Valuation Flashcards
Equity Value
Also known as ‘market capitalization’
Equity Value = Share Price x Fully Diluted Shares Outstanding
where Fully Diluted Shares Outstanding = Basic Shares Outstanding + ‘In-the-Money’ Options and Warrants + ‘In-the-Money’ Convertible Securities
Equity value only provides a measure of relative size. For insight on absolute and relative market performance, look at the company’s current share price as a percentage of its 52-week high (to gauge current market sentiment and outlook for the individual company and broader sector). If a given company’s percentage is significant out of line with that of its peers, it is generally an indicator of company-specific issues.
Treasury Stock Method (TSM)
Calculation method to find the incremental shares represented by a company’s in-the-money options and warrants.
TSM assumes that all tranches of in-the-money options and warrants are exercised at their weighted average strike price with the resulting option proceeds used to repurchase outstanding shares of stock at the company’s current share price.
Because ‘in-the-money’ means lower exercise strike price than current market price, always results in NET ISSUANCE of shares (DILUTIVE).
Cash-Pay Convertible Bond (‘Convert’)
Represents a straight debt instrument and an embedded equity call option that provides for the context to be exchanged into a defined number of shares of the issuer’s common stock under certain circumstances.
- Determine if the converts are in-the-money (ie. is the current market price above the conversion price?)
- If in-the-money, convert into additional shares with the if-converted method (physical settlement) or net share settlement (NSS).
- If out-of-the-money, treat as debt.
If-Converted Method
In-the-money converts are converted into additional shares by dividing the convert’s amount outstanding by its conversion price.
Once converted, the convert is treated as equity and is included in the calculation of the company’s fully diluted shares outstanding and equity value.
The convert must be excluded from the calculation of the company’s total debt.
The conversion of in-the-money converts also requires an upward adjustment to the company’s net income to account for the foregone interest expense payments associated with the coupon on the convert.
Conversion is typically EPS dilutive (due to additional share issuance); however net income is actually higher on a pro forma basis.
Net Share Settlement (NSS)
Converts issued with a NSS accounting feature permits the issuer to satisfy the face (or accreted) value of the in-the-money convert with at least a portion of cash upon conversion.
Thus, only the value represented by the excess of the current share price over the conversion price is assumed to be settled with the issuance of additional shares.
Enterprise Value
The theoretical takeover price if a company were to be bought.
Represents the sum of all ownership interests in a company and claims on its assets from both debt and equity holders.
EV = Equity Value + Total Debt + Preferred Stock + Non-controlling Interest - Cash and Cash Equivalents
Is considered independent of capital structure. (Ex. if a company raises additional debt that is held on the BS as cash, its EV remains constant as new debt is offset by the increase in cash).
This means that similar companies would be expected to have consistent EV multiples despite differences in capital structure.
One important exception is highly leveraged companies, which may trade at a discount relative to peers due to higher risk of financial distress and potential constraints to growth.
Revenue
Total dollar amount realized by a company through the sale of its products and services during a given time period.
All else being equal, companies with greater sales volumes tend to benefit from scale, market share, purchasing power, and lower risk profile. Often rewarded with a premium valuation relative to peers.
Gross Profit
Gross Profit = Revenue - COGS
Profit earned by company after subtracting costs directly related to the production of its products and services.
Key indicator of operational efficiency and pricing power, and is usually expressed as percentage of sales for analytical purposes.
EBITDA
EBITDA = EBIT + depreciation + amortization (where D&A is sourced from the cash flow statement)
Widely used proxy for operating cash flow as it reflects the company’s total cash operating costs for producing its products and services
Fair ‘apples-to-apples’ comparison among companies in the same sector because it is free from differences resulting from capital structure (ie. interest expense) and tax regime (ie. tax expense)
EBIT
Often the same as reported operating income
Also independent of tax regime and serves as useful metric for comparing companies with different capital structures
Less indicative as a measure of operating cash flow from EBITDA because it includes non-cash D&A expense. (Important because D&A reflects discrepancies among different companies in capital spending and/or depreciation policy and acquisition histories).
Net Income
Residual profit after ALL company’s expense have been netted out
The earnings available to equity holders once all of the company’s obligations have been satisfied
Can be viewed on a per share basis (EPS)
Gross Profit Margin
Gross Profit Margin = Gross Profit / Revenue
Measures the percentage of sales remaining after subtracting COGS
Driven by a company’s direct cost per unit (ex. materials, manufacturing, direct labor, etc.)
