8. You are researching XMI Corp (XMI). XMI has shown steady earnings per share g
ID: 2386319 • Letter: 8
Question
8. You are researching XMI Corp (XMI). XMI has shown steady earnings per share growth (18 percent a year during the past several years) and trades at a very high multiple to earnings (its P/E is currently 40 percent above the average P/E for a group of the most comparable stocks). XMI has generally grown through acquisition, buy using XMI stock to purchase other companies whose stock traded at lower P/Es. In investigating the financial disclosures of these acquired companies and talking to industry contacts, you concluded that XMI has been forcing the companies it acquires to accelerate the payment of expenses before the acquisition deals are closed. As one example, XMI asks acquired companies to immediately pay all pending accounts payable, whether or not they are due. Subsequent to the acquisitions, XMI reinstitutes normal expense payment patters.a. What are the effects of XMI's reacquisition expensing polices?
b. The statement is made that XMI's "P/E is currently 40 percent above the average P/E for a group of the most comparable stocks." What type of valuation model is implicit in that statement?
Explanation / Answer
8. You are researching XMI Corp (XMI). XMI has shown steady earnings per share growth (18 percent a year during the past several years) and trades at a very high multiple to earnings (its P/E is currently 40 percent above the average P/E for a group of the most comparable stocks). XMI has generally grown through acquisition, buy using XMI stock to purchase other companies whose stock traded at lower P/Es. In investigating the financial disclosures of these acquired companies and talking to industry contacts, you concluded that XMI has been forcing the companies it acquires to accelerate the payment of expenses before the acquisition deals are closed. As one example, XMI asks acquired companies to immediately pay all pending accounts payable, whether or not they are due. Subsequent to the acquisitions, XMI reinstitutes normal expense payment patters.
XMI's expensing policies with respect to acquisitions
1. inflate its earnings per sharegrowth rate.
2. By pushing down pre-acquisition EPS to an artificially low number,
3. XMI can show unusual post-acquisition earnings growth rates.
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The statement is made that XMI's "P/E is currently 40 percent above the average P/E for a group of the most comparable stocks." What type of valuation model is implicit in that statement?
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The underlying model is a-------------- relative valuation model
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