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VALUATION:PACKET2RELATIVEVALUATION,ASSET-BASEDVALUATIONANDPRIVATECOMPANYVALUATIONAswathDamodaranUpdated:September20169/2016
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Test1:Areyoupricingorvaluing?
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Test2:Areyoupricingorvaluing?
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TheEssenceofRelativeValuation(Pricing)
¨ Inrelativevaluation,thevalueofanassetiscomparedtothevaluesassessedbythemarketforsimilarorcomparableassets.
¨ Todorelativevaluationthen,¤ weneedtoidentifycomparableassetsandobtainmarketvaluesfortheseassets
¤ convertthesemarketvaluesintostandardizedvalues,sincetheabsolutepricescannotbecomparedThisprocessofstandardizingcreatespricemultiples.
¤ comparethestandardizedvalueormultiplefortheassetbeinganalyzedtothestandardizedvaluesforcomparableasset,controllingforanydifferencesbetweenthefirmsthatmightaffectthemultiple,tojudgewhethertheassetisunderorovervalued
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Relativevaluationispervasive…
¨ Mostassetvaluationsarerelative.¨ MostequityvaluationsonWallStreetarerelativevaluations.
¤ Almost85%ofequityresearchreportsarebaseduponamultipleandcomparables.
¤ Morethan50%ofallacquisitionvaluationsarebaseduponmultiples¤ Rulesofthumbbasedonmultiplesarenotonlycommonbutareoften
thebasisforfinalvaluationjudgments.¨ Whiletherearemorediscountedcashflowvaluationsin
consultingandcorporatefinance,theyareoftenrelativevaluationsmasqueradingasdiscountedcashflowvaluations.¤ Theobjectiveinmanydiscountedcashflowvaluationsistobackintoa
numberthathasbeenobtainedbyusingamultiple.¤ Theterminalvalueinasignificantnumberofdiscountedcashflow
valuationsisestimatedusingamultiple.
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Whyrelativevaluation?
“IfyouthinkI’mcrazy,youshouldseetheguywholivesacrossthehall”
JerrySeinfeldtalkingaboutKramerinaSeinfeldepisode
“A little inaccuracy sometimes saves tons of explanation”H.H. Munro
“ If you are going to screw up, make sure that you have lots of company”
Ex-portfolio manager
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TheMarketImperative….
¨ Relativevaluationismuchmorelikelytoreflectmarketperceptionsandmoodsthandiscountedcashflowvaluation.Thiscanbeanadvantagewhenitisimportantthatthepricereflecttheseperceptionsasisthecasewhen¤ theobjectiveistosellasecurityatthatpricetoday(asinthecaseofan
IPO)¤ investingon“momentum” basedstrategies
¨ Withrelativevaluation,therewillalwaysbeasignificantproportionofsecuritiesthatareundervaluedandovervalued.
¨ Sinceportfoliomanagersarejudgedbaseduponhowtheyperformonarelativebasis(tothemarketandothermoneymanagers),relativevaluationismoretailoredtotheirneeds
¨ Relativevaluationgenerallyrequireslessinformationthandiscountedcashflowvaluation(especiallywhenmultiplesareusedasscreens)
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Multiplesarejuststandardizedestimatesofprice…
Numerator = What you are paying for the asset
Denominator = What you are getting in return
Market value of equity Market value for the firmFirm value = Market value of equity
+ Market value of debt
Market value of operating assets of firmEnterprise value (EV) = Market value of equity
+ Market value of debt- Cash
Revenuesa. Accounting revenuesb. Drivers- # Customers- # Subscribers= # units
Earningsa. To Equity investors - Net Income - Earnings per shareb. To Firm - Operating income (EBIT)
Book Valuea. Equity= BV of equityb. Firm= BV of debt + BV of equityc. Invested Capital= BV of equity + BV of debt - Cash
Multiple =
Cash flowa. To Equity- Net Income + Depreciation- Free CF to Equityb. To Firm- EBIT + DA (EBITDA)- Free CF to Firm
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TheFourStepstoDeconstructingMultiples
¨ Definethemultiple¤ Inuse,thesamemultiplecanbedefinedindifferentwaysbydifferent
users.Whencomparingandusingmultiples,estimatedbysomeoneelse,itiscriticalthatweunderstandhowthemultipleshavebeenestimated
¨ Describethemultiple¤ Toomanypeoplewhouseamultiplehavenoideawhatitscrosssectional
distributionis.Ifyoudonotknowwhatthecrosssectionaldistributionofamultipleis,itisdifficulttolookatanumberandpassjudgmentonwhetheritistoohighorlow.
¨ Analyzethemultiple¤ Itiscriticalthatweunderstandthefundamentalsthatdriveeachmultiple,
andthenatureoftherelationshipbetweenthemultipleandeachvariable.¨ Applythemultiple
¤ Definingthecomparableuniverseandcontrollingfordifferencesisfarmoredifficultinpracticethanitisintheory.
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DefinitionalTests
¨ Isthemultipleconsistentlydefined?¤ Proposition1:Boththevalue(thenumerator)andthestandardizingvariable(thedenominator)shouldbetothesameclaimholdersinthefirm.Inotherwords,thevalueofequityshouldbedividedbyequityearningsorequitybookvalue,andfirmvalueshouldbedividedbyfirmearningsorbookvalue.
¨ Isthemultipleuniformlyestimated?¤ Thevariablesusedindefiningthemultipleshouldbeestimateduniformlyacrossassetsinthe“comparablefirm” list.
