Lesson 7 - Comparative Valuation Approaches Flashcards
What is comparative analysis?
Involves comparing the subject company to “comparable companies” in the same industry.
What types of comparative analysis are there?
Benchmarking
Analysis of public equity market data (public company multiple approach)
Analysis of recent transactions (transaction multiple approach)
Acquirer rules of thumb
Purpose of comparative analysis
Provide a general understanding of the risk-reward dynamics in a given industry
Assess overall reasonableness of the valuation conclusions
Should companies be in the same industry and only undertake the same business functions as the subject business?
Yes
What factors do you consider when choosing comparable companies?
Company size - revenues, assets, number of employees
Level of diversification - “pure play” firms are better comparable
Degree of vertical integration
Relative market share
Cost structure and degree of operating leverage; capital vs. labor intensive business
Financial structure (capital mix)
General principles
Companies in commodity type industries make better comparable than companies with a large number of proprietary products
Industries should be well defined
Comparison is more meaningful in mature industries rather than in emerging ones
Possible Comparability Adjustments:
Adjustments may be required to enhance comparability:
Differences in accounting policies:
Inventory valuation Depreciation methods Revenue recognition R&D expenditures Future income taxes Differences in income tax rates Differences in financial structure
Determining appropriate capital structure for subject business:
Various measures of financial leverage
Debt serviceability
Use of Benchmark Analysis
Evaluating the adequacy of net trade ___________ _____________.
Working Capital.
Assessing reasonableness of projected operating results:
Profit margins Asset utilization Operating cost structure Employee head counts Sales or profit per employee
Public Company Multiple Approach
What are the applications of this approach?
Identify public companies that are comparable to the subject company.
Establish valuation multiples for the comparable company(s) based on the trading price of its stock
Apply the public company multiples to the subject company
Equity value approach
Starting point is to establish the market capitalization of the public company:
Shares outstanding X current market price of the stock
Commonly used multiples under the equity value approach:
Price/earnings ratio - (market capitalization divided by earnings available to common shareholders
Market/book ratio - (market capitalization divided by book value of common equity)
Enterprise value approach:
Starting point is to establish enterprise value (“EV”). What is enterprise value?
Market capitalization plus FMV of “net debt”. Net debt is defined as all interest bearing debt, capital leases and preferred shares, net of cash or near cash assets.
What are some commonly used multiples under the enterprise value approach?
EV/EBIT
EV/EBITDA
EV/Revenue