Comparable Companies Analysis Flashcards
How to calculate Enterprise Value?
EV =
Equity Value
+ Total Debt
+ Preferred Stock
+ Non-controlling interest
- Cash & Cash Equivalents
How to calcute equity value?
Equity Value =
Share price x Fully Diluted Shares Outstanding
Describe the components of fully diluted shares outstanding.
Fully diluted shares outstanding =
Basic shares outstanding +
In-the-money options and warrants +
In-the-money convertibles
How to value in-the-money options and warrants in the calculation of fully diluted shares outstanding?
Use the “Treasury Stock Method”.
1) All outstanding options and warrants are exercised at weighted average strike price.
2) Proceeds are used to repurchase shares at current share price/offer price.
Since current price > strike price for in-the-money options, net issuance occurs, which is dilutive
Name the methods used for calculating in-the-money convertible and equity-linked securities.
1) If-converted method (in-the-money converts are converted into additional shares by dividing the converts amount outstanding by its conversion price)
Conversion increases the # of shares (EPS dilutive), but also requires upward adjustment of net income due to foregone interest payment of convertible
2) Net share settlement (only difference between current share price and conversion price is settled by additional share issuance, while face value is settled in cash => less dilutive than “if-converted”)
Elements of a company’s business profile
- Sector
- Products and Services
- Customers and End Markets
- Distribution Channels
- Geography
Elements of a company’s financial profile.
- Size (market value (EV, Equity Value), key financial data (Sales, Gross profit, EBITDA,EBIT, net income)
- Profitability (Gross / EBITDA/ EBIT / Net income margins)
- Growth (historical sales, EPS, EBITDA etc.)
- Return on investment (ROIC, ROE, ROA)
- Credit profile (Leverage, Coverage, Rating)
Gross profit
Sales - COGS
COGS: costs directly related to production of company’s products and services such as manufacturing cost, raw materials, direct labor etc.
Gross margin = (Gross profit) / (Sales)
A key indication of operational efficiency.
EBITDA
Take EBIT and add D&A sourced from Cash Flow Statement.
Best proxy of operating cash flow, as EBIT includes non-cash D&A expense. Independent of capital structure and taxation, so good comparative measure.
Also, since pre-D&A, differences in recent CapEx, depreciation policy & amotization from recent acquisitions are excluded
EBIT
Sales - COGS - SG&A
Operating income, independent of capital structure and taxes, but includes non-cash D&A expense, so less indicative measure of operating cash flow than EBITDA and reflects discrepancies in capital spending, depreciation policy and acquisition histories (amortization)
Net income
“Earnings”
Residual profit available to shareholders after all expenses have been netted out.
ROIC
Return on invested capital
Return generated by all capital provided to a company.
EBIT/ EBITDA / NOPAT
/
(Average Net Debt + Equity)
ROE
Return on equity
Return generated on the equity provided to a company by its shareholders.
Net income / Shareholders Equity
ROA
Return on Assets
Measures the return generated by a company’s asset base
ROA = Net income / Total Assets
Dividend yield
Measures the return to shareholders from a company’s dividends.
Div. yield = Dividend / Share price
Leverage
Leverage refers to a company’s debt level.
Measured as
a) Debt / EBITDA (how many years of a company’s cash flows are needed to repay its debt)
b) Debt / Total Capitalization , where
Total Capitalization = Equity + Debt + Pref. Stock + Non-controlling interest
Coverage
Measures company’s ability to meet its interest obligations.
Coverage ratio = EBITDA / Interest Expense
Credit ratings
S&P, Fitch
Investment Grade
AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-
Non-investment grade:
BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D
Income statement overview
Sales - COGS
= Gross profit
- SG&A
= EBITDA
- D&A
= EBIT
- Taxes, Interest payments
=Net income
Equity Value Multiples
Share price / Diluted EPS (“P/E”)
=
Equity value / Net income
For equity value, need profit flowing to equity holders, i.e. net income
EV multiples
EV / EBITDA
EV / EBIT
EV / Sales
For EV-multiples, need profit accruing to both equity and debt holders.
Limitations of P/E
- mainly for mature companies with stable earnings
- problematic for companies with little or no earnings such as startups or distressed companies
- dependent on capital structure since net income is after interest payments
- dependent on taxation as net income is after taxes
Common mistakes in comparable companies analysis.
- inappropriate comparables
- incorrect calculations (fully diluted equity value, EV LTM, Calendarization)
- failure to accurately scrub financial for non-recurring items and recent events
Advantages of Comparable Companies Analysis
- Market-based (information used to value a company based on actual market prices, reflecting market information and expectations)
- Relativity (easily measurable and comparable versus other companies)
- Quick and convenient (valuation is based on a few easy-to-calculate inputs)
- Current (based on prevailing market data, i.e. can be updated daily)
Disadvantages of comparable companies analysis
- Market-based (valuation can be skewed by market gyrations, e.g. Dot-Com boom or Credit crunch)
- Absence of relevant comparables (often hard to find perfect, “pure-play” comparables)
- Potential disconnect from cash-flow (based on prevailing market condition instead of company’s projected cash flow generation)
- Company specific issues (valuation based on OTHER companies fails to capture target specific strengths and weaknesses)
