Another the shares. But as discussed above,

Another best-known valuation method is the price/earnings ratio or multiple, which divides share prices by profits. Look at the group’s EPS for 2002, where the EPS was 32 pence and the price for the close day of 2002 was �4.95. So the PE ratio equal to 495/32 = 15.47 times. This figure means that how much pence investors willing to pay for each penny of earnings per share of the group. Compare with the three competitors, this company’s PE ratio was quiet lower.

Where Acambis’s PE ratio was 28.6 times, Celltech’s was 22.3 time, 21 times for Skyepharma, and the average of these three companies was 24 times. If we apply the average ratio into Galen’s current EPS, then we can find the price per share should be 32p X 24 = 768p. The real market price, however, was �4.95 only at the beginning of year 2003. Is it undervalued? Look into the trends in the following months, the price kept an upward tendency until to 10th-Nov-03, which closed at 773.6p, and the current PE ratio is 33.28 times which similar with the competitor Celltech (31.87 times), other two competitors are facing a loss. Base on these historical figure, it is clear that the company was undervalued at the beginning of year 2003. The market experienced a movement up to the real value during the following eight-months.

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Is the PE ratio always a clear and simple way to value a business? As many literatures suggested that PE ratio is a reasonable indicator for share price ( Leibowitz ; Kogelman 1990), really which is widely used to value a business, especially for the new issues. However, sometimes it is confusing. According to Louth (2003), Biotech companies’ shares are traded at around average 17-20 times expected earnings currently. It is little higher than the average on the FTSE All Share that is around17 times currently.

Compare to the industry and FTSE all share average level, the Galen’s share seemed overvalued, theoretically it will go in down, investor should sell out the shares. But as discussed above, the current value of Galen is more close to the real value, and it still has a rising trends in the market. Look back to the group’s annual report, the groups keep a high increasing in the R&D expense and capital expenditure that around 30% growing rate per year, and the whole group shows a strong growing tendency. All these show the group has high present value of growth opportunities (PVGO), thus the share price will go up theoretically. The two results concluded from the PE ratio are conflicting, would the investors to buy or sell the shares currently? Confusing!

The trouble with the PE ratio, naturally, centers on the elusive “E”. Reported earnings is base on the past performance of the company, it is a historical figure, and which cannot show the future cash flow. Actually, investors only concern about how much they can earn in the future, not the history, when they make an investment decision. PE ratio is misleading also because that earning is only an accounting figure, which means different things for different firms. Companies can manipulate earnings in a variety of creative ways, such as adding sales of assets into income, changing depreciation policies, cutting back on provisions for bad debts, even repurchasing own shares to reduce the number of share outstanding.

The NAV method approach: The third method will be used is the net asset value (NAV). Net asset value equal to the total assets minus the total liabilities, which is wholly belong to the shareholders, so it also called as ‘shareholders’ fund’ or ‘owners’ equity’. In other words NAV shows the minimum value of a business. Market analysts always compare it with the total market value of the business, and the module is called market-book ratio, which divides total market value by total book value of shareholders’ fund.

For the Galen Group, the number of share outstanding is around 187,805,000, and the share price was �4.95 at the end of year 2002, so the total market value equal to 4.95 X 187,805 = 929,634,750. At the same time the total net book value of shareholders’ fund was 671,959,000, so the market-book ratio equal 929,634.75/671,959 = 1.38 times. Compare to other the competitors, Acambis’s was 5.93 times, celltech’s was 3.45 time and 2.07 times for Skyepharma, the average figure of these three companies is 3.82, the Galen’s market-book ratio is quiet lower. If investors believe the average market-book ratio was suitable for Galen, then the share price should be around �13.70 (= �4.95 X 3.82/1.38) per share. There is a quite difference with the real market price, even now, almost one year passed, the price still quite lower than that figure.

Why there is a big difference the theoretical and market value? It is because there are some problems behind this NAV method. First of all, the book value of fix assets are always out-of-date. Since such value are based on the historical cost, which cannot show the real market value. Although adjusting such value by current cost accounting method annually may more close to the market value, considering time and cost involved it would be unacceptable. Except the value of tangible assets, the intangible assets are not easy to value. Since biotech company always have significant intangible assets, some are recoded in the balance sheet but some not, such as the internal acquired goodwill and the new technologies. Thirdly, stock value are often unreliable since stock maybe recorded by different methods.


Overview all of these indicators, none is wholly satisfactory. Since there are too many factors need to forecast, such as the future cash flow. Also those methods are too relying on the historical accounting figure, which may mislead. Earnings, for instance, may be massaged by clever finance directors easily. And the last, there are a lot of uncertainty, such as inflation and the rate of return required by the investors. Remember the concepts of EMH? The changing of share price is a random walk that just like tossing a coin, no indicators can show the price will go in up or down. Considering these facts, are share valuation methods rubbish?

Before answering this question, let us look into the share market. In the open markets, shares just like a common goods, which value is the price at which the shares would change hands between a willing buyer and a willing seller, neither both having reasonable knowledge of the facts or not. Except such valuation methods, there are also other significant factors that influence the share value. Economy environment can drastically change from time to time especially for particular kinds of industry. As interest rates go down, the value of the share goes up. Share price also follow the rule of supply and demand.

When there are a lot of bills for sale in a particular share and few buyers, the value goes down. When there are a lot of buyers and few sellers, the value goes up. Biotech companies, for instance, just three years ago the average PE ratio was much higher in the industry, at around 25-30 times (Louth 2003), which reflect that investors had high confidence in the potential future profit. But now, which is only traded at 17 times of the earning, same lever as FT-SE all companies. As Laura (2003) said ‘ biotech companies angers investors’, once investor lost their confidence in the industry and do not willing to hold the shares any more, the price go down.

If market is efficient, the share prices fully reflect available information. The share price trends is just a random walk, and no one can control or predicate the share price will go up or down, unless they have extra or internal information. Thus all the works done to valuing share in the future is wasting time. Look at the method discussed above, all of them are unsatisfactory and sometimes are misleading. Since share price are influenced by a number of factors as discussed above.

None of such methods are wholly satisfactory, however this does not mean such valuation methods are rubbish. At least they provide different concepts of the business value. Base on such concepts, different group of people predicate different price that they will buy or sell the shares. By the endless new financial and non-financial information, the acceptable price level also be changed at any time. Thus none methods can predicate the share price correctly, since that is a human being and human are changeful.

In the case of Galen Group, the market price under the PE Ratio approach was  68, NAV approach value is �13.70, and the DDM approach value is nil. The real market price, however, was �4.95 at the balance sheet day. There is a big difference between the result of each methods and the real market price. It is difficult to say that which method is better or not, since these methods have their own advantages and disadvantages. They just provide a basic concept about the share value in the market.


Farrell, J, L. (1985), ‘The Dividend Discount Model: A Primer’, Financial Analysis Journal, Nov-Dec, p16-25.