Valuation

MPA FIN 286

Alessandro Previtero
Slide Pack Week 4 Part 2
Relative Valuation

Todays Content
I.

Announcements:

Review session tomorrow.

Airthread case due Monday

II.

Glossary:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/
datafile/variable.htm

III. Relative Valuation Approach

IV. Boston Beer Case

Overview - 2

I. Company Valuation
Introduction
Discounted Cash Flow (DCF) Models
Discount Rate
No Friction Model
WACC (Weighted Average Cost of Capital)
APV (Adjusted Present Value)
Multiples
Other topics: LBOs, M&A, etc.

Multiples Approach
There is a significant philosophical difference between discounted
cash flow and relative valuation.
In discounted cash flow valuation, we are attempting to
estimate the intrinsic value of an asset based upon its capacity
to generate cash flows in the future.
In relative valuation, we are making a judgment on how much
an asset is worth by looking at what the market is paying for
similar assets.
The multiples approach is a relative valuation that is based on the
idea that similar companies should be equally priced
1. Identify a set of comparable companies
2. Calculate a valuation metric to value the asset
3. Calculate an initial estimate of value
4. Adjust the value to the special characteristics of the company

Company Valua4on Mul4ples - 4

Multiples Approach

Comparables
A

115

$40

$50

$100

$15

EBITDA

30

$10

$15

$20

$5

3.3

MULTIPLE 3.83

Company Valua4on Mul4ples - 5

Valuation Ratios
Several ratios are used to value assets
Equity (Stock Price) Multiples
P/E
PEG
MVE/BVE
Enterprise Value Multiples
V/EBITDA
V/FCF
V/Sales
V/EBIT
The choice of which ratio to use depends on the type of firm that is
valued, and the choice of comparables
For mature companies, I like to use the V/EBIT ratio. Why?

Company Valua4on Mul4ples - 6

Choice of Comparables
Good comparables should match the investment to be valued on
the characteristics that determine its value.
For companies, characteristics include industry, cost structure,
capital structure, growth potential, life-cycle, presence or
absence of strategic/growth options, and others
For real estate, important comparable characteristics include
location, age, condition, etc.
For power plants, important characteristics are demand for
power, efficiency (heat rates, etc.), technology, etc.
No two investments are identical
In every comps valuation you must assess the extent to which
the differences across assets are likely to have a material effect
on the valuation multiples.
Operating Leverage (fixed costs relative to revenue) increases
investment risk
Investments with higher operating leverage will experience
more volatility in operating income in response to changes in
revenues
Company Valua4on Mul4ples - 7

An example of trading multiples (1/2)

You want to know whether Amazon is over- or under-valued using

a simple PE ratio approach.

Information on forward PE ratios:

PE Oct 16, 2012
Amazon (AMZN)
Barnes & Noble (BSK)

156.53
NM

Expedia (EXPE)

17.05

Ebay (EBAY)

19.34

Source: Capital IQ

Company Valua4on Mul4ples - 8

An example of trading multiples (2/2)

But Amazon exhibits much more growth than the other companies
Consensus of 27% for average EPS growth over next 5 years
We could use instead the so-called PEG ratio:

PE
PEG =
Annual EPS growth 100

Information on forward PEG ratios:

PEG Oct 16, 2012
Amazon (AMZN)

4.16

Barnes & Noble (BSK)

NM

Expedia (EXPE)

1.27

Ebay (EBAY)

1.35

Source: Capital IQ

Company Valua4on Mul4ples - 9

Multiples Approach and DCF

The Multiples approach is a very rough approximation of the DCF
Example: From DCF to P/E
Assumptions

E[FFCFt ] FFCF Earnings

V =

t
rg
rg
(1 + r )
t =0
V
1

E rg

1. FFCF growing perpetuity

V /N
1

E/N rg

4. Comparable Risk ( r )

P
1

=M
EPS r g

2. FFCF ~ Earnings
3. Comparable leverage

5. Comparable growth rate (g)

Company Valua4on Mul4ples - 10

Multiples: Example
Company A is trading at a P/E multiple of 20, and company B is
trading at a P/E multiple of 30. Are shares of company B overpriced
relative to shares of company A?
No! Company B could have:
1. higher FCF in the future (terminal value)
2. same E but higher FCF (higher DA, lower Capex, better NWC
management, )
3. Higher leverage
4. Lower risk
5. Higher growth rate

In order to correct for these approximations, you need to adjust the

P/E ratio

Adjust P/E ratios using regression analysis

run a DCF!

Company Valua4on Mul4ples - 11

An example of transaction multiples (1/2)

Consider you want to value a home with 3,581 sq.ft.

One year old
Oversized lot
Has swimming pool

Information about recent transactions in same area (comparables):

Comp #1

Comp #2

Average

$330,000

$323,000

n.a.

Square footage

3,556

4,143

n.a.

Selling price/sq.ft.

