Week 4 Flashcards
What is the equity valuation?
estimate a value for a firm or its security
Three primary equity valuation models:
Discount cash flow (DCF)
Cost
Comparable (or comparable approach)
What is the comparables approach?
entity’s value should bear some resemblance to other equities in a similar class (relative valuation approach)
Two primary comparables approach
First (most common) looks at market comparables for a firm and its peers
Second looks at market transactions where similar firms or divisions have been bought out or acquired by other rivals, private equity firms or other classes of large, deep-pocketed investors
What is a comparable company analysis (CCA)?
Calculate a company’s “implied value” (what it should be worth) based on what other, similar companies are worth
What are the steps for CCA?
- Select an appropriate set of comparable PUBLIC companies
- Determine the metrics and multiples you want to use
- Calculate the metrics and multiples for the companies
- Apply the median or 25th/75th percentile multiples from the set to your company to estimate its Implied Equity Value and Enterprise Value
How many companies should be in a set?
50 is too many to be useful, 1-2 does not have enough data
Formula for company value
Company value = cashflow / (discount rate - CF growth rate)
Where CF growth rates must be < discount rate
If one company has a higher expected growth rate, it _______ trade at higher multiples
Should
Calculate the company’s equity value and enterprise value based on…
current share price, shares outstanding, and balance sheet
What is law of one price?
- firms which generate identical cashflows will have the same value
- identical assets will have the same price regardless of where they are traded (firms which generate identical cashflows and the same growth rate prospects, no matter which industry)
What do analysts look for?
- Comparison firms that have similar future prospects
- No fundamental differences between firms
- Same growth rates
- Same cost of capital (discount rate)
- Industry (or comparison set) is correctly valued
Formula for P/E ratio
Share price / earnings
What does price / earnings ratio mean?
- Meaningless for a company with little to no earnings
- Does not take capital structure (risk) into consideration
What does price / book ratio mean?
- Measures how much an investor is willing to pay for each dollar of book value
- One would think that purchasing shares in a Company at less than book value (ie. Price/Book < 1) would be a good investment
- Advantages of using this metric are that book value is – - Commonly used for comparing financial firms as the assets and liabilities of a financial firm are well represented by book value