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Relative Valuation
Relative Valuation
-Parvesh Aghi
Fundamental Principles of Relative Valuation
2
Relative Valuation
3
Two components to relative valuation
4
USE OF RELATIVE VALUATION
5
Reasons for Popularity
Reflects the
It is easier to
current
defend
market mood
6
Potential Pitfalls
7
STANDARDIZED VALUES AND MULTIPLES
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Multiples
Revenue Sector-
Multiples. Specific
Multiples.
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Earnings Multiples
Price/ Enterprise
Earning value* /
Ratio EBIDTA
PE ratio :
when buying a
* value of the
stock
Enterprise operating
assets of the
EV/ EBIDTA:
when buying a value / EBIT firm.
business
10
Book Value Multiples
Enterprise
Price / Book
Value/ Book
Value of equity
Value of assets.
11
Revenue Multiples
Enterprise
Price –to
Value /
Sales ratio*
Sales
12
Sector-Specific Multiples
EV / Per square
foot EV / Per
Employee.
(retailers)
13
RIGHT MULTIPLES
Multiple Positive Limitation Conclusion
1. Captures picture of profitability of comparable Can be used for almost every industry except,
companies, which is not the case with ev/sales Can not be used for the industry having loss making industry, banking and financial
EV/EBIT multiple negative ebitda companies
2. EV based multiples are not effected by We should avoid using this multiple for capital
differnces in capital structure intensive industry
3. Not effected by non operating items of income Huge D&A exp can distort earnings in capital
and expenses. intensive industry if we use EBIT
Can be used for industry not having sales, but does not capture financial performance Eg, Whatsapp, and other app based
EV/operating matrix subscribers etc of comparable companies companies
14
MULTIPLES USED
104
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FOUR BASIC STEPS TO USING MULTIPLES
DEFINE DESCRIBE
ANALYSE APPLY
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FOUR BASIC STEPS TO USING MULTIPLES
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1.Multiple is defined consistently and measured uniformly
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Consistency
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Consistency
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Consistency
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Uniformity
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2.Distributional characteristics of a multiple
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Distributional characteristics of a multiple
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Distributional characteristics of a multiple
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Time variation in multiples
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Analyse the multiple
Intuitively, then, firms with higher growth rates, less risk, and
greater cash flow generating potential should trade at higher
multiples than firms with lower growth, higher risk, and less
cash flow potential.
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Analyse the multiple
33
Analyse the multiple
34
Analyse the multiple
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MULTIPLES – Key driver
36
4.Application Tests
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Application Tests
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Controlling for differences across firms
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Subjective Adjustments
The multiple is calculated for each of the comparable firms, and the
average is computed.
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Subjective Adjustments
»EPD
42
Subjective Adjustments
43
Modified Multiples
In this approach, you modify the multiple to take into account the
most important variable determining it—the companion variable.
44
Modified Multiples
» The P/E ratios and expected growth rates in EPS over the next five years, based on
consensus estimates from analysts, for the firms that are categorized as beverage
firms are summarized in the following table:
45
Modified Multiples
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Sector Regressions
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Market Regressions
48
Market Regressions
49
Market Regressions
51
Predicted PE vs Actual PE - Regression
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Market Regressions
53
Market Regressions
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Market Regressions
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MULTIPLES – Key driver
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Steps in performing comparable company analysis
57
»Limitations of Statistical Techniques
» Statistical techniques are not a panacea
for research or for qualitative analysis. They are
tools that every analyst should have access to,
but they should remain tools. In particular, when
applying regression techniques to multiples, we
need to be aware of both the distributional
properties of multiples that we talked about
earlier in the chapter and the relationship among
and with the independent variables used in the
regression.
58
» The fact that multiples are not normally distributed can pose problems when using standard regression
techniques. These problems are accentuated with small samples, where the asymmetry in the distribution can be
magnified by the existences of a few large outliers.