$92.80

$77.96

$85.38

$332,317

$279,175

$305,746

Sale price

Estimated value

Source: Titman and Martin 2007, chapter 6

Company Valua4on Mul4ples - 12

An example of transaction multiples (2/2)

We need to adjust our estimates for distinctive features:

Comp #1

Comp #2

Average

$332,317

$279,175

$305,746

Plus lot premium

$20,000

$20,000

$20,000

Plus pool

$15,000

$15,000

$15,000

$367,317

$314,175

$340,746

Estimated value
Adjustments

Estimated market value

Question: how would you value a house using a DCF approach?

Source: Titman and Martin 2007, chapter 6

Company Valua4on Mul4ples - 13

Adjusting Multiples (1/2)

Using raw multiples provides only a rough approximation of the true
value of a company
As we have seen, sales growth rate, leverage, betas and other
company-specific characteristics affect multiple ratios.
Solution adjust multiples using specific company characteristics
1. Identify key drivers that affect multiples
2. Run Market- or Industry- wide regressions between multiples
and key drivers
3. Find predicted value of multiples ratio for your company

Company Valua4on Mul4ples - 14

Adjusting Multiples (2/2)

US Market-wide Regressions of Mul6ples (Jan 2009)

R2

PE = 7.62 + 77.98 gEPS + 7.67 Payout -5.37 Beta

28.6%

PEG = -1.343 -0.48 Beta + 0.89 Payout 1.17 ln(gEPS)

53.3%

PBV= 1.28 + 6.72 gEPS + 0.33 Payout -1.65 Beta + 8.67 ROE

68.3%

PS= 0.29 + 4.32 gEPS+ 0.31 Payout 0.86 Beta + 11.42 Net Margin

62.3%

EV/Invested Capital= 1.10 + 3.99 g + 5.06 ROIC 1.35 (Debt/Capital)

50.1%

EV/Sales = 1.72 + 1.94 g+ 5.58 Opera4ng Margin 4.87 Tax Rate

50.3%

EV/EBITDA= 6.68 +25.34 g- 7.99 Tax rate -1.59 (Debt/Capital) -1.837 RIR

19.3%

g = Expected growth rate in revenues for next 5 years (if not available, use gEPS)
Payout = Dividends/Earnings
ROIC = Return on capital = EBIT (1- tax rate)/ Invested Capital
OperaIng Margin = EBIT/ Sales
Invested Capital = Book value of equity + Book value of debt - Cash
ROE = Net Income/ Book value of Equity
Tax Rate = EecIve tax rate
Debt/Capital = Debt/ (Market value of Equity + Debt)
RIR = Reinvestment Rate = (Cap Ex DepreciaIon + Chg in WC)/ EBIT (1-t)
Source: Damodarans Website - hUp://pages.stern.nyu.edu/~adamodar/

Company Valua4on Mul4ples - 15

HOG Multiples Valuation

Step #1 : Find Comparable Companies

Step #2 : Get Financial and Operating Statistics for

Comparable Companies

Step #3 : Compute Weights for Comparable

Companies

Step #4 : Find Trading Multiples for Comparable

Companies

Step #5 : Apply Trading Multiples to HOG

Step #6 : Use Regression Approach

Company Valua4on Mul4ples - 16

Multiples: Pros and Cons

PROS

If done correctly, using market-calculated mul4ples to value the asset

gives the best es4mate of market value
It reects the current market, 1000s of par4cipants
It is the answer to the ques4on what are people paying for
comparable assets RIGHT NOW
The mechanics are predy easy (Although its surprisingly easy to
screw-up)
You dont have to try and explicitly project the future

CONS

Multiples Approach

GIGO Garbage In, Garbage Out

If you use the wrong comps, youll get the wrong answer
Good comps are hard to nd
Oien theres no good way to determine whether or not the target
assets value should be more or less or equal to the mean of the comp
set
It will never detect a market bubble
For the same reason it gives a very good measure of market
value, it cant detect when market value is wrong
Company Valua4on Mul4ples - 17

Multiples Vs DCF (1/2)

You might prefer using DCF over Multiples when:
The firm is relatively unique in its industry and theres no good
comps
You suspect a bubble or a panic or some other type of market
irrationality
The firm operates in an industry with very few public firms so
theres just not much comp data
You believe you have superior information (e.g. CFs forecast)
You might prefer using Multiples over DCF when:
If you have really good comps and you believe the market is
operating rationally
If you have very little confidence in projections of future
performance
If youre trying to solely determine market value, or the amount
you could get in a sale of the asset or the price youll have to pay
to buy the asset
Company Valua4on Mul4ples - 18

Multiples Vs DCF (2/2)

In practice, we almost always use both methods and
consider both values
I recommend doing the DCF first so that you can get
an understanding of the business which will allow you
to discern better comps for the relative value work
Both the DCF value and the Relative Value measures
provide important clues and information about the
value of the asset youre working with, and provide
somewhat of a check on each other (very important)

Company Valua4on Mul4ples - 19

Next Wednesday Boston Beer Co. Case

Group Assignment: 3-4 people
Answer questions posted on Canvas
Print a copy of your report to hand it in at the beginning of the class
Be ready to answer questions in class.
Please use only the information provided in the case
For your convenience, I posted on Canvas an excel file with the main
tables in the exhibits.

Company Valua4on Mul4ples - 20