Companies ideally seek to increase their gross margin through a combination of improved sourcing/procurement of raw materials, enhancing pricing power, improving the efficiency of manufacturing facilities and processes
EBITDA Margin, EBIT Margin
EBITDA Margin = EBITDA / Revenue
EBIT Margin = EBIT / Revenue
Used to measure a company’s OPERATING profitability.
Can also be used to frame relative performance among peer companies and across sectors.
Net Income Margin
Net Income Margin = Net Income / Sales
Measures a company’s OVERALL profitability.
Net of interest expense and is therefore affected by capital structure. (Important because companies with similar operating margins may have substantially different net income margins due to differences in leverage).
Compound Annual Growth Rates (CAGR)
CAGR = (Ending Value / Beginning Value) ^ (1/n) - 1
where n = number of years
Return on Invested Capital (ROIC)
ROIC = EBIT / (Average Net Debt + Equity)
Measures the return generated by ALL capital provided to a company:
- Uses a pre-interest earnings statistic in the numerator, like EBIT (because it is independent of tax regime and capital structure; they are un-levered)
- Uses a metric that captures both debt and equity
Denominator is usually calculated on an average basis
Return on Equity (ROE)
ROE = Net Income / Average Shareholders’ Equity
Measures the return generated on the EQUITY provided to a company by its shareholders:
Important indicator of performance as companies are intently focused on shareholder returns
Return on Assets (ROA)
ROA = Net Income / Average Total Assets
Measures the return generated by a company’s asset base; indicates the asset efficiency of a business.
Dividend Yield
Implied Dividend Yield = (Most Recent Quarterly Dividend Per Share x 4) / Current Share Price
Measure of returns to shareholders
Measures the annual dividends per share paid by a company to its shareholders expressed as a % of its share price
Leverage Ratio
Generally, the higher a company’s leverage, the higher its risk of financial distress due to the burden associated with greater interest expense and principal repayments
Debt-to-EBITDA
Because EBITDA is typically used as rough proxy for operating cash flow, this ratio can be viewed as a measure of how many years of a company’s cash flows are needed to repay its debt.
Coverage Ratio
Debt-to-Total Capitalization = Debt / (Debt + Pfd Stock + Non-controlling Interest + Equity)
Coverage
Broad term that refers to a company’s ability to meet its interest expense obligations
Generally comprised of a financial statistic representing operating cash flow (e.g. LTM EBITDA) in the numerator and LTM interest expense in the denominator
Interest Coverage Ratio
Interest Coverage Ratio = (EBITDA, (EBITDA - CapEx), or EBIT) / Interest Expense
The higher the coverage ratio, the better positioned the company is to meet its debt obligations –> stronger credit profile
Calculation of LTM Financial Data
LTM = Prior Fiscal Year + Current Stub - Prior Stub
If the most recent quarter is the fourth quarter of a company’s fiscal year, then non LTM calculations are necessary as the full prior fiscal year (as reported) serves as the LTM period
Calendar-ization of Financial Data
Any variation in fiscal year ends among comparable companies MUST be addressed for benchmarking purposes
Next Calendar (CY) Sales = (Month #) * (Fiscal Year Actual Sales) / 12 + (12 - Month #) * (NFY Sales) / 12
Adjustments for Non-Recurring Items
Important to distinguish between pre-tax and after-tax amounts
Full pre-tax charges can be added back to EBIT(DA). But to calculate adjusted net income and diluted EPS, need to calculate the tax expense on the incremental pre-tax earnings and subtract it.
What kind of denominators can enterprise value multiples be calculated with?
Must be a financial statistic that flows to BOTH debt and equity holders
Ex. Sales, EBITDA, EBIT
What kind of denominators can equity value multiples be calculated with?
Must be a financial statistic that flows ONLY to equity holders
Ex. Net Income, Diluted EPS
Price-to-Earnings Ratio (P/E)
P/E = Share Price / Diluted EPS
P/E = Equity Value / Net Income
Can be viewed as a measure of how much investors are willing to pay for a dollar of a company’s current or future earnings
Particularly relevant for mature companies that have a demonstrated ability to consistently grow earnings
Important limitations to remain cognizant of:
- Not relevant for companies with little or no earnings
- Net income (and EPS) is net of interest expense and therefore dependent on capital structure. This means that two otherwise similar companies can substantially different P/E ratios due to differences in leverage.
Enterprise Value-to-EBIT(DA)
EV/EBITDA is more commonly used
Independent of capital structure and taxes, (and any distortions that may arise from differences in D&A among different companies)
Enterprise Value-to-Sales
Most commonly used as:
- Sanity Check (because sales is not directly indicative of profitability or cash flow generation)
- Reference point for valuation for companies with little or no earnings
