Application of Principal Component Analysis on Equity Valuation Multiples: Evidence from Malaysian Firms
Keywords:
equity valuation multiples, price-earnings, price-book value, price-cash flow price-sales multiples, principal component analysis, MalaysiaAbstract
Investment analysts often used equity valuation multiples to assess the performance of stocks in relation to likely future return to shareholders. Valuation multiples used by analysts are price to earnings, price to book value, price to cash flow and price to sales multiples. However, researchers have argued that correlation exists between the multiples hence assessing them individually and later merging them to one multiple results to reduplication. This study employed the principal component analysis (PCA) method to condense the four equity valuation multiples (EVM) of 223 randomly selected listed firms in Malaysia for the period of 2008-2013. The PCA result reveals that three (3) components explained 99% of the total variables variance. Suggesting that, the three components (price to earnings, price to book value and price to cash flow multiples) can satisfactorily explain all the EVMs. The implication is that strong correlation exists between EVMs of Malaysian firms. Therefore, the study recommends the application of principal component analysis methodology in the analysis of the equity valuation multiples because of correlation that exists between the valuation multiples. The study is limited to EVMs, entity valuations are not covered in the study. Applying PCA to equity valuation multiples ensures accuracy and reliability of result interpretation due to absence of multicolearity in the decomposed principal component.
Downloads
References
Ahuja, V., & Medury, Y. (2010). Corporate blogs as e-CRM tools – Building consumer engagement through content management. Journal of Database Marketing & Customer Strategy Management, 17 (2), 91–105. doi:10.1057/dbm.2010.8
Ammann, M., Oesch, D., & Schmid, M. M. (2011). Corporate governance and fi rm value : International evidence. Journal of Empirical Finance, 18, 36–55. doi:10.1016/j.jempfin.2010.10.003
Ashton, D., Cooke, T., Tippett, M., & Wang, P. (2003). Linear information dynamics, aggregation, dividends and “dirty surplus” accounting (Vol. 1). Exeter, Bristol.
Ayoola, F. J., Adeyemi, M. A., & Jabaru, S. O. (2015). On the Estimation of Crime Rate in the Southwest of Nigeria : Principal Component Analysis Approach Global Journal of Scientific Research, 15(2), 1–9.
Bensemann, J., & Shadbolt, N. (2015). Farmers ’ Choice of Marketing Strategy : A Study of New Zealand Lamb Producers. International Food and Agribusiness Management Review, 18 (3), 211–243.
Bird, R., & Casavecchia, L. (2007). Sentiment and Financial Health Indicators for Value and Growth Stocks: The European Experience. Sentiment and Financial Health Indicators for Value and Growth Stocks: The European Experience. doi:10.1080/13518470701705777
Boone, A. L., Casares, F. L., Karpoff, J. M., & Raheja, C. G. (2007). The determinants of corporate board size and composition: An empirical analysis. Journal of Financial Economics, 85 (1), 66–101. doi:10.1016/j.jfineco.2006.05.004
Brooks, C. (2008). Introductory econometrics for finance. The Edinburgh Building, Cambridge CB2 8RU, UK: Cambridge University Press.
Chen, K. H., & Shimerda, T. A. (1981). An empirical analysis of useful financial ratios. Financial Management, Spring, 51–63.
Dey, A. (2008). Corporate governance and agency conflicts. Journal of Accounting Research, 46 (5), 1143–1181. doi:10.1111/j.1475-679X.2008.00301.x
Elbadry, A., Gounopoulos, D., & Skinner, F. (2015). Governance Quality and Information Asymmetry. Financial Markets, Institutions & Instruments, 24(2-3), 127–157. doi:10.1111/fmii.12026
Fairfield, P. M. (1994). P / E , P / B and the Present Value of Future Dividends. Financial Anaiysts Journal, JULY(August), 23–32.
Gherghina, Ş. C. (2015). Corporate Governance Ratings and Firm Value : Empirical Evidence from the Bucharest Stock Exchange. International Journal of Economics and Financial Issues, 5 (1), 97–110.
Graham, D. J., Wagner, M. S., & Castner, D. G. (2006). Information from complexity: Challenges of TOF-SIMS data interpretation. Applied Surface Science, 252 (19), 6860– 6868. doi:10.1016/j.apsusc.2006.02.149
Habib, A., & Azim, I. (2008). Corporate governance and the value-relevance of accounting information: Evidence from Australia. Accounting Research Journal, 21 (2), 167–194. doi:10.1108/10309610810905944
Isaksson, A., & Lantz, B. (2015). Outsourcing strategies and their impact on financial performance in small manufacturing firms in sweden. International Journal of Business and Finance Research, 9 (4), 11–20.