¤ Ifearnings-basedmultiplesareused,theaccountingrulestomeasureearningsshouldbeappliedconsistentlyacrossassets.Thesameruleapplieswithbook-valuebasedmultiples.
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Example1:PriceEarningsRatio:Definition
PE=MarketPriceperShare/EarningsperShare¨ ThereareanumberofvariantsonthebasicPEratioinuse.Theyarebaseduponhowthepriceandtheearningsaredefined.Price: isusuallythecurrentprice
issometimestheaveragepricefortheyearEPS: EPSinmostrecentfinancialyear
EPSintrailing12monthsForecastedearningspersharenextyearForecastedearningspershareinfutureyear
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Example2:StayingonPEratios
¨ AssumingthatyouarecomparingthePEratiosacrosstechnologycompanies,manyofwhichhaveoptionsoutstanding.WhatmeasureofPEratiowouldyieldthemostconsistentcomparisons?a. Price/PrimaryEPS(actualshares,nooptions)b. Price/FullyDilutedEPS(actualshares+alloptions)c. Price/PartiallyDilutedEPS(countingonlyin-the-money
options)d. Other
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Example3:EnterpriseValue/EBITDAMultiple
¨ TheenterprisevaluetoEBITDAmultipleisobtainedbynettingcashoutagainstdebttoarriveatenterprisevalueanddividingbyEBITDA.
1. Whydowenetoutcashfromfirmvalue?2. Whathappensifafirmhascrossholdingswhichare
categorizedas:¤ Minorityinterests?¤ Majorityactiveinterests?
Enterprise ValueEBITDA
=Market Value of Equity + Market Value of Debt - Cash
Earnings before Interest, Taxes and Depreciation
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Example4:AHousingPriceMultiple
Thebubblesandbustsinhousingpriceshasledinvestorstosearchforamultiplethattheycanusetodeterminewhenhousingpricesaregettingoutofline.Onemeasurethathasacquiredadherentsistheratioofhousingpricetoannualnetrentalincome(forrentingoutthesamehouse).Assumethatyoudecidetocomputethisratioandcompareittothemultipleatwhichstocksaretrading.Whichvaluationratiowouldbetheonethatcorrespondstothehouseprice/rentratio?a.PriceEarningsRatiob.EVtoSalesc.EVtoEBITDAd.EVtoEBIT
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DescriptiveTests
¨ Whatistheaverageandstandarddeviationforthismultiple,acrosstheuniverse(market)?
¨ Whatisthemedianforthismultiple?¤ Themedianforthismultipleisoftenamorereliablecomparisonpoint.
¨ Howlargearetheoutlierstothedistribution,andhowdowedealwiththeoutliers?¤ Throwingouttheoutliersmayseemlikeanobvioussolution,butifthe
outliersalllieononesideofthedistribution(theyusuallyarelargepositivenumbers),thiscanleadtoabiasedestimate.
¨ Aretherecaseswherethemultiplecannotbeestimated?Willignoringthesecasesleadtoabiasedestimateofthemultiple?
¨ Howhasthismultiplechangedovertime?
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1.Multipleshaveskeweddistributions…
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0.
100.
200.
300.
400.
500.
600.
700.
0.01To4 4To8 8To12 12To16 16To20 20To24 24To28 28To32 32To36 36To40 40To50 50To75 75To100 100andover
PERatios:UScompaniesinJanuary2016
Current Trailing Forward
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2.Makingstatistics“dicey”
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CurrentPE TrailingPE ForwardPENumberoffirms 7480 7480 7480NumberwithPE 3,344. 3,223. 2,647.Average 59.42 46.04 29.63Median 18.53 18.29 16.98Minimum 0.11 0.28 0.15Maximum 32,269.00 6,900.00 2,748.00Standarddeviation 777.02 256.06 81.27Standarderror 13.44 4.51 1.58Skewness 37.27 19.9 18.7425thpercentile 11.88 12.32 13.175thpercentile 30.25 29.52 24.28
US firms in January 2016
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3.Marketshavealotincommon :ComparingGlobalPEs
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0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
US Europe Japan EmergingMarkets Aus,NZ&Canada Global
TrailingPERatiosbyRegion
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3a.Andthedifferencesaresometimesrevealing…PricetoBookRatiosacrossglobe– January2013
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4.Simplisticrulesalmostalwaysbreakdown…6timesEBITDAwasnotcheapin2010…
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Butitmaybein2016,unlessyouareinJapan,AustraliaorCanada
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0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
100
EV/EBITDAMultiplesinJanuary2016
US Europe Japan EmergingMarkets Aus,NZ&Canada Global
Average 25thperc. Median 75thperc.UnitedStates 439.06 7.70 11.80 28.00Europe 98.53 6.73 10.12 16.55Japan 69.64 4.67 7.20 11.59EmergingMarkets 112.64 6.76 11.91 28.07Aus,NZ&Canada 77.17 5.24 8.85 15.77Global 148.16 6.43 10.58 21.67
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AnalyticalTests
¨ Whatarethefundamentalsthatdetermineanddrivethesemultiples?¤ Proposition2:Embeddedineverymultipleareallofthevariablesthat
driveeverydiscountedcashflowvaluation- growth,riskandcashflowpatterns.
¨ Howdochangesinthesefundamentalschangethemultiple?¤ Therelationshipbetweenafundamental(likegrowth)andamultiple
(suchasPE)isalmostneverlinear.¤ Proposition3:Itisimpossibletoproperlycomparefirmsonamultiple,
ifwedonotknowhowfundamentalsandthemultiplemove.
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ASimpleAnalyticaldevice
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