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| PA’s analysis of a sample of European companies looked at their over/undervaluation (horizontal axis) and their liquidity (vertical axis). A score of more than one on the horizontal axis represents an undervalued company and less than one is overvalued. On the vertical axis, a company with a score of below one raises cause for concern. The horizontal axis assesses the level of over/undervaluation by the market using a simplified (and intentionally conservative) form of discounted cash flow which assumes that long-run return on equity (ROE) will be close to the average ROE over the last three years and long-run growth will be around 3 per cent per annum. On this axis, more than one represents an undervalued company, less than one is overvalued. On the vertical axis we have assessed liquidity, determined by the weighted average of a number of factors: primarily interest cover, dividend cover and the ratio of debt to equity. On this axis, a company below one is likely to have substantial difficulties in covering its debt payments and therefore refinancing its operations. |
