6/16/2010

 Why value a company?

 Ownership
 Profit sharing
 Control

 How to value a company? Consider..

 Cost
VALUATION OF A COMPANY  Potential profit
 Future income

LETS SAY YOU ARE SELLING A BIKE YOU OWN

HOW MUCH WOULD YOU ASK FOR THIS BIKE?
W HY?
What are the things we have to consider while valuing the bike?
EVALUATION
 First, look at the general market.. What are the
factors that determine the price.. Supply, demand,
competition, substitutes)
 you might try to find out if there are any other bikes
on sale that are similar, to estimate the cost
 Do an evaluation of the bike itself (features, special
functions)
 How special is it to the buyer( premium!!)

LOOK AT ITS FEATURES AND FUNCTIONS HOW DO YOU DETERMINE THE PRICE?
 How old is it?  Compare it to others
 How much mileage?  Add a premium or discount to features
 Any accidents?

 Any repairs?

 Resale value?

 Availability?

 What else?

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HOW DO YOU VALUE A COMPANY, TO DETERMINE

THE ATTRACTIVENESS OF THE INDUSTRY OWNERSHIP CONSIDERATION
 Start from the big picture..macro economic  Investment in associates
environment  Less than 20% ownership
 Look at non-monetary features  No significant control
 Porter five forces to determine its competitive edge  Valuation with equity method,
 rivalry, the threat of substitutes, buyer power, supplier  Pro rata share of the earnings
power, and barriers to entry
 MINORITY INTEREST
 Swot analysis (unique features, patent, specialized
 Do not consider the assets, liabilities, revenue or
workforce,
expenses
 Pest(le) analysis
 Ownership between 20-50% is called minority active,
 Political, Economic, Sociological, Technological, Legal and less than 20% is called minority passive .
and Environmental.
 You might want to pay a premium or ask for a
discount based on this information

JOINT VENTURES BUSINESS COMBINATION

 50% OWNERSHIP  More than 50% share
 Have influence in the company  Get total control of the business
 Valuation with PROPORTIONAL CONSOLIDATION  Treat it as a subsidiary
(IFRS)  Use CONSOLIDATION OR ACQUISITION
 Combine proportion of revenue, expenses, assets METHOD for valuation
and liabilities only  Combine revenues, expenses, assets and liabilities

 Remember the minority interest.

 Think of GOODWILL and SYNERGY

VALUATION WITH VALUATION WITH

MONETARY CONSIDERATIONS MONETARY CONSIDERATIONS
 Asset method  Cash Flow method
 Value of the assets, either historic value (cost),  Discounted cash flow method
replacement or value in use (depreciation to be  Free cash flow to Firm (FCFF)
considered)  Free cash flow to Equity (FCFE)
 Earnings method,  Comparable method
 Gordon growth method
 Compare its value with others
 PVGO method  P/E multiple
 Residual Income method  P/B ratio, P/Sales ratio,

