2. Relative Valuation
ď Valuation is a generic term that refers to the notion of comparing
the price of an asset to the market value of similar assets.
ď Valuing peer companies in the same industry
ď Valuation by historical data
Disadvantages
ď Peers may not be valued correctly
ď Assumption that historically, average of past is a good indicator
3. Relative Valuation Method
â˘Price multiples & enterprise value multiples
â˘Trailing multiples & Forward multiples
ďąMethods
âBased on comparables
âBased on forecasted fundamentals (justified
multiple)
4. Price Multiples
ď Price to earnings
ď Price to book value
ď Price to sales
ď Price to cash flow
ď Dividend yield
5. EPS Adjustments Required
ďąAdjust for potential EPS dilution and non-recurring
Earnings.
ďąDealing with very low or negative EPS â EPS not
meaningful, use normalized EPS, or use earnings yield for
ranking.
ďąCyclicality in earnings â use normalized EPS
ďąBV â Book Value
ďąROE â Return on Equity
EPS(normalised) = ROE * BV
6. Justified P/E
â˘P0/E0 = (1-b)(1+g)/(r-g)
â˘P/E increases with growth
b â Earning Retention Ratio
g â Substantial rate of growth
b = (1 â Dividend Payout Ratio)
P0/E1 = (1-b)/(r-g) = (1-b)/(r-RoExb)
7. Present Value of Growth Opportunities
ď The first term indicates the component in case of no growth
and second term indicates the component related to growth
opportunities.
V0 = E1/r + PVGO
8. Enterprise Value Multiples
Unlike EPS, EBITDA controls for effects of depreciation &
amortization. However, unlike free cash flows it does not take into
account cash flows due to working capital changes or capex.
EV = MV of equity + MV of preferred equity + MV
of debt â Value of cash and marketable securities