Ittner, C. D., & Larcker, D. F. (2001). Assessing empirical research in managerial accounting: a value-based management. Journal of Accounting and Economics, 32, 349– 410.
Jing Liu, Nissim, D., & Thomas, J. (2002). Equity valuation using multiples. Journal of IPBJ Vol. 7(2), 17-26 (2015) 25
Accounting Research, 40, 135–172.
Kim, C. (1986). New books in review. Journal of Marketing Research, November, 485–487. Kong, X. (2011). Why are social network transactions important ? Evidence based on the
concentration of key suppliers and customers in China. China Journal of Accounting
Research, 4(3), 121–133. doi:10.1016/j.cjar.2011.06.003
Kuo, C.-Y., & Tswei, K. (2011). Does corporate governance influence equity value? An
evidence from Taiwan electronic industry. The ¡nternational Journal of Finance, 22, 6525–6546.
Larcker, D. E., & Richardson, S. A. (2007). Corporate governance, accounting outcomes, and organizational performance. The Accounting Review, 82, 963–1008.
Lenka, S. K. (2015). Measuring financial development in India : A PCA approach. Theoretical and Applied Economics, XXII(1), 187–198.
Libby, R. (1975). Accounting ratios and the prediction of failure: Some behavioral evidence. Journal of Accounting Research, Spring, 150–163.
Liu, J., Nissim, D., & Thomas, J. (2007). Is cash flow king in valuations? Financial Analysts Journal, 63, 56–70.
Lys, T., Naughton, J. P., & Wang, C. (2015). Signaling through corporate accountability reporting. Journal of Accounting and Economics, 60(1), 56–72. doi:10.1016/j.jacceco.2015.03.001
Miller, K. D., & Bromiley, P. (1990). Strategic risk and corporate performance: An analysis of alternative risk measures. Academy of Management Journal, 33, 756–779.
Nikolaev, V. V. (2010). Debt covenants and accounting conservatism. Journal of Accounting
Research, 48(1), 137–175. doi:10.1111/j.1475-679X.2009.00359.x
Passamani, G., Tamborini, R., & Tomaselli, M. (2015). Sustainability vs credibility of fiscal consolidation. The Journal of Risk Finance, 16(3), 321–343. doi:10.1108/JRF-11-2014-0163
Penman, S. H. (2006). Valuation, capital budgeting, and value-based management. Journal of Applied Corporate Finance, 18, 1–10.
Sajedinejad, S., Majdzadeh, R., Vedadhir, A., Tabatabaei, M., & Mohammad, K. (2015). Maternal mortality: a cross-sectional study in global health. Globalization and Health, 11(1), 4. doi:10.1186/s12992-015-0087-y
Schreiner, A. (2007). Equity valuation using multiples: An empirical investigation. University of St.Gallen Graduate.
Sehgal, S., & Pandey, A. (2010). Equity valuation using price multiples: evidence from India. Asian Academy of Management Journal of Accounting and Finance, 6, 89–108.
Shahed, I., Barker, R., & Clubb, C. (2008). The Use of Valuation Models by UK Investment Analysts. European Accounting Review, 17, 503–535.
Sheu, H., & Lee, S. (2012). Excess cash holdings and investment: the moderating roles of financial constraints and managerial entrenchment. Accounting and Finance, 52(September 2011), 287–310. doi:10.1111/j.1467-629X.2012.00500.x
Vyas, S., & Kumaranayake, L. (2006). Constructing socio-economic status indices: how to use principal components analysis. Health Policy and Planning, 21, 459–68. doi:10.1093/heapol/czl029
Downloads
Published
How to Cite
Issue
Section
License
This work is licensed under a Creative Commons Attribution 4.0 International License.
Disclaimer
Global Business Management Review (GBMR) has taken all reasonable measures to ensure that material contained in this website is the original work of the author(s). However, the Journal gives no warranty and accepts no responsibility for the accuracy or the completeness of the material; no reliance should be made by any user on the material. The user should check with the authors for confirmation.
Articles published in the Global Business Management Review (GBMR) do not represent the views held by the editors and members of the editorial board. Authors are responsible for all aspects of their articles except the editorial screen design.
Submission of an article is done with the understanding that the article has not been published before (except in the form of an abstract or as part of a published lecture, or thesis) that it is not under consideration for publication somewhere else; that if and when the article is accepted for publication, the author's consent to automatic transfer of the copyright to the publisher.