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Corporate Valuation > Topic II. Valuation by Multiples > Flashcards

Topic II. Valuation by Multiples Flashcards

1
Q

What are some reasons for doing valuation by multiples?

A
  • Quick, Convenient to calculate
  • Use readily available data
  • Simple, intuitive interpretations
  • Easily-digestible
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2
Q

What is the physical interpretation of a price-to-earnings (P/E) ratio?

A

It’s the amount you pay for $1.00 of earnings

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3
Q

What is the physical interpretation of an

Enterprise Value / Total Asset ratio?

A

It’s the amount you paid much you pay for a $1.00 of assets - if you were an unlevered firm.

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4
Q

What are the steps required to complete a valuation by multiples analysis?

A
  1. Choose comparable firms
  2. Choose bases for multiple
  3. Choose: average/median across industries
  4. Determine the base for the firm being valued
  5. Value the firm (convert to price per share)
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5
Q

What is the single most important step in the valuation by multiples analysis process?

A
  1. Choosing comparable firms
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6
Q

What is the formula for enterprise value?

A

Enterprise Value =MC +Total Debt− C

where:

MC=Market capitalization; equal to the current stockprice multiplied by the number of outstanding stock shares

Total debt=Equal to the sum of short-term andlong-term debt

C=Cash and cash equivalents; the liquid assets ofa company, but may not include marketable securities​

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7
Q

True/False: The vast majority of corporate debt is traded.

A

False: The vast majority of corporate debt is not traded.

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8
Q

How do we value a company’s debt?

A

we use the book value of a company’s debt

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9
Q

A valuation multiple consists of a _________ and a _________.

A

A valuation multiple consists of a numerator and a denominator.

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10
Q

What metrics can we use for the denominator?

A

Choose the denominator (base) from either:

  • Balance Sheet
  • Income Statement
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11
Q

What does the left side of the balance sheet represent?

Balance Sheet

Total Assets | Total Debts

|

|

Shareholders Equity

A

The left side of the balance sheet represents enterprise value.

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12
Q

What does the right side of the balance sheet represent?

Balance Sheet

Total Assets | Total Debts

|

|

Shareholders Equity

A

Those who have contributed funds to get that firm up and running.

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13
Q

Draw the simplest form of an income statement

A
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14
Q
A
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15
Q

Is the following an acceptible ratio?

[Enterprise Value]

[Total Assets]

A

Yes, because Enterprise Value and Total Assets both represent all shareholders.

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16
Q

Is the following is an acceptible ratio?

[Enterprise Value]

[Stockholders Equity]

A

No!

EV represents ALL shareholders whereas, whereas stockholders equity only represents stockholders.

17
Q

Is the following is an acceptible ratio?

[Equity Value]

[Net Income]

A

Yes!

Because Equity Value represents stockholders and Net Income represents stockholders.

18
Q

What is the trick for knowing if an income statment metric represents all stakeholders (enterprise value) or just shareholders (equity value)?

A

Income Statement

+ REV

  • COGS

- SGA

EBIT <———— EBIT and above is all stakeholders (Enterprise Value)

  • Taxes <———– Amount attributible to governments

- Interest <———– Above line represents debt holders, shareholders

Net Income <———— Represents all shareholders (Equity Value)

19
Q

What are two acceptible Equity Value ratios?

A

[Market Value of Equity] / [Balance Sheet Shareholders Equity]

[Market Value of Equity] / [Net Income] == P/E

20
Q

What are four acceptible “Enterprise Ratio” metrics?

A
  • EV / Total Assets
  • EV / Revenue
  • EV / EBITDA
  • EV / EBIT
21
Q

What is, historically, the most accurate ratio?

A

Enterprise Value / Total Assets

22
Q

What is, historically, the least accurate ratio?

A

[Market Value] / [Net Income]

(P/E Ratio)

23
Q

What are the three ratios recommended by Craig Lewis?

A
  1. Enterprise Value / Total Assets
  2. Market Value of Equity / Book Value of Equity
  3. Enterprise Value / EBITDA
24
Q

If given the following metrics, how would you calculate enterprise value?

  • Average(EV/TA)
  • TA
A

EV = Average(EV/TA) * TA

25
Q

How do you select comparable firms?

A

​Go down the line and filter based on the following (starting from the top):

  1. Industry Classification
  2. Technology
  3. Clientele
  4. Size
  5. Leverage
  6. Profitibility
26
Q

Explain the regression-based approach to valuting by multiples?

A
  1. Use every company in an industry
  2. Choose metrics which are pertinent (EV/EBITDA, Revenue, Size)
  3. Metrics become ‘x’ (independent) variables
  4. Company value becomes ‘y’ (dependent) variable.
  5. Calculate a linear regression equation.
  6. Use ‘company of interests’ variables in the regression equation.
27
Q

What is the MAIN IDEA behind valuation by multiples?

A

“The basic idea behind using multiples for valuation is that similar assets should sell for similar prices, whether they are houses or shares of stock.”

28
Q

What is the issue of using P/E ratio as a multiple?

A

Although the P/E is widely used, it is distorted by capital structure and nonoperating gains and losses.

29
Q

When you are building multiples, the denominator should be a _____\_(forecast, historical) of profits, preferably normalized for unusual items, rather than _______\_ (forecasted, historical) profits.

A

When you are building multiples, the denominator should be a forecast of profits, preferably normalized for unusual items, rather than historical profits.

30
Q

Why are forward-looking metrics used when completing a valuation by multiples?

A

Forward-looking multiples generally have lower variation across peer companies.

31
Q

Why is enterprise value to EBITA preferrable to the P/E ratio?

A

Using net enterprise value to EBITA (or NOPAT) rather than a P/E eliminates the distorting effect of different capital structures”

32
Q

Why is ROIC preferred over return on assets (ROA)?

A

ROIC is independent of operations structure. ROA is a function of operations structure.

33
Q

Why is ROIC preferred over return on assets (ROE)?

A

ROIC is independent of capital structure. ROE is a function of capital structure.

34
Q

Which company would have a lower P/E ratio (all other things held equal)?

Company A: 100% Equity Financed

Company B: 80% Equity Financed, 20% Debt Financed

A

Company B because “P/E drops for the company with higher leverage”

35
Q

What is a potential problem with using the following multiple:

Enterprise-Value-to-EBITDA

A

“Enterprise-Value-to-EBITDA Multiple Distorted by Capital Investment”

36
Q

“DiversCo, a large U.S. company, operates in two areas: energy and retail clothing. You observe an analyst report that values DiversCo using multiples analysis based on a peer group of other large U.S. diversified companies. Do you think that this is an appropriate approach? Why or why ”

A

This is not an appropriate approach.

Valuations should be bottoms-up, not top-down. Diversified companies trade on the basis of the valuations of their individual businesses.

Same thing should be done by Divers Co. It should be valued as the sum of its retail business and energy business.

Also, some times a conglomerate discount is applied to Sum of the Parts valuation.

37
Q

Why should one use forward-looking multiples as opposed to backward-looking multiples when valuing companies?

A

This also avoids much of the ‘one-time item’ problem with actual reported earnings and ensures greater comparability of historical multiples to current and forward priced multiples if these are calculated using the same prospective earnings approach.

38
Q

What are the limitations of using enterprise-value-to-revenues multiples?

A

Ratio places emphasis on high revenue, which does not always correlate to cash flow.

Corporate Valuation (8 decks)

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