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CONSIDER
 business valuations using any method should not
be too high or too low because that could be costly,
resulting in either overpayment or lost opportunities.
 The firms that face important investment,
acquisition, or growth decisions, particularly in a
rapidly changing competitive environment, effective
management requires an understanding of value
creation and a command over valuation analysis.
COMPARABLE COMPANY ANALYSIS
 Identify the set of comparable firms.
 Calculate various relative value measures based on
the current market prices of companies in the
sample.
 Calculate descriptive statistics for the relative value
metrics and apply those measures to the target
firm.
 Estimate a takeover premium.
 Calculate the estimated takeover price for the target
as the sum of estimated stock value based on
comparables and the takeover premium.
THINGS TO CONSIDER
 When using the method of comparables to identify
attractively priced stocks, the analyst must account
for differences in the stocks’ fundamentals. A stock
with a high P/E ratio may still be attractive because
of its rapid growth, while a stock with a high
dividend yield (low price-to-dividend) may be
unattractive because earnings do not support the
dividend and no growth is anticipated.
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COMPARABLE COMPANY ANALYSIS
 Advantages:
 Data for comparable companies is easy to access.
 Fundamental valuation assumptions are sound.
 Current market-based estimates of value, not guesses about
the future.
 Disadvantages:
 Assumes the market’s valuation of the comparable
companies is accurate.
 Estimate is a fair stock price, not a fair takeover price. An
appropriate takeover premium must be determined
separately.
 Difficult to include synergies or changing capital structures
into the analysis.
 Historical data may not reflect current conditions in the M&A
market.
 The basic idea of the method of comparables is to
compare a stock’s price multiple to the benchmark.
Firms with multiples below the benchmark are
undervalued, and firms with multiples above the
benchmark are overvalued.
LIMITATIONS
 Using relative valuation methods that require the
use of comparable firms is challenging in an
international context due to differences in
accounting methods, cultures, risk, and growth
opportunities.
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 Shares of TKR Construction (TKR) are selling for
$50. Earnings for the last 12 months were $4.00
per share. The average trailing P/E ratio for firms in
TKR’s industry is 15. Assume a growth rate of 0%.
Using the method of comparables, what price is
indicated for TKR?
 A) $33.33. B) $50.00. C) $60.00.
 Proprietary Technologies, Inc., (PTI) has a leading
price-to-earnings (P/E) ratio of 28 while the median
leading P/E of a peer group of companies within the
industry is 20. Based on the method of
comparables, an analyst would most likely conclude
that PTI should be:
 A) sold or sold short as an overvalued stock.

 B) bought as an undervalued stock.

 C) viewed as a properly valued stock.

P/E ANALYSIS P/E ANALYSIS

p/e ratio Company A p/e ratio Company A Company B Company C
2008 6 2008 6 6.3 5.6
2009 6.5 2009 6.5 6.8 6.9
2010 5.5 2010 5.5 5.8 5.2

If the earning (net profit) was 1000 each year, what was the If the earning (net profit) was 10 per share each year, what was
maximum value and which year? the maximum share price and which year?
What was minimum value and which year? What was minimum share price and which year?
What is the average value? What is the average share price?

Note the assumptions!!!!

Can you tell which company is the best company to invest?

Why??
Which company is most volatile (instable)?

DIVIDEND YIELD METHOD DIVIDEND YIELD METHOD

Divident pay Company A Divident pay Company A Company B
out ratio out ratio
2008 10% 2008 10% 9.5%
2009 6.5% 2009 6.5% 6.3%
2010 5.5% 2010 5.5% 5.2%
If the dividend was 10 each year, what was the maximum share If the dividend was 10 each year, what was the maximum share
price and which year? price and which year?
What was minimum share price and which year? What was minimum share price and which year?
What is the average share price? What is the average share price?

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DISADVANTAGES OF USING THE PRICE-TO- DISADVANTAGES OF USING DIVIDEND YIELD

EARNINGS RATIO INCLUDE: INCLUDE:

 Earnings can be negative.  Dividend yield is only one component of the return
 The volatile, transitory portion of earnings makes on a stock.
interpretation difficult.  All else equal, higher dividends will lead to slower

 Management discretion distorts reported earnings. growth, which drives the other component of
returns, price appreciation.

CHALLENGES OF VALUATION CASH FLOW METHOD

 The challenges involved with valuation standards
are:
 There are many different valuation standards.
 Compliance is at the appraiser’s discretion.
 It is difficult to ensure compliance to the standards.
 Technical guidance on the use of standards is
limited.
 Valuation will depend on the definition of value
used.
 Example
 A company forecast of cash flows for the next 5
years is 200, 230, 250, 270 and 290. what is the
expected value of the company if the required rate
of return is 10%?
 Would the value be higher or lower if the required
rate was 12%?
 What happens after year 5 is an important factor
to consider
 What would you pay for the same company now
if you could sell it for 500 at the end of 5 years