Question

Identify two comparable firms（woolworths and metcash） of coles and justify the choice

Answer 1

PER = (ROE-g) / [ROE*(Ke-g)]

A comparable company is one that satisfies the following three conditions:

1. It has a similar growth potential as the company being valued (Coles)

Woolworths and Metcash have both reported largely similar growth over the past 5 years (2014-19), which is similar to Coles.

	EPS
Firm	2019	2020E	Growth rate
Coles	0.715	0.703	-1.68%
Woolworths	1.334	1.349	1.12%
Metcash	0.226	0.224	-0.88%

Analysts expect a higher (& positive) growth rate for Woolworths compared to the other two firms for the year ending 2020.

2. It has a similar risk profile as the company being valued (Coles)

Required rate of return, or Ke, has a negative impact on the price-earnings multiple. Required rate of return depends on the risk-free rate, the market risk premium and the beta of a stock. This means that the capital structure is another key consideration when choosing comparable companies for a comparable universe. The more debt a company has, the greater the risk shareholders adopt.

Firm	LT Debt To Equity
Coles	353.75
Woolworths	157.71
Metcash	93.44

Coles is highly leveraged, consequently, it has the highest beta value and in turn, highest required rate of return.

3. Its profitability (ROE) is comparable to the company being valued (Coles)

PER increases at a decreasing rate with increasing ROE.

Firm	ROE (TTM) 2019
Coles	8.52%
Woolworths	4.96%
Metcash	-1.26%