Comparables Flashcards
What is the premise of a comparables companies analysis
Similar companies provide a relevant reference point for valuing a target because they share key characteristics (business, financial, performance drivers and risks)
Name the four pros of a comparable companies analysis
market based
relativitly
quick and convenient
current
Name the four cons of a comparable companies analysis
market based
absence of relevant comparables
potetial disconnect from cash flow
company-specific issues
What is the general format of a key multiple
numerator: measure of value
denominator: finanical statistic
Equity value maultiples describe flows to
equity holders
enterprive value multiples describe flows to
debt and equity holders
the theory is that when firms are comparable, we can use the multiples approach to determine the value of one firm based on the value of another.
Multiples Approach
Name three broad key multiples
equity, enterprise and sector specific
Name two equity value multiples and describe them
P/E -
Some common price multiples are the price-to-earnings (P/E) ratio, the price-to-book (P/B) ratio, and the price-to-sales (P/S) ratio. These ratios are used in conjunction with other fundamental metrics, such as EBIDTA, in order to give analysts and investors a quick initial impression of whether a company would make a good viable investment. However, because these multiples are very simplistic, they should not be the only measure of assessing a potential investment.
Equity value/NI
A measure of the value of a stock that compares a company’s enterprise value to its revenue. EV/R is one of several fundamental indicators that investors use to determine whether a stock is priced well. The EV/R multiple is also often used to determine a company’s valuation in the case of a potential acquisition. Other valuation multiples that investors looking at EV/R would likely consider include EV/EBITDA, P/E and P/BV. EV/revenue is most commonly expressed as a number in decimal form followed by an x, as in 2.6x.
Name three enterprise value multiples and describe them
EV/EBITDA
EV/EBIT
EV/Sales
EV/EBITDA
A financial ratio that measures a company’s return on investment. The EBITDA/EV ratio may be preferred over other measures of return because it is normalized for differences between companies. Using EBITDA normalizes for differences in capital structure, taxation and fixed asset accounting. Meanwhile, using enterprise value also normalizes for differences in a company’s capital structure.
While computing this ratio is much more complicated, it is sometimes preferred because it provides a normalized ratio for comparing the operations of different companies. If a more conventional ratio (such as net income to equity) were used, comparisons would be skewed by each company’s accounting policies. EBITDA/EV is commonly used to compare companies within an industry.
EV/EBIT
Definition of ‘EBIT/EV Multiple’
A financial ratio used to measure a company’s return on investment. While the EBIT/EV ratio is not very commonly used, it does have certain advantages in comparing companies. First, using EBIT as a measure of profitability eliminates the potential distorting effects of differences in tax rates. Secondly, using EBIT/EV normalizes for the effects of different capital structures.
Investopedia explains ‘EBIT/EV Multiple’
The EBIT/EV ratio can provide a better comparison than a more conventional net income/equity ratio. A downside to this ratio is that it does not normalize for depreciation and amortization costs. Thus, there are still potential distorting effects when companies use differing methods in accounting for fixed assets.
EV/Sales
A valuation measure that compares the enterprise value of a company to the company’s sales. EV/sales gives investors an idea of how much it costs to buy the company’s sales. This measure is an expansion of the price-to-sales valuation, which uses market capitalization instead of enterprise value. EV/sales is seen as more accurate because market capitalization does not take into account as well as enterprise value the amount of debt a company has, which needs to be paid back at some point. Generally the lower the EV/sales the more attractive or undervalued the company is believed to be.
Investopedia explains ‘Enterprise-Value-To-Sales - EV/Sales’
The EV/sales measure can be negative when the cash in the company is more than the market capitalization and debt structure, signaling that the company can essentially be bought with its own cash.
The EV/sales measure can be slightly deceiving: a high EV/Sales is not always a bad thing as it can be a sign that investors believe the future sales will greatly increase. A lower EV/sales can signal that the future sales prospects are not very attractive. It is important to compare the measure to that of other companies in the industry, and to look deeper into the company you are analyzing.
Name the 5 steps of a Comparable companies Analysis
- Select universe of comparable companies
- Locate necessary financial information
- Spreak key statistics, ratios and trading multiples
- Benchmark comparable companies
- Determine Valuation
How do you select universe of comparable companies
understand your target; find companies with similar business and financial characteristics; start with target’s public competitors and refine later
