Key Rule #7 to #9 Flashcards
Why must we use multiples? Why not just compare cash flows?
Comparability- different acc systems and CFS formats
What do revenue multiples measure?
Sales
What does TEV/Rev measure?
Company’s price in relation to sales
What do the EBIT family and NI multiples measure?
co price in relation to profits
What are the EBIT family and NI multiples proxies of?
cash flow
Who gets the money in Rev/ EBIT/ EBITDA/ EBITDAR/ NI?
Everybody (equity investors, debt investors, preferred investors, gov)
NI- equity investors
Why does whoever gets the money in Rev/ EBIT/ EBITDA/ EBITDAR/ NI get it?
nobody been paid yet
above interest, dividends, taxes
NI- everyone else but equity investors paid
Who gets the money in NI?
equity investors only
Why does the group who gets the $ in NI get it?
interest anx taxes have been deducted alr
Which out of Rev/ EBIT/ EBITDA/ EBITDAR/ NI has had opex deducted?
All but Rev
Which out of Rev/ EBIT/ EBITDA/ EBITDAR/ NI has had capex deducted?
EBIT
NI
How is capex deducted in EBIT?
not a direct capex deduction, rather, via depreciation
How is capex deducted in NI?
not a direct capex deduction, rather, via depreciation
Which of Rev/ EBIT/ EBITDA/ EBITDAR/ NI has had interest taxes non core biz deducted?
NI
What is the definition of EBIT?
Operating income adjusted for non-recurring charges
What is the definition of EBITDA?
Operating Income adjusted for non-recurring charges and D&A
What is the definition of EBITDAR?
Operating Income adjusted for non-recurring charges and D&A
What does Revenue mean?
top line sales of the biz before any expenses/ cash outflow
What does EBIT mean?
Proxy for core, recurring biz profitability before impact of capital structure and taxes
What does EBITDA mean?
Proxy for core, recurring business cash flow from operations before impact of capital structure and taxes.
What does EBITDAR mean?
Proxy for core, recurring business cash flow from operations before the impact of capital structure, leases and taxes,
What does net income mean?
Profit after taxes, the impact of capital structure (interest) and non-core business activities.
What is P/E?
Way of valuing co thru Price per share/ earnings per share.
What is another name for P/E?
EqV / NI
What does P/E mean?
- higher PE suggests high expectations for future growth, perhaps because the company is small or is an a rapidly expanding market.
- low PE suggests expectations are not too high and the company is more likely to outperform earnings forecasts.
List out the multipels of Rev, EBIT, EBITDA, EBITDAR and NI
TEV/everything except EqV/NI
What can EBIT sometimes act as a proxy for
FCF
What can EBITDA sometimes act as a proxy for?
CFO
What is a key use case for Rev?
whe co has -ve EBIT/ EBITDA etc/ and is cash flow -ve
What is a key use case for EBIT?
When capex is more important and/or you want to include the partial impact of capex
Why is EBIT close to FCF?
like FCF, reflects impact of Capex
What is a key use case of EBITDA?
- when Capex isn’t as important- eg smaller % of rev
or - want to normalize companies w very different capex and d&a
What is a key use case of EBITDAR?
- normalize diff lease accounting treatments
or - comparing companies that use gaap to ifrs
What is a key use NI case?
Try to avoid if you can. Just a quick comparison.
WHat are the rules for using IS multiples?
1) If metric deducts Net Interest (and preferred div if applicable), use EqV as numerator
2) If denominator of a TEV-based multiple doesn’t deduct an IS expense, numerator should add back corr. B/S line item
Draw the funnel and explain it.
Before net interest expense and preferred dividends are deducted, who is paid?
all investors
After net interest expense and preferred dividends are deducted, who is paid?
equity investors
What are the 3 items of the balance sheet that can be mults?
- Book Value (net assets)
- Net operating assets
- invested capital
What does P/BV or Eq/BV mean?