» � In a multiple regression, the independent variables are themselves supposed to be independent of each other.
Consider, however, the independent variables that we have used to explain valuation multiples – cash flow potential
or payout ratio, expected growth and risk. Across a sector and over the market, it is quite clear that high growth
companies will tend to be risky and have low payout. This correlation across independent variables creates
�multicollinearity� which can undercut the explanatory power of the regression.
» � Earlier in the chapter, we noted how much the distributions for multiples changed over time, making
comparisons of PE ratios or EV/EBITDA multiples across time problematic. By the same token, a multiple regression
where we explain differences in a multiple across companies at a point in time will itself lose predictive power as it
ages. A regression of PE ratios against growth rates in early 2005 may therefore not be very useful in valuing stocks
in early 2006.
» � As a final note of caution, the R-squared on relative valuation regressions will almost never be higher than
70% and it is common to see them drop to 30 or 35%. Rather than ask the question of how high an R-squared has to
be to be meaningful, we would focus on the predictive power of the regression. When the R-squared decreases, the
ranges on the forecasts from the regression will increase. As an example, the beverage sector regression (from
illustration 7.3) yields a forecasted PE of 32.97 but the R-squared of 51% generates a range of 27.11 to 38.83 for the
forecast with 95% accuracy; if the R-squared had been higher the range would have been tighter.
»
»
59
Limitations of Statistical Techniques
Statistical techniques are not a panacea for research or for qualitative analysis. They are tools that every analyst should have access to,
The fact that multiples are not normally distributed can pose problems when using standard regression techniques. These problems are acce
In a multiple regression, the independent variables are themselves supposed to be independent of each other. Consider, however, the indepe
Earlier in the chapter, we noted how much the distributions for multiples changed over time, making comparisons of PE ratios or EV/EBIT
As a final note of caution, the R-squared on relative valuation regressions will almost never be higher than 70% and it is common to see the
60
»BACK UP SLIDES
61
Find the right comparable companies
This is the first and probably the hardest (or most subjective)
step in performing ratio analysis of public companies.
62
»The analyst will run a screen based on criteria
that include:
»Industry classification
»Geography
»Size (revenue, assets, employees)
»Growth rate
»Margins and profitability
63
Gather financial information
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Gather financial information
65
Setup the comps table
» In Excel, you now need to create a table that lists all the
relevant information about the companies you’re going to
analyze.
» The main information in comparable company analysis
includes:
» Company name
» Share price
» Market capitalization
» Net debt
» Enterprise value
» Revenue
» EBITDA
» EPS
66
» Analyst estimates
Calculate the comparable ratios
» With a combination of historical financials and analyst
estimates populated in the comps table, it’s time to start
calculating the various ratios that will be used to value the
company in question.
» The main ratios included in a comparable company analysis
are:
» EV/Revenue
» EV/Gross Profit
» EV/EBITDA
» P/E
» P/NA
» P/B
67
Use the multiples from the comparable companies to value the company
in question
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Interpreting the results
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»To properly evaluate the numbers in the comps
table you have to understand why numbers are
what they are. Why does Company A trade at a
discounted EV/EBITDA multiple to Company B?
»Is it because it’s undervalued and a good buying
opportunity?
»Or, is it because it has a much lower growth rate
and requires more capex spending?
70
»Even though Company A trades at a lower
multiple, it might actually be “more expensive”
than Company B!
»The is where the art of being a great financial
analyst comes into play.
