Relative Valuation - Multiples PDF

https://www.youtube.com/watch? v=T3Ud5WQCrzQ Relative valuation - multiples I want to sell this car, how much would you pay for it???  Relative Valuation What is it?: The value of any asset can be estimated by looking at how...

https://www.youtube.com/watch? v=T3Ud5WQCrzQ Relative valuation - multiples I want to sell this car, how much would you pay for it???  Relative Valuation What is it?: The value of any asset can be estimated by looking at how the market prices “similar” or ‘comparable” assets. Philosophical Basis: The intrinsic value of an asset is impossible (or close to impossible) to estimate. The value of an asset is whatever the market is willing to pay for it (based upon its characteristics) Information Needed: To do a relative valuation, you need an identical asset, or a group of comparable or similar assets a standardized measure of value (in equity, this is obtained by dividing the price by a common variable, such as earnings or book value) and if the assets are not perfectly comparable, variables to control for the differences Market Inefficiency: Pricing errors made across similar or comparable assets are easier to spot, easier to exploit and are much more quickly corrected. Aswath Damodaran 11  https://www.youtube.com/watch?v=MvwhS39de1o Aswath Damodaran 12  When relative valuation works best.. This approach is easiest to use when there are a large number of assets comparable to the one being valued these assets are priced in a market there exists some common variable that can be used to standardize the price This approach tends to work best for investors who have relatively short time horizons are judged based upon a relative benchmark (the market, other portfolio managers following the same investment style etc.) can take actions that can take advantage of the relative mispricing; for instance, a hedge fund can buy the under valued and sell the over valued assets Aswath Damodaran 13 What are the “multiples”? Are measures that allows you to make a quick estimation on the value of a company They used “comparable” companies since you are actually comparing the company you are interested in against others. For example, if we want to value a company with P/EBITDA multiple, we need to look for the P/EBITDA of similar companies, get the average or median and then multiply times the EBITDA of the company we are interested in. This will give us the equity value.  All multiples follow this structure: In numerator you will find a market measure, such as Enterprise Value (EV) or Share Price (P). In the denominator you will always find a measure directly related to company´s operations. Do not confuse with financial ratios. D/E is not a multiple!!! The Essence of relative valuation? Even if you are a true believer in discounted cashflow valuation, presenting your findings on a relative valuation basis will make it more likely that your findings/recommendations will reach a receptive audience. In some cases, relative valuation can help find weak spots in discounted cash flow valuations and fix them. The problem with multiples is not in their Most-known multiples  Market Enterprise value Capitalization divided by: divided by: EBIT Net income EBITDA Dividends Sales Net cash flow Gross profits EBT Total assets Assets less liabilities Net fixed assets Stock Price Industry-specific divided by: multiples EPS Cable TV: Dividends per share MVIC/subscribers Cash flow per share Retailers: Book value per share MVIC/square foot Technology: MVIC/patents  Market approach Industry multiples EV/EBITDA and EV/Revenues multiples To december 31th, 2016 If I´m valuing a 16.5x technology company that generates anual 11.6x 12.1x revenues for 5M, 10.0x according to 8.5x 9.2x EV/Revenues 7.2x multiple, its 2.7x Enterprise value 0.9x 1.2x 1.5x would be: 0.7x Manufacturing Retail Comsumption Technology Biotechnology Sw, apps and products social networks 5M*1.5x=7.5M Deloitte, 2018 EV/EBITDA EV/Revenues  1st. Activity  EXERCISES 16.5x 11.6x 12.1x 9.2x 10.0x 8.5x 7.2x 1.5x 2.7x 0.9x 1.2x 0.7x Manufacturing Retail Comsumption Technology Biotechnology Sw, apps and products social networks 1. Estimate the value of Apple assuming an EBITDA of $ 25 MM 2. Calculate de value of CostCo if the company has Revenues for $ 8 MM 3. Which is the value of Microsoft if the EV of the company is $ 3.22 MM. Which multiple would you use? What can you conclude about this exercise 4. Estimate the EBITDA for Microsoft 5. Estimate the value of Zara if you found that the company has an EBITDA of $ 18 MM. 6. What is the value of TikTok if the company has an EBITDA for $20 MM. Compare the results with those obtained for Apple and conclude The Four Steps to Understanding Multiples The Four Steps to Understanding Multiples Define the multiple In use, the same multiple can be defined in different ways by different users. When comparing and using multiples, estimated by someone else, it is critical that we understand how the multiples have been estimated Describe the multiple Too many people who use a multiple have no idea what its cross sectional distribution is. If you do not know what the cross sectional distribution of a multiple is, it is difficult to look at a number and pass judgment on whether it is too high or low. Analyze the multiple It is critical that we understand the fundamentals that drive each multiple, and the nature of the relationship between the multiple and each variable. Apply the multiple Defining the comparable universe and controlling for differences is far