How efficiently co has used its equity to grow
means little for most b/c market values not linked directly to BS
unless commercial banks, insurance firms
Why is P/BV or Eq/BV not used frequently?
means little for most b/c market values not linked directly to BS
When is P/BV or Eq/BV used frequently?
cos where market values linked to BS eg. commercial banks, insurance firms
What does TEV/IC mean?
How efficiently co is using capital
What are the historical multiples and what do they mean?
LTM/ TTM
last 12 months
Why are historical mults useful?
- represent real life
When to use historical mults?
when part of co’s current fiscal year has passed and results are available for at least 1 quarter
and something major has happened in the year eg. pandemic
What are forward multiples?
Future multiples
Why are forward multiples important?
represent consensus expectations for company
For forward multiples or anything at all, which EqV and TEV do you use?
The current ones. NEVER PROJECT
What is the endgame of multiples?
select cos that are similar to subject co in
- financial metrics (DR, CF)
- geog
- industry
So that differences in cash flow growth rate should explain diff in mults
What do higher multiples mean?
higher mults mean we are willing to pay more for it
therefore willing to pay more for cash flow growth rate
What are the cons of using mults to value?
- mults are based on IS metrics but co value dep on cash flow
- assumes that DR always stays the same
- cos may not be truly comparable
- non financial factors eg. earnnings drop b/c lawsuit expense which causes mults and stock price to drop even if long term performance hasn’t changed
Why are FCF based metrics better than IS mults?
bring us closer to actual discretionary cash flow co generates
How do you calculate FCF?
Cash flow from operations - capex
What does FCF correspond to?
EqV
What are the FCF valuation mults?
EqV / FCF or P / FCF
Which investor group has a claim to FCF?
Equity investors
What does FCF mean?
How much discretionary cash flow the co generates after interest but before debt principal repayments?
What is a key use case for FCF?
standalone financial statement analysis and transactional models eg. m&a, lbo
What is UFCF’s formula?
nopat + d&a and sometimes other non-cash adjustments +/- wc change - capex
What is nopat?
ebt x (1 - tax rate)
What does UFCF correspond to?
TEV
Who has a claim on the UFCF money?
Equity investors and debt investors
What does UFCF mean?
How much discretionary cash flow co generates before both interest expense and debt principal repayments
- core biz- rev and expenses only
What is the LFCF formula?
net income to common + d&a and sometimes other non cash adjustments +/- changes in working capital - capex (mandatory?) debt repayments + debt issuances
What does LFCF pair with?
EqV
What is the LFCF valuation multiple?
P/LFCF or EqV/LFCF
What does LFCF mean?
how much discretionary cash flow flow does the company generate after servicing all of its debt related expenses?
What is a use case for UFCF?
DCF
What is a use case for LFCF?
very few. Disagreement over calc method so problematic
How does UFCF differ in calc from FCF and LFCF?
does not count interest expense
does not count non-core biz income/ expense
B/c EBIT
Why is LFCF so bad to use?
too much disagreement about calc
- which debt payment to subtract
- should it add debt issuance
What is a valuation multiple?
- shorthand for co’s value based on its cash flow, cash flow growth rate
- We could value a co with the formula (cash flow) / (DR-CFGR)
- but mults let you express it in a condensed way, single number
- help compare cos of diff sizes and see how cheap/ ex they are
How do we use mults in real life?
1) Use them in comparable company analysis
-> find public cos similar to the one, use the mults to value cos
2) Look at growth rates of various metrics & corr mults to see how co is currently priced
3) DR and CF figures should be similar, so differences in CFGR should explain diff in mults
Why are mults and growth rates not correlated?
- co valuation is based on cash flow,
- different from EBIT and EBITDA which are approximations of cash flow
- difficult to find 100% comparable companies -> differences in discount rates b/c risk and potential returns will differ
- current events affect mults even if don’t change co’s long term performance eg. legal case
Why could EBITDA/EBIT, approximations of cash flow, be different from cash flow itself?
Eg. EBITDA growth could be 10% but Cash Flow growth might be 5% b/c of taxes, change in WC etc.
