Financial Insights

Name: Rajkumar Krishnan Enrollment No: 161600911321

MAX SOFTWARE SERVICES: RELATIVE VALUATION

 Financial Insights

Name: Rajkumar Krishnan Enrollment No: 161600911321

Question 1

What do you understand by relative valuation? Explain its pros and cons from investor’s point of
view.

Relative Valuation
A relative valuation model is a business valuation method that compares a firm's value to
that of its competitors to determine the firm's financial worth. Relative valuation models
are an alternative to absolute value models, which try to determine a company's intrinsic
worth based on its estimated future free cash flows discounted to their present value. Like
absolute value models, investors may use relative valuation models when determining
whether a company's stock is a good buy.
Relative valuation uses multiples and benchmarks to determine firm value. A benchmark
is selected by finding an average and that average is used to determine relative value.
Relative Valuation Multiples
There are many different types of relative valuation ratios, such as price to free cash flow,
enterprise value (EV), operating margin, price to cash flow for real estate and price-to-
sales (P/S) for retail.
Some of the most common and useful metrics to utilize in relative valuation include:
 Price to earnings ratio
 Return on equity
 Operating margin
 Enterprise value
 Price to free cash flow
One of the most popular relative valuation multiples is the price-to-earnings (P/E) ratio. It
is calculated by dividing stock price by earnings per share (EPS). A company with a high
P/E ratio is trading at a higher price per dollar of earnings than its peers and is considered
overvalued. Likewise, a company with a low P/E ratio is trading at a lower price per
dollar of EPS and is considered undervalued. This framework can be carried out with any
multiple of price to gauge relative market value.
Advantages
Usefulness: Valuation is about judgment, and multiples provide a framework for making
value judgments. When used properly, multiples are robust tools that can provide useful
information about relative value.
Simplicity: Their very simplicity and ease of calculation makes multiples an appealing
and user-friendly method of assessing value. Multiples can help the user avoid the
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potentially misleading precision of other, more 'precise' approaches such as discounted

cash flow valuation or EVA, which can create a false sense of comfort.
Relevance: Multiples focus on the key statistics that other investors use. Since investors
in aggregate move markets, the most commonly used statistics and multiples will have
the most impact.
Limitations
Like any valuation tool, relative valuation has its limitations. The biggest limitation is the
assumption that the market has valued the business correctly. During the Internet bubble,
investing in a dot-com because its P/E was 60 versus an industry average of 90 turned out
to be a painful mistake.
Second, all valuation metrics are based on past performance. Future performance drives
stock prices and relative valuation does not account for growth.
Finally and most important, relative valuation is no assurance that the "cheaper" company
will outperform its peer.
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Name: Rajkumar Krishnan Enrollment No: 161600911321

Question 2
Use at least three multiples and compare Max software with the industry peers. Also describe the
use and advantages of multiples used by you.

Valuation using multiples

In economics, valuation using multiples is a process that consists of:
Identifying comparable assets (the peer group) and obtaining market values for these
assets.
Converting these market values into standardized values relative to a key statistic, since
the absolute prices cannot be compared. This process of standardizing creates valuation
multiples.
Applying the valuation multiple to the key statistic of the asset being valued, controlling
for any differences between asset and the peer group that might affect the multiple.
Valuation multiple
A valuation multiple is simply an expression of market value of an asset relative to a key
statistic that is assumed to relate to that value. To be useful, that statistic – whether
earnings, cash flow or some other measure – must bear a logical relationship to the
market value observed; to be seen, in fact, as the driver of that market value.
In stock trading, one of the most widely used multiples is the price-earnings ratio (P/E
ratio or PER) which is popular in part due to its wide availability and to the importance
ascribed to earnings per share as a value driver. However, the usefulness of P/E ratios is
lessened by the fact that earnings per share is subject to distortions from differences in
accounting rules and capital structures between companies.
Other commonly used multiples are based on the enterprise value of a company, such as
(EV/EBITDA, EV/EBIT, EV/NOPAT). These multiples reveal the rating of a business
independently of its capital structure, and are of particular interest in mergers,
acquisitions and transactions on private companies.
Equity price based multiples
Equity price based multiples are most relevant where investors acquire minority positions
in companies. Care should be used when comparing companies with very different
capital structures. Different debt levels will affect equity multiples because of the gearing
effect of debt. In addition, equity multiples will not explicitly take into account balance
sheet risk.
Enterprise value based multiples
Enterprise value based multiples are particularly relevant in mergers & acquisitions
where the whole of the company’s stock and liabilities are acquired. Certain multiples
such as EV/EBITDA are also a useful complements to valuations of minority interests,
especially when the P/E ratio is difficult to interpret because of significant differences in
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capital structures, in accounting policies or in cases where net earnings are negative or
low.

