Key Rule 1 Flashcards
3 main points expected to know about valuations:
- How do you value a company - key methodologies, metrics and multiples
- What does a valuation tell you, and how can you interpret the results
- Why do valuations matter, and what do they mean in the real world.
Key Rule 1:
How do you value a company?
2 ways:
relative valuation - comparing it to what similar companies are worth
Intrinsic valuation - estimating NPV of future cash flows, or estimating how much assets are worth.
Relative valuation
Mostly look at other public companies - comparable public companies (Public Comps), and recent M&A deals (precedent transactions), to estimate what company might be worth
Relative valuation example
3 companies similar to yours in revenue growth, profit margins, and industry focus have recently sold for 3x annual profits, 5x annual profits, and 4x annual profits in the past year.
From that, you might conclude that your own company is worth around 4x annual profits, since that’s the median profit multiple of the set.
Intrinsic valuation
Most methodologies come down to:
1. Estimating future cash flows and discounting them to their present value, because money today worth more than money tomorrow
2. Valuing the firm’s assets and assuming that firm’s total value is linked to adjusted asset value - liabilities
- usually use DCF
- or could value assets - liabilities = net asset value or liquidation model
So when do you use which methodology?
Almost always use Public Comps and Precedent Transactions to value companies in any industry because universal.
- will use different metrics and valuation multiples depending on industry
Why and where can DCF analysis not be relevant?
- where does it work?
- Free cash flow is not a meaningful metric in some industries
- Industry is asset-centric and so you’re better off valuing the company’s assets and liabilities
E.g. - commercial banks, insurance firms, real estate investment trusts
Works well for stable, mature companies with predictable growth rates and profit margins, not high-growth start-ups.
Where does relative valuation work well
Public comps and precedent transactions work best when there’s a lot of good market data and there are truly similar companies
- bd when data is spotty, and when company being analysed is unique
DCF or precedent transactions or public comps, which produce higher numbers?
DCF more dependent on assumptions than relative valuation.
- generally precedent transactions produces higher numbers than public comps because buyer must pay a premium to acquire a 100% of another company
- DCF can produce highest, depends on how conservative assumptions are.
Following criteria to pick comparable public companies:
- Geography
- Industry
- Financial
Precedent transactions picking criteria:
- Geography
- Industry
- Financial
- Time: transactions since x, or transactions between year x and year y, very important as markets change over time
Other methodologies to be aware of
Asset based valuations:
- liquidation valuations - value assets, assume they are sold to repay liabilities, remainder is gone to equity investors and EV. (Net asset value model)
Variants on Public Comps and Precedent Transactions:
- M&A premiums analysis, select PT, but instead of calculating valuation multiples, calculate premium buyer paid for the seller in each case
- future share price analysis, project company’s future share price based on the P/E multiple of compare companies and then discount to present value
- Sum of the parts - split a company into different segments, pick different sets of Public Comps and Precedent Transactions for each, value each separately and then add up to find company’s total value.
Final methodology - LBO
Assume a private equity firm acquires a company, needs to achieve a certain IRR, then work backwards to calculate how much they could potentially pay to achieve that return.