Why could a co’s TEV/EBITDA mult be higher than the median for comparable cos?
1) market expects this co’s cash flows to grow faster that comparable cos
2) DR won’t differ by huge amt since they’re comparable cos -> risk and potential returns should be similar
3) Current events- eg. legal
What kind of companies should you buy?
the undervalued ones
What does it mean if a co is undervalued?
similar or lower multiples than peer cos
but with same/ higher growth
How is FCF calc different under IFRS?
- IFRS cos start CFO section with something other than NI so need to adjust eg. subtract net interest expense
- don’t add back entire D&A line item on CFS- only the part unrelated to leases
Unlevered FCF vs Levered FCF- uses
- UFCF: DCF b/c can value co. while ignoring cap struc
- FCF- standalone co analysis and determining debt repayment capacity
- LFCF- not useful for much b/c of disagreement about basic calc but could use it in levered fcf, may better represent net change in cash
Why use EBIT and EBITDA instead of FCF or UCF since the latter is closer to cash flow?
convenience- FCF and UFCF are more accurate but take more time to calc b/c need to review full cash flow statement
comparability- FCF and UFCF vary between different cos, regions, inds, accounting syst -> need to normalize figures -> need discretion and explanation
Which to pair with EqV or TEV?
- If denominator deducts net interest expense: EqV
- debt investors have been paid, only equity investors can earn something now
- if denominator does not deduct net interest expense, piairs with TEV
If company has both debt and preferred stock why is using NI wrong when calc P/E mult?
- it’s creating a mult based on metrics in btw EqV and TEV- wrong!!
- If use NI instead of NITC, need to use EqV+Preferred Stock in numerator
- halfway to TEV but missing the other adjustments
How can you tell which type of free cash flow has TEV or EqV?
If it has deducted net interest expense- use EqV (eg. FCF or LFCF)
If not- use TEV eg. UFCF.
What is the EBITDA formula?
Rev - COGS - OpEx excluding D&A
If EBITDA decreases, how do Unlevered FCF and Levered FCF change?
decrease since the Operating Income
that flows into both of them will be lower.
When you calculate Unlevered FCF you’re
not counting the tax shield from the interest expense. Why?
- u r ignoring capstr so have to ignore everything related to capstr
- exlude interest so need to exclude tax benefit from that interest
When you create “forward multiples” based on projections for metrics such as Revenue
and EBITDA, how do you adjust Enterprise Value? Do you project it forward as well?
- no, never project TEV or EqV
- use the current values and divide by historical or projected metrics
- b/c Current EqV and TEV represent past performance and market’s future expectations for co
Two companies have the same amount of Debt, but one has Convertible Debt, and the
other has traditional Debt.
Both companies have the same Operating Income, Tax Rate, and Equity Value. Which
company will have a higher P / E multiple?
- interest rates on Convertible Debt are lower than the rates on traditional Debt, -
- company with Convertible Debt will have a lower interest expense and, therefore, a higher Net Income.
Therefore, it will have a lower P / E multiple than the company with traditional Debt because both companies have the same Equity Value.
A company is currently trading at 10x TEV / EBITDA. It wants to sell an Operating Asset for 2x the Asset’s EBITDA. Will that transaction increase or decrease the company’s Enterprise Value and its TEV / EBITDA multiple?
The sale will reduce the company’s Enterprise Value because the company is trading an
Operating Asset for Cash, which is a Non-Operating Asset.
Even though the company’s Enterprise Value decreases, its TEV / EBITDA multiple increases
because the Asset’s multiple was lower than the entire company’s multiple.
Pretend that the company’s total EBITDA was $100, and that this Asset contributed $20 of that
EBITDA. Therefore, the company’s Enterprise Value before the sale was $1,000.
The company now sells the Asset for $40. After the sale, the company’s Enterprise Value falls by
$40, and its EBITDA falls by $20. So, its new TEV / EBITDA is $960 / $80, or 12x.
