Relative Valuation ~ Primer

Relative Valuation ~ Primer

relative valuation, multiples, PE Ratio, EPS, EBIDTA, ROE, ROI, WACC, Cost of equity, researchRelative Valuation is Valuing an asset by comparing with prices of similar assets in market. In relative valuation the value is relative to how the market is pricing comparable firms
There are three basic steps
–Identify comparable assets
–Standardize – price of the asset or the value of equity
–Adjust for differences  
Why popularity of Relative Valuation in analyst circle?
•It is Easy to sell a story based on comparables
–Pebble beach golf – Japanese paid 750$ mn in late 1980’s
–At that time All of Tokyo real was estimated to be cost more than all of US real estate put together
–Business potential did not justify the price
–Imagine selling a DCF based valuation!!!
•Most  Assumptions and inaccuracies are hidden
•If you mess up so would have others
–You don’t want to be wrong all alone on the street
Is there widespread use ?? Of course …
•Majority of research reports are based on Relative Valuation
•Mergers and Acquisitions derive valuations based on a  multiple based prices of comparable firms.
•Many investment strategies  are based on multiple (eg: Venture Capital/PE fund investing in entrepreneurial ventures)
•Terminal Value in DCF often calculated using Relative Valuation
•DCF used to justify Relative Valuation quite often
More on Common Multiples later….

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  • Common Multiples used in Valuation | Enrich Life Finance Wise

    […] Common Multiples used in Valuation Posted on June 13, 2012 by Kapil You can analyse the past, but you have to design the future ~ Edward de Bono    A multiple is simply expression of market value of an asset relative to a key statistic that is assumed to relate to that value   Here are some of the most common multiples used in evaluating a business :       1.Earnings of the asset –Price/Earnings Ratio (PE) and variants (PEG and Relative PE) –Value/EBIT –Value/EBITDA –Value/Cash Flow   2.Book value of the asset –Price/Book Value(of Equity) (PBV) –Value/ Book Value of Assets –Value/Replacement Cost (Tobin’s Q)   3.Revenues generated by the asset –Price/Sales per Share (PS) –Value/Sales   5.Asset or Industry Specific Variable , specific to the industry make analysis relevant. –Price/kwh –Price per ton of production –Price per subscriber –Price per click –In PR industry – pricing based on coverage –Pb with sector specific multiples – One needs to be careful if industry is mis priced   We really want relationship to cash flows!!! Comparisons which matter in Valuation – We cannot compare profit margins ((NP margin / Gross Profit Margin)) across industries because profit margins is useful for comparing companies within an industry and not across.   – However we can compare (ROE or ROIC) across industries since ultimately investors and entrepreneurs chase return on investments, it makes sense to compare them across industries. – But investments need not necessarily be made into the industries with highest RoE. Both RoE as well as the quantum of capital that can be deployed have to be studied. – Similarly if two companies in the same industry have different depreciation policies and operate in different tax environments, it makes sense to use EBIT(1-t) to factor in (remove) the tax impact / depreciation impact and then compare   – This will also imply that cost of total capital should be compared to RoIC and cost of equity to RoE and the two should not be mixed and matched   More information and an Interesting note on relative valuation here […]

    June 13, 2012 at 9:40 PM

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