more difficult in practice than it is in theory. Definitional Tests Is the multiple consistently defined? Proposition 1: Both the value (the numerator) and the standardizing variable ( the denominator) should be to the same claimholders in the firm. In other words, the value of equity should be divided by equity earnings or equity book value, and firm value should be divided by firm earnings or book value. Is the multiple uniformly estimated? The variables used in defining the multiple should be estimated uniformly across assets in the “comparable firm” list. If earnings-based multiples are used, the accounting rules to measure earnings should be applied consistently across assets. The same rule applies with book-value based multiples. Descriptive Tests What is the average and standard deviation for this multiple, across the universe (market)? How asymmetric is the distribution and what is the effect of this asymmetry on the moments of the distribution? How large are the outliers to the distribution, and how do we deal with the outliers? Throwing out the outliers may seem like an obvious solution, but if the outliers all lie on one side of the distribution, this can lead to a biased estimate. Capping the outliers is another solution, though the point at which you cap is arbitrary and can skew results Are there cases where the multiple cannot be estimated? Will ignoring these cases lead to a biased estimate of the multiple? How has this multiple changed over time? Analytical Tests What are the fundamentals that determine and drive these multiples? Proposition 2: Embedded in every multiple are all of the variables that drive every discounted cash flow valuation - growth, risk and cash flow patterns. How do changes in these fundamentals change the multiple? The relationship between a fundamental (like growth) and a multiple (such as PE) is almost never linear. Proposition 3: It is impossible to properly compare firms on a multiple, if we do not know how fundamentals and the multiple move. Application Tests Given the firm that we are valuing, what is a “comparable” firm? While traditional analysis is built on the premise that firms in the same sector are comparable firms, valuation theory would suggest that a comparable firm is one which is similar to the one being analyzed in terms of fundamentals. Proposition 4: There is no reason why a firm cannot be compared with another firm in a very different business, if the two firms have the same risk, growth and cash flow characteristics. Given the comparable firms, how do we adjust for differences across firms on the fundamentals? Proposition 5: It is impossible to find an exactly identical firm to the one you are valuing. And, how do multiples work?? Source: Greenwood and White (2006) Company A (private company) received an offer of $502million for the equity of the company. They want to use the fastest valuation method. The following information from similar companies that are listed on the Mexican Stock Exchange (BMV) was taken on April 27 2018: PE EVS PBV ratio ratio ratio With: PE ratio = Price to B 12 2.9 0.9 Earnings ratio; EVS ratio C 14 3.2 1.2 = Enterprise Value to Sales ratio; PBV ratio = D 13 3.4 1.1 Price to Book Value E 12 3.1 1.1 (equity) The following information from company A is given: (all amounts in millions of pesos) 2017 Net Income 35 Sales 220 Book Value of Equity 600 Debt outstanding 250 Cash 25 Company A (private company) received an offer of $502million for the equity of the company. They want to use the fastest valuation method. The following information from similar companies that are listed on the Mexican Stock Exchange (BMV) was taken on April PE 27 2018: ratio B 12 C 14 D 13 E 12 The following information from company A is given: (all amounts in millions of pesos) 2014 2015 2016 2017 2018e Net 50 60 40 35 35 Income Sales 300 390 270 220 210 Book Different PE ratios Remember PE = PER = Share price / Earnings per share PE = Market cap / Net income available for common stockholders You can compute PE ratio using current earnings, trailing earnings and forward earnings, the only difference will be the denominator and each type of calculation will reflect an expectation on the income for the company. Price Earnings Ratio: Definition PE = Market Price per Share / Earnings per Share There are a number of variants on the basic PE ratio in use. They are based upon how the price and the earnings are defined. Price: is usually the current price (though some like to use average price over last 6 months or year) EPS: Time variants: EPS in most recent financial year (current), EPS in most recent four quarters (trailing), EPS expected in next fiscal year or next four quarters (both called forward) or EPS in some future year Primary, diluted or partially diluted Before or after extraordinary items Measured using different accounting rules (options expensed or not, pension fund income counted or not…) PEG Ratio: Definition PE ignores expected growth The PEG ratio is the ratio of price earnings to expected growth in earnings per share. PEG = PE / Expected Growth Rate in Earnings Definitional tests: Is the growth rate used to compute the PEG ratio on the same base? (base year EPS) over the same period?(2 years, 5 years) from the same source? (analyst projections, consensus estimates..) Is the earnings used to compute the PE ratio consistent with the growth rate estimate? No double counting: If the estimate of growth in earnings per share is from the current year, it would be a mistake to use forward EPS in computing PE