CORPORATE

VALUATION
Relative Valuation Assignment

S U B MITTE D T O :
S H A ILESH R A S T O G I

Submitted by
Akshay Raut
PRN: 20020141025
Roll No.: 43125
Finance - D
Relative Valuation
In relative valuation, we value an asset based upon how similar assets are priced in
the market. A prospective house buyer decides how much to pay for a house by
looking at the prices paid for similar houses in the neighbourhood. A baseball card
collector makes a judgment on how much to pay for a Mickey Mantle rookie card by
checking transactions prices on other Mickey Mantle rookie cards. In the same vein, a
potential investor in a stock tries to estimate its value by looking at the market pricing
of “similar” stocks.
A relative valuation model is a business valuation method that compares a
company's value to that of its competitors or industry peers to assess 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, without any reference to another company or industry average.
Like absolute value models, investors may use relative valuation models when
determining whether a company's stock is a good buy. Since no two assets are
exactly the same, any relative valuation attempt should incorporate differences
accordingly.
Prices can be standardised using a common variable such as earnings, cashflows,
book value, or revenues.
Earnings Multiples
Price/Earning Ratio (PE) and the variants
Value/EBIT
Value/EBDITA
Value/Cashflow
Enterprise value/EBDITA
Book Multiples
Price/Book Value of equity PBV
Revenues
Price/Sales per Share (PS)
Enterprise Value/Sales per Share (EVS)
Sectors chosen for analysis
Consumer Staples
Industrial

Companies for the sectors

chosen:

Consumer Staples
Britannia Industries Ltd
Dabur Ltd
Godrej Consumer Ltd
Marico Ltd
Kwality Milk Foods Ltd
 8 Multiple Analysis to be performed
1. PE Ratio:
The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that
measures its current share price relative to its per-share earnings (EPS). The
price-to-earnings ratio is also sometimes known as the price multiple or the
earnings multiple.

P/E Ratio = (Current Market Price of a Share / Earnings per Share)

It is used by investors and analysts to determine the relative value of a

company's shares in an apples-to-apples comparison.
PE ratio has 3 main drivers:
Dividend Payout Ratio (DPR)
Equity Risk (ke)
Growth (g)
Growth (g) is one of the main companion variables which is compared
along with PE Ratio.
Note: Drivers are parameters which significantly influence Multiples
while comparable parameter is the one which impacts the most.

2. PEG Ratio:
The PEG ratio is a company’s Price/Earnings ratio divided by its earnings
growth rate over a period of time. The PEG ratio adjusts the traditional P/E
ratio by taking into account the growth rate in earnings per share that are
expected in the future. This can help “adjust” companies that have a high
growth rate and a high price to earnings ratio.

PEG Ratio=EPS GrowthPrice/EPS

where:EPS = The earnings per share

PEG ratio has 3 main drivers:

Dividend Payout Ratio (DPR)
Equity Risk (ke)
Growth (g)
Equity Risk (ke) is one of the main companion variables which is
compared along with PEG Ratio.
 3. PB Ratio:

Companies use the price-to-book ratio (P/B ratio) to compare a firm's

market capitalisation to its book value. It's calculated by dividing the
company's stock price per share by its book value per share (BVPS). An
asset's book value is equal to its carrying value on the balance sheet, and
companies calculate it netting the asset againstnits accumulated
depreciation.

Market capitalisation = Market value of a stock x Number of outstanding

shares

PB ratio has 4 main drivers:

Dividend Payout Ratio (DPR)
Return on Equity (RoE)
Equity Risk (ke)
Growth (g)

Return on Equity (RoE) is one of the main companion variables which is

compared along with PB Ratio.

4. P/S Ratio:
The P/S ratio is an investment valuation ratio that shows a company's
market capitalization divided by the company's sales for the previous 12
months. It is a measure of the value investors are receiving from a
company's stock by indicating how much are they are paying for the stock
per dollar of the company's sales. A ratio of less than 1 indicates that
investors are paying less than $1 per $1 of the company's sales.

P/S Ratio=SPS/MVS
where: MVS=Market Value per Share, SPS=Sales per Share

PS ratio has 4 main drivers:

Dividend Payout Ratio (DPR)
Net Profit Margin (NPM)
Equity Risk (ke)
Growth (g)
 5. EV/EBITDA:
EV/EBITDA is a ratio that compares a company’s Enterprise Value (EV) to its
Earnings Before Interest, Taxes, Depreciation & Amortization ( EBITDA). The
EV/EBITDA ratio is commonly used as a valuation metric to compare the
relative value of different businesses. The ratio is used to compare the
entire value of a business with the amount of EBITDA it earns on an annual
basis. This ratio tells investors how many times EBITDA they have to pay,
were they to acquire the entire business.

Enterprise Multiple = EV/EBITDA

where: EV=Enterprise Value=Market capitalization +total debt−cash and
cash equivalents
EBITDA=Earnings before interest, taxes, depreciation and amortization

EV/EBITDA ratio has 3 main drivers:

Effective Tax Rate (ETR)
Return on Capital Employed (RoC)
Dep/EBITDA
Effective Tax Rate (ETR) is one of the main companion variables which is
compared along with EV/EBITDA Ratio.