»
71
Valuation
EV/Sales EV/EBITDA EV/EBIT P/E
Company Name x x x x
Infosys Ltd 3.7x 13.4x 14.6x 21.4x
Wipro 2.5x 10.5x 12.1x 16.7x
Tata
Consultancy 5.4x 18.2x 19.1x 25.7x
services
HCL
2.3x 9.4x 10.9x 14.2x
Technologies
Tech Mahindra 1.8x 8.9x 10.7x 14.6x
72
Market Data Financial Data
Company
(Rs/share) (Rs crores) (Rscrores) (Rs crores) (Rs crores) (Rs crores) (Rs crores)
Name
Tata
Consultancy 2165 8,11,828 7,97,818 1,46,463 43,817 41,761 31,562
services
HCL
1063 1,43,998 1,39,982 60,427 14,869 12,796 10,120
Technologies
Tech
659 63,583 61,281 34,742 6,871 5,742 4,354
Mahindra
73
Market Data Financial Data Valuation
Market EV/EBITD
Price EV Sales EBITDA EBIT Earnings EV/Sales EV/EBIT P/E
Cap A
Company
($/share) ($M) ($M) ($M) ($M) ($M) ($M) x x x x
Name
The Coca-
Cola 38.14 1,68,041 1,85,122 46,854 13,104 11,127 7,381 4.0x 14.1x 16.6x 22.8x
Company
Pepsico,
81.37 1,23,883 1,43,824 66,415 12,344 9,878 5,618 2.2x 11.7x 14.6x 22.1x
Inc.
Dr Pepper
Snapple
52.31 10,326 12,764 5,997 1,319 1,103 620 2.1x 9.7x 11.6x 16.7x
Group,
Inc.
Monster
Beverage
69.62 11,618 11,004 2,246 606 584 357 4.9x 18.1x 18.9x 32.5x
Corporatio
n
National
Beverage 20.81 964 968 645 78 66 41 1.5x 12.5x 14.6x 23.5x
Corp.
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75
76
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Multiple Positive Limitation Conclusion
79
CASE STUDY
CAMPBELL TO
ACQUIRE SNYDER’S-
LANCE, INC. TO
EXPAND IN FASTER-
GROWING SNACKING
CATEGORY
80
About Snyder’s-Lance
Snyder's-Lance, Inc.,
headquartered in Charlotte,
NC, manufactures and
markets snack foods
throughout the United States
and internationally.
Snyder's-Lance's products
include pretzels, sandwich
crackers, pretzel crackers,
potato chips, cookies, tortilla
chips, restaurant style
crackers, popcorn, nuts and
other snacks.
81
About Snyder’s-Lance
82
Campbell Soup Company
is a multi-national food
company headquartered
in Camden, N.J., with
annual sales of
approximately $8.1
billion.
83
Highlights
84
» CAMDEN, N.J. and CHARLOTTE, N.C., Dec. 18,
2017 - Campbell Soup Company (NYSE: CPB) and
Snyder’s-Lance (NASDAQ: LNCE) today announced
that the companies have entered into an agreement
for Campbell to acquire Snyder’s-Lance for $50.00
per share in an all-cash transaction.
» The purchase price represents a premium of
approximately 27 percent to Snyder’s-Lance’s closing
stock price on Dec. 13, 2017, the last trading day
prior to media reports regarding a potential
transaction. The acquisition, which has been
approved by the
85
» Boards of Directors of both companies, will enable
Campbell to expand its portfolio of leading snacking
brands.
» Snyder’s-Lance is a leading snacking company that
manufactures and markets snack food throughout the
United States. The company’s portfolio includes well-
known brands such as Snyder’s of Hanover, Lance,
Kettle Brand, KETTLE chips, Cape Cod, Snack
Factory Pretzel Crisps, Pop Secret, Emerald and
Late July. Snyder’s-Lance has leading market
positions in its core categories including pretzels,
sandwich crackers, kettle chips, deli snacks and
organic and natural tortilla chips.1
86
Acquisition and Snyder’s-Lance Highlights:
88
COMPARABLE DEAL ANALYSIS
SNYDER Equity Enterprise ENTERPRISE VALUE EQUITY
Value Value
89
DETAILS
90
ENTERPRISE VALUE
91
KEY FINANCIALS
92
EQUITY CONSIDERATION
93
TREASURY STOCK METHOD
94
95
Comparison of Multiples IPO Valuation
26