. To overcome this difficulty, both researchers and academics approximate private entities through public equivalents. One of the inputs that is needed to do that is the discount rate, by which the cash flows, from investing in a private firm, need to be adjusted to account for the risk that such investments entail.
    The main focus of this thesis is to carefully examine the variables that have been identified throughout the literature, as being impactful to the discount rate. These factors are examined through the scope of a novel methodology and will allow appraisers to have a framework of reference when valuing a private company. The purpose is not only to highlight the determinants of the Price to Earnings (P/E) ratio in the private companies’ valuation however, but to do so in an international setting, as both the UK and the US are examined, in an attempt to document differences in the risk profiles of investors from these countries.
    To determine the level at which each of the factors, affects the discount rate, Principal Component Analysis is employed, on public companies, selected to proxy private firms. This methodology is used to reduce the size of extensive datasets, while retaining most of their variability. The components produced, are linear combinations of the original variables, devoid of any multicollinearity issues inherent in large datasets. These components are then regressed against a valuation proxy, a Price-to-Earnings ratio, calculated initially for the public companies’ dataset and later, for a private companies’ set, the latter being adjusted to account for the illiquidity discounts exclusive to private enterprises during the Mergers and Acquisitions process.
    The results indicate that a private company’s discount rate can be approximated best with the inclusion of the Free Cash Flows (FCF), the Debt-to-Equity, Assets, Cost of Debt, Total Beta, Z-Score, Auditors and Jensen’s Alpha for the UK and Earnings Before Interests Taxes Depreciation Amortization (EBITDA), external shocks (Financial Crisis), FCF, Debt-to-Equity, Return on Capital, Percentage of Insiders Holding Stock, Beta, Tax Rate, Marginal Profit (MPK) and Jensen’s Alpha for the US. Investors from the UK, appear to be more risk-averse than their US counterparts, as they seem to value traditional variables more, than the ones focused on profitability, earnings and debt.
    Date of AwardAug 2020
    Original languageEnglish
    Awarding Institution
    • University of Portsmouth
    SupervisorRichard Trafford (Supervisor) & Konstantinos Kallias (Supervisor)

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