pillars of wall street - valuation fundamentals - relative valuation Flashcards
trading comparables analysis
relative valuation methodology that uses trading multiples of comparable companies to value the target company
pros of trading comparables analysis
market efficiency ensures that trading values reflect industry trends, business risk and market growth
based on a few inputs, making valuation easy to calculate
valuation is based on key statistics that are relevant to investors
cons of trading comparables analysis
markets are not always efficient and rational; therefore, market-based valuation can be skewed during severe market ups and downs
assumes peer group is correctly valued by the markets
it’s rare that there is another company that is exactly comparable to the one that you are trying to value
price/earnings multiple
most common equity multiple you’ll see
defined as [share price] / [diluted earnings per share]
diluted earnings per share = [net income available to common shareholders] / [diluted WASO]
net income available to common = [consolidated net income] - [non-controlling interest] - [preferred dividends]
diluted WASO = basic shares outstanding + net new shares
net new shares calculated using treasury stock method
danger with equity multiples
equity multiples are dependent on capital structure; therefore, you should only consider equity multiples when the comparable companies you are looking at have similar capital structures
how multiples are used
EV/revenue:
useful for companies with no earnings (startups)
usually used as sanity check on EV/EBITDA
not that relevant because cash flow and profitability not taken into account
EV/EBITDA:
the standard valuation metric in most sectors
independent of capital structure and taxes
good proxy for cash flow of a business
independent of D&A (meaning if one company spent more than another on acquisition-related amortization or depreciated more cap ex. it won’t affect this figure)
P/E:
most widely recognized trading multiple
relevant for mature companies with stable earnings growth
not relevant for companies with no earnings
dependent on capital structure so it’s useful when comparing companies with similar capital structures
higher P/E corresponds to higher expectations in earnings growth
LTM vs. NTM
LTM = last twelve months NTM = next twelve months (forecast of future)
investors will likely focus on NTM data for valuation purposes because they are interested in what is going to happen in the future
transaction comparables analysis
relative valuation methodology based on multiples of M&A transactions in same industry as the target company
in general, produces higher valuation than trading comps analysis due to premium paid for majority acquisition
pros of transaction comparables analysis
analysis is based on actual acquisition multiples and control premiums
recent transactions reflect prevailing M&A and capital market conditions (so best to look at recent transactions)
trends like foreign purchasers or financial buyers are made clear
cons of transaction comparables analysis
past transactions may not reflect prevailing market conditions
since every transaction is unique, we may not know all factors that went into forming the purchase price
transaction multiples often have wide range of values
may be comparing apples to oranges; truly comparable transactions are rare
