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Valuation Methods
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 don’t 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 (Gordon’s
Growth Model)
Divide both sides by earnings per share
10Value of Equity
e n
DPSP
r g
0 1
0 0
1
e n
P DPSPE
EPS EPS r g
0n
0
1(Payout Ratio) 1+g
e n
PPE
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
10Value of Equity
e n
DPSP
r g
0 1
0 0
1
e n
P DPSPBV
BV BV r g
0 1 1
0 0 1
1
e n
P EPS DPSPBV
BV BV EPS r g
00 n
0
1(Payout Ratio) 1+g
e n
PROE 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
10Value of Equity
e n
DPSP
r g
0 1
0 0
1
e n
P DPSPS
Sales Sales r g
0 1 1
0 0 1
1
e n
P EPS DPSPS
Sales Sales EPS r g
00 n
0
1Gross Profit Margin (Payout Ratio) 1+g
e n
PPS
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 3PE 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
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