Valuation Methods

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n%20Methods%20(2010).ppt

Methods of Corporate
Valuation
Asset-Based Methods
Using Comparables
Free Cash Flow Methods
Option-Based Valuation

Asset-Based Methods
Balance sheet approach:
Cash and working capital (book value close to its
realizable value)
Property, Equipment, and Land (appraisal value)
Intangibles.
Book value of equity vs market value of
equity


Relative Valuation
What is relative valuation?
What is the logic underlying relative
valuation?
Using comparables
What is relative valuation?
Relative to revenues or cash flows
Relative to Earnings
Relative to the Book Value of Equity
Relative to Revenue
Price/Sales (PS)
Value/Sales (VS)
Usually used in valuing retailing firms
Relative to Earnings
Price/Earnings Ratio (PE)
Trailing Price/Earnings Ratio (trailing PE)
A trailing PE is a price-earnings ratio based on the
most recent 12 months' results. U.S. companies report
quarterly, so a trailing PE is computed based on the
most recent four quarters.
Forward Price/Earnings Ratio (forward PE)
Also called estimated PE. Forward PE divides a stock's
current price by its estimated future earnings per share.
Forward PE is often used to compare a company's
current earnings to its estimated future earnings.
Relative to the Book Value of
Equity
Price/Book Value (PBV)
Market to book Value (MB)
Advantages to using multiples
in valuation analysis
Require fewer explicit assumptions than
DCF
Easy to compute and dont require
forecasting
Commonly quoted and used by
management and press
Disadvantages to using
multiples in valuation analysis
Require more implicit assumptions than
DCF
Logic behind valuation analysis is often
misunderstood
Identification of comparable firms is
subjective
What is logic underlying
relative valuation? P/E ratio
Think about a basic DCF model (Gordons
Growth Model)


Divide both sides by earnings per share
1
0
Value of Equity
e n
DPS
P
r g

0 1
0 0
1
e n
P DPS
PE
EPS EPS r g

0
n
0
1
(Payout Ratio) 1+g
e n
P
PE
EPS r g

Comparing two PE ratios

across firms assumes
Identical payout ratio
Identical cost or equity
Identical expected stable-growth rate
What is logic underlying relative
valuation? Price to book value


Divide both sides by book value of equity



1
0
Value of Equity
e n
DPS
P
r g

0 1
0 0
1
e n
P DPS
PBV
BV BV r g

0 1 1
0 0 1
1
e n
P EPS DPS
PBV
BV BV EPS r g

0
0 n
0
1
(Payout Ratio) 1+g
e n
P
ROE PBV
BV r g

Comparing two PE ratios

across firms assumes
Identical payout ratio
Identical cost or equity
Identical expected stable-growth rate
Identical ROE
What is logic underlying relative
valuation? Price to sales

Divide both sides by sales





1
0
Value of Equity
e n
DPS
P
r g

0 1
0 0
1
e n
P DPS
PS
Sales Sales r g

0 1 1
0 0 1
1
e n
P EPS DPS
PS
Sales Sales EPS r g

0
0 n
0
1
Gross Profit Margin (Payout Ratio) 1+g
e n
P
PS
Sales r g

Comparing two PE ratios

across firms assumes
Identical payout ratio
Identical cost or equity
Identical expected stable-growth rate
Identical Gross profit margin
Using comparables
Construct the multiple for the set of comparable
firms
Average the multiple across the set of
comparable firms
Compare individual firm to this average
Differences may be attributed to differences in
underlying logic of multiple
Differences may be attributed to inefficient
markets (price)
Remember to control for
differences between firms
Growth
Payout
Risk
ROE
Profit Margin
Ways to control for differences between firms
Sample firms and sort according to attributes (Growth,
Payout, Risk, ROE, Profit)
Requires a large number of potential comparables
Compare your firm to subset of comparables with similar
attributes
Modify the multiples to make them more comparable
Divide the PE ratio by the expected growth rate in EPS (PEG
Ratio)
Divide PBV ratio by the ROE (Value Ratio)
This assumes firms are comparable on all other attributes
Run regression of multiples on attributes


Use coefficient values from regression and attributes for the firm
to predict the correct multiple for the firm.
0 1 2 3
PE growth payout risk
Regression-based multiple
analysis
Damodaran ran regressions on 2,475 firms using data from
1998

PE=291.27*Growth+37.74*Payout+21.62*Beta
PBV=3.99*Payout-0.79*Beta+60.65*growth+31.56*ROE
PS=11.56*Growth+1.41*Payout-1.42*Beta+11.93*Margin

Free cash flow method
Free cash flows to equity
Free cash flows to firm
Basic case
Firms with insufficient valuation data
Acquisition valuation
Option base valuation
Real option approach in valuing firm