Multiples

Following are the three multiples has been considered to compare Max software with other peers

Multiple Definition Advantages Disadvantages

 Least susceptible to
accounting differences  A crude measure
 Remains applicable even as sales are
EV/Sales Enterprise value / net sales
when earnings are rarely a direct
negative or highly value driver
cyclical
Enterprise value / Earnings  Ignores variations
 EBITDA is a proxy for
before Interest, Tax, in capital
free cash flows
Depreciation & expenditure and
 Probably the most
Amortization. Also excludes depreciation
EV/EBITDA popular of the EV based
movements in non-cash  Ignores potential
multiples
provisions and exceptional value creation
 Unaffected by
items through tax
depreciation policy
management
 Susceptible to
 Better allows for
differences in
differences in capital
Enterprise value / Earnings depreciation
intensiveness compared policy
EV/EBIT and before interest and
to EBITDA by
EV/EBITA taxes (and Amortisation)  Ignores potential
incorporating
value creation
maintenance capital
expenditure through tax
management

Comparison
The calculation of EV is follow the below formula
Enterprise value = Market Capital (Number of shares * Share Price) + Net Debt (Current &
Non-current liabilities – Cash)
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EV/Sales

Company EV Net Sales Multiples

TCS (978,610,498*538.55) 52,564,200,000 10.42
+ (42,535,800,000 +
5,362,100,000 ) –
26,981,400,000
= 547,947,183,697.9
Infosys (572,490,211*1,323.90) 59,880,000,000 11.37
+(20,040,000,000 + 0 )
– 96,950,000,000
= 681,009,790,342.9
Wipro (1,454,662,502*245.90) 38,999,000,000 11.11
+(67,989,000,000 +
56,892,000,000) –
49,117,000,000
= 433,465,509,241.8
HCL Tech (667,935,809*102.05) 10,886,000,000 9.48
+ (30,221,750,000 +
24,092,500,000) -
19,298,000,000
= 103,179,099,308.45

Avg = (10.42 + 11.37 + 11.11 + 9.48) / 4 = 10.56

Value Equity (Max Software) = ((Multiples * Net Sales) – Net Debt) / Number of shares
VE = ((10.56 * 1,636,980,000) - (8,862,800,000 + 5,150,000,000 -
3,923,350,000))/208,989,160
VE = 34.44

EV/EBITDA

Company EV EBITDA Multiples

TCS (978,610,498*538.55) 67,428,100,000 8.13
+ (42,535,800,000 +
5,362,100,000 ) -
26,981,400,000
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= 547,947,183,697.9
Infosys (572,490,211*1,323.90) 71,950,000,000 9.47
+(20,040,000,000 + 0 )
- 96,950,000,000
= 681,009,790,342.9
Wipro (1,454,662,502*245.90) 55,730,000,000 7.78
+(67,989,000,000 +
56,892,000,000) -
49,117,000,000
= 433,465,509,241.8
HCL (667,935,809*102.05) 21,883,000,000 4.72
Tech + (30,221,750,000 +
24,092,500,000) -
19,298,000,000
= 103,179,099,308.45

Avg = (8.13 + 9.47 + 7.78 + 4.72) / 4 = 7.53

Value Equity (Max Software) = ((Multiples * EBITDA) – Net Debt) / Number of shares
VE = ((7.53 * 3,376,190,000) - (8,862,800,000 + 5,150,000,000 -
3,923,350,000))/208,989,160
VE = 73.37

EV/EBIT

Company EV EBIT Multiples

TCS (978,610,498*538.55) 61,787,300,000 8.87
+ (42,535,800,000 +
5,362,100,000 ) -
26,981,400,000
= 547,947,183,697.9
Infosys (572,490,211*1,323.90) 64,340,000,000 10.58
+(20,040,000,000 + 0 )
- 96,950,000,000
= 681,009,790,342.9
Wipro (1,454,662,502*245.90) 47,596,000,000 9.11
+(67,989,000,000 +
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56,892,000,000) -
49,117,000,000
= 433,465,509,241.8
HCL (667,935,809*102.05) 17,736,000,000 5.82
Tech + (30,221,750,000 +
24,092,500,000) -
19,298,000,000
= 103,179,099,308.45

Avg = (8.87 + 10.58 + 9.11 + 5.82) / 4 = 8.6

Value Equity (Max Software) = ((Multiples * EBIT) – Net Debt) / Number of shares
VE = ((8.6 * 2,418,190,000) - (8,862,800,000 + 5,150,000,000 -
3,923,350,000))/208,989,160
VE = 51.23
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Reference:

Relative Valuation: Using Stocks To Value Other Stocks

http://www.investopedia.com/articles/stocks/11/relative-valuation-stocks-valuing-
stocks.asp

Relative valuation model

http://www.investopedia.com/terms/v/valuation.asp

Valuation using multiples

https://en.wikipedia.org/wiki/Valuation_using_multiples
https://en.wikipedia.org/wiki/Enterprise_value