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Reading Material-Relative Valuation

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13 views

Reading Material-Relative Valuation

Uploaded by

Dheia Binoya
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Relative Valuation

Relative Valuation

- This approach is based on the premise that the value of an asset can be estimated by
analysing how market prices ‘similar’ or ‘comparable’ assets. The basic belief here is that it is
impossible or extremely difficult to estimate the intrinsic value of an asset, and therefore,
the value of an asset is whatever the market is willing to pay for it.
- Most valuation in the Stock Market are relative valuations.

Steps in Relative Valuation:

1. Identifying comparable asset. Identify comparable assets and obtain market values for
these assets.
• Analyze the subject company
• Select comparable companies
2. Estimate Relative Value. Convert these market values into standardized values, since the
absolute prices cannot be compared. This process of standardizing creates price multiples.
• Choose Valuation Multiples
• Calculate the valuation multiple for comparable companies
• Value the subject company
3. Analyze Under/Over Valuation. Compare the standardized value or multiple for the asset
being analyzed with the standardized values for comparable asset, adjusting for any
differences between the firms that might affect the multiple, to judge whether the asset is
under or over valued.

Most commonly used multiples

a. Revenue or sales multiples


b. EBITDA multiples
c. Operational multiples
d. Operating free cash flow multiples
e. Earnings multiples
f. Book value multiples

Market Value:

- The starting point of determining market multiples is the market values of companies whose
shares are listed and hence quoted on a stock exchange. Publicly listed companies, those
with shares listed on stock exchanges, have their share prices quoted by market makers
whose job is to provide a market in shares. This gives an instant picture of a company’s
value. The market value of a company may be derived from multiplying the share price by
the number of shares in issue.
- For large companies traded on the major stock exchanges, the share price will represent a
price at which the shares were very recently traded and so will give an up-to-date valuation.
For less liquid shares, in closely held companies or traded and so will give an up-to-date
valuation. For less liquid shares, in closely held companies or traded on emerging stock
markets, the price may be somewhat out of date or may not be realistic for a larger than the
average trade. Such less liquid stocks will have wider spreads between the bid and ask prices
to reflect their lack of liquidity- It will be more difficult for a market maker to sell on or buy
back the trade the maker has completed.

Market Multiples
Valuation Multiple Description/Formula Pros Cons
Net asset Value =Total Asset-Total Easy to Relies on
Liabilities-Preference compute, useful accounting value
shares for companies in and not
easily valued economic value
fixed asset
Dividend Yield = Dividend per shares / Difficulty
Market price per share associated with
market price per
share, varying
A measure of income yield expectations of
from a share and ignores investors.
the capital gain or loss
element of return
Price to Book Ratio =Share Price/Book Value
per share

At the company level, the


ratio of market value of
shareholders’ funds. A
measure of how much
more than asset value is
being paid
Tobin’s Q =Market Capitalization / Has economic Dependent on
Replacement cost of rationale, useful accounting
assets net of liabilities for valuation of values
markets, tries to
If over 1, this deems stock adjust historic
markets to be highly values
valued
Price to Earnings =Shares Price/ Earnings Commonly used Sensitive to
ratio or PE Multiple per share ratio, easy to accounting
or compute standards, time
=Market Capitalization/ value of money
Earnings for shareholders not fully taken
into account,
needs
The most common normalizing
measure of valuation when earnings
using a multiple of are erratic
accounting earnings
Earnings Yield ratio =Earning per
share/Market price per
share
Price to Cash Flow =Share Price / Cash Flow Takes Time value of
or investment into money not fully
=Market Capitalization / account, taken onto
Cash Flow represents real account,
cash belonging confusion over
A measure of valuation to shareholders definition of
using cash flow, although cash flow.
the definition of cash flow
can vary according to
analyst

Enterprise Value to =Enterprise Value / Commonly used Ignores capital


EBITDA EBITDA ratio, more expenditure
stable than cash requirements
A valuation multiple for flow, allows and differences
enterprise as a whole and companies with in tax rates
using a surrogate for different between
operating cash flow before financial companies
tax structures to be
compared,
allows
international
comparisons.
Enterprise Value to = Enterprise Value / Sales Commonly used Ignores value to
Sales ratio in countries shareholders,
A valuation multiple for where earnings taxes, capital
the enterprise as a whole are meaningful structure.
which is unaffected by numbers,
accounting differences. enables
accounting
distortions to be
minimized

Specific Valuation Valuation multiples based Commonly used Important


Ratios on a value driver for a in acquisitions, differences
specific sector. For gives reference between
instance, telecom on points within a companies may
subscriber based, retail on sector be ignored, time
floor space, etc. value of money
not fully taken
into account,
considers only
one value
drivers.

Relative Valuation Application

-Relative Valuation is easy to use under the following circumstances:


a. There are large number of assets comparable to one being valued
b. These assets are priced in a market.
c. There exist some common variables that can be used to standardize the price

References:

1. Vyas, N. (2016). Business Valuation Method. The Institute of Cost and Works
Accountants of India
2. https://www.wallstreetprep.com/knowledge/dcf-model-training-6-steps-building-dcf-
model-excel/
3. https://www.fairvalueacademy.org/discounted-cash-flow-dcf-approach

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