Sustainable Land Development Today - April 2008 - (Page 12) FMI contrasted quarterly changes in the total enterprise value (TEV)1 of publicly traded E&C companies against a series of economic indicators, including changes in GDP, changes in interest rates, and changes in the total amount of construction put in place. Each group’s TEV correlated positively with GDP and the amount of construction put in place in the United States. However, the degree of correlation varied substantially between the groups. Residential homebuilders exhibited the highest degree of correlation to these economic indicators, suggesting that homebuilders are particularly sensitive to the health of the overall economy as well as fluctuations in the construction cycle. Specifically, analysis of the relationship between TEV of homebuilders and GDP revealed a median correlation coefficient2 of 0.89. A correlation coefficient of this magnitude suggests that approximately 80 percent of the variance in homebuilders’ enterprise values can be explained by changes in GDP. Analysis uncovered an even stronger relationship between the TEV of homebuilders and the amount of total residential construction put in place. In comparison to other E&C companies, changes in the economic environment had little effect on the TEV of specialty contractors. A weak relationship between these variables suggests that, over the period examined, changes in the value of specialty contractors were relatively independent from changes in the economy. With the exception of residential homebuilders, the TEV of E&C companies did not correlate strongly with changes in interest rates. So fluctuations in interest rates do not materially influence the value of non-homebuilding 1 “” E&C companies. Analysis uncovered a relatively strong inverse relationship between mortgage rates and the value of residential homebuilders, suggesting that homebuilders will benefit when interest rates decrease and suffer when interest rates increase. To determine how much the overall stock market influences E&C stocks, FMI contrasted the quarterly share prices of each publicly traded E&C company with the E&C industry moves relatively independently from the stock market as a whole. the S&P500 and the Dow Jones Industrial Average (DJIA) from June 30, 1997, to June 30, 2007. Each of the E&C groups exhibited a higher degree of correlation with the DJIA than with the S&P500. Yet, fluctuations in these indices explained only a small amount of movement in the share prices of E&C companies. For example, the basic construction-materials group exhibited the highest degree of correlation with the DJIA; however, only 44 percent of the quarterly change in the share prices could be explained through changes in the DJIA. Thus, the E&C industry moves relatively independently from the stock market as a whole. In order to determine the financial metrics that have had the greatest influence on the value of publicly traded E&C firms over the past 10 years, FMI studied the relationship between the following sets of variables: TEV/Revenue, TEV/EBITDA (earnings before interest, taxes, depreciation, and amortization), TEV/EBIT (earnings before interest and taxes), Price/Net Income, and Price/Book Value (P/BV). Analysis revealed that changes in revenue were highly correlated with changes in TEV, and changes in share price were highly correlated with changes in book value. This suggests that changes in an E&C company’s revenue base and book value influence the valuation of the company to a greater degree than changes in earnings. A number of reasons explain why the financial markets rely heavily on book value and revenue in determining the market value of E&C companies. First, P/BV is widely regarded as a good metric to value stocks of companies in capital-intensive industries, such as E&C, which have a large amount of tangible assets on their books. Second, P/BV provides an indication of the inherent value of a company and, as such, can be used as a proxy for the price that investors are willing to pay for a company experiencing negligible growth. Since E&C is a relatively slowgrowth industry, analysts consider P/BV to be a reliable measure of valuation. Price/BVs dependability as a measure of valuation is further enhanced by the low utilization of debt in the typical capital structure of an E&C company. This is Total enterprise value represents the total economic value of a company. Total enterprise value is calculated as: market capitalization + total debt + minority interest - cash. 2 A correlation coefficient represents the degree of association or strength between two variables. A value of +1 indicates a perfectly positive relationship, ñ1 indicates a perfectly inverse relationship, and 0 indicates no relationship between the variables. 12 April 2008 Sustainable Land Development Today
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