6. EV/EBIT:
The enterprise value to earnings before interest and taxes (EV/EBIT) ratio is
a metric used to determine if a stock is priced too high or too low in relation
to similar stocks and the market as a whole.
The EV/EBIT ratio compares a company’s enterprise value (EV) to its
earnings before interest and taxes (EBIT). EV/EBIT is commonly used as a
valuation metric to compare the relative value of different businesses. While
similar to the EV/EBITDA ratio, EV/EBIT incorporates depreciation and
amortization.

EV is an important component of several ratios investors can use to

compare companies, such as the EBIT/EV multiple and EV/Sales. The EV of a
business can be calculated using the following formula:

EV = Equity Market Capitalization + Total Debt − Cash (& Cash Equivalents)

EV/EBIT ratio has 3 main drivers:
Effective Tax Rate (ETR)
Reinvestment Rate (RR)
Growth for EBIT (g)
Growth for EBIT (g) is one of the main companion variables
which is compared along with EV/EBIT Ratio

7.EV/S:
Enterprise value-to-sales (EV/sales) is a financial valuation
measure that compares the enterprise value (EV) of a company to
its annual sales. The EV/sales multiple gives investors a
quantifiable metric of how to value a company based on its sales,
while taking account of both the company's equity and debt.

EV/Sales=(MC+D−CC)/Annual Sales
where:MC=Market capitalizationD=DebtCC=Cash and cash
equivalents

EV/S ratio has 3 main drivers:

Operating Profit Margin Post-Tax (OPM)
Reinvestment Rate (RR)
Growth for EBIT (g)
Operating Profit Margin Post-Tax (OPM) is one of the main
companion variables which is compared along with EV/EBIT
Ratio

8. EV/CV:
EV/Capital Employed Ratio is a measure of enterprise value
normalized by the level of capital used by the business. For
example, a large business with a large capital stock is bound to
realize a large enterprise value solely due to its large capital
holdings. The ROCE ratio measures how much profit a company
can generate with the total capital in the business; that is, how
many dollars of profit each dollar spent on capital has generated.
EV/CV ratio has 5 main drivers:
Operating Profit Margin Post-Tax (OPM)
Reinvestment Rate (RR)
Growth for EBIT (g)
Debt Ratio
Return on Capital Employed (RoC)
Operating Profit Margin Post-Tax (OPM) is one of the main
companion variables which is compared along with EV/CV Ratio

Drivers:

1. Dividend Payout Ratio (DPR)

The dividend payout ratio is the ratio of the total amount of
dividends paid out to shareholders relative to the net income of
the company. It is the percentage of earnings paid to
shareholders in dividends.

2. Equity Risk (ke)

Equity risk is "the financial risk involved in holding equity in a
particular investment." Equity risk often refers to equity in
companies through the purchase of stocks, and does not
commonly refer to the risk in paying into real estate or building
equity in properties . AKA Cost of Equity.

3. Growth (g)
The sustainable growth rate (SGR) is the maximum rate of growth
that a company or social enterprise can sustain without having to
finance growth with additional equity or debt. The SGR involves
maximizing sales and revenue growth without increasing financial
leverage.
4. Operating Profit Margin Post-Tax (OPM)
Operating margin measures how much profit a company makes
on a dollar of sales after paying for variable costs of production,
such as wages and raw materials, but before paying interest or
tax. It is calculated by dividing a company’s operating income by its
net sales. Higher ratios are generally better, meaning the company
is efficient in its operations and is good at turning sales into
profits.

5. Reinvestment Rate (RR)

The reinvestment rate is the amount of interest that can be
earned when money is taken out of one fixed-income investment
and put into another. For example, the reinvestment rate is the
amount of interest the investor could earn if he purchased a new
bond while holding a callable bond called due because of an
interest rate decline.

6. Debt Ratio
The debt ratio is a financial ratio that measures the extent of a
company’s leverage. The debt ratio is defined as the ratio of total
debt to total assets, expressed as a decimal or percentage. It can
be interpreted as the proportion of a company’s assets that are
financed by debt.

7. Return on Capital Employed (RoC)

Return on capital employed (ROCE) is a financial ratio that can be
used in assessing a company's profitability and capital efficiency.
In other words, this ratio can help to understand how well a
company is generating profits from its capital as it is put to use .
 Analysis

Steps for analysis:

1. Selecting 5 companies from 2 sectors each for analysis

2. Extracting all required data from prowess to be used for
analysis
3. Post collection of data, we run regression on each multiple
with taking
4. the ‘Multiple’ as Y-Variable and the rest of the drivers as X-
variable for regression.
5. Based on the derived coefficients, we estimate all the
multiples
6. Based on difference in expected and actual multiple value,we
use
7. Following decision rule to decide whether the company is
Overvalued or Undervalued.
8. Decision Rule:
If (Expected Value - Actual Value) of Multiple > 0, then
Undervalued
If (Expected Value - Actual Value) of Multiple < 0, then
Overvalued
6. If company comes as Overvalued in more than 4 Multiples it is
treated as Overvalued company overall else it is Undervalued.