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Valuation Methods

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)

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Valuation Methods

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  1. Valuation Methods

  2. Methods of Corporate Valuation • Asset-Based Methods • Using Comparables • Free Cash Flow Methods • Option-Based Valuation

  3. 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

  4. Relative Valuation • What is relative valuation? • What is the logic underlying relative valuation? • Using comparables

  5. What is relative valuation? • Relative to revenues or cash flows • Relative to Earnings • Relative to the Book Value of Equity

  6. Relative to Revenue • Price/Sales (PS) • Value/Sales (VS) • Usually used in valuing retailing firms

  7. Relative to Earnings • Price/Earnings Ratio (PE) • Trailing Price/Earnings Ratio (trailing PE) • A trailing PEis 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.

  8. Relative to the Book Value of Equity • Price/Book Value (PBV) • Market to book Value (MB)

  9. 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

  10. 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

  11. 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

  12. Comparing two PE ratios across firms assumes … • Identical payout ratio • Identical cost or equity • Identical expected stable-growth rate

  13. What is logic underlying relative valuation? Price to book value • Divide both sides by book value of equity

  14. Comparing two PE ratios across firms assumes … • Identical payout ratio • Identical cost or equity • Identical expected stable-growth rate • Identical

  15. What is logic underlying relative valuation? Price to sales • Divide both sides by sales

  16. Comparing two PE ratios across firms assumes … • Identical payout ratio • Identical cost or equity • Identical expected stable-growth rate • Identical Gross profit margin

  17. 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)

  18. Remember to control for differences between firms • Growth • Payout • Risk • ROE • Profit Margin

  19. 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.

  20. 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

  21. Free cash flow method • Free cash flows to equity • Free cash flows to firm • Basic case • Firms with insufficient valuation data • Acquisition valuation

  22. Option base valuation • Real option approach in valuing firm

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