Absolute vs Relative Valuation

A. Absolute- known as intrinsic value

- calculate the present worth of businesses by forecasting their future income stream.

-uses information available in FS and books of accounts of a company to arrive at its intrinsic pr
real worth.

-reductive because it focuses on the characteristics of the company in isolation.

*no comparison to its competitors in the same industry.

- try to determine a company's intrinsic worth based on its projected cash flows.

Types of absolute:

1. DCF model- arrive at the PV of the company.

- Discount rate = ROR
- Valuation for anything that can affect cash flow
- DCF= the sum of the cash flow in each period divided by one plus the discount rate
(WACC) raised to the power of the period number.
- It represents the value an investor would be willing to pay for an investment, given a
required rate of return on their investment (the discount rate).
2. Dividend Discount Model
- a quantitative method of valuing a company’s stock price based on the assumption
that the current fair price of a stock equals the sum of all of the company’s future
dividends discounted back to their present value.
- https://corporatefinanceinstitute.com/resources/knowledge/valuation/dividend-
discount-model/
- Shortcomings:
a. follows a perpetual constant dividend growth rate assumption.
b. the model is not fit for companies with rates of return that are
lower than the dividend growth rate.

B. Relative- relative value is based on the value of similar assets or companies.

- that compares a company's value to that of its competitors or industry peers to assess the
firm's financial worth.

- look at financial statements and other multiples of the companies they're interested in and
compare it to other, similar firms to determine if those potential companies are over or undervalued.

- uses multiples, averages, ratios, and benchmarks to determine a firm's value.

Types of Relative:

1. Comparable Company Analysis- value firms by comparing them to publicly traded companies
with similar business operations
- looks at ratios of similar public companies and uses them to derive the value of
another business.
 Steps:
a. Find the right comparable companies. (industry classification, geography, size,
growth rate, margins and profitability)
b. Gather financial information
c. Setup comps table
* The main information in comparable company analysis includes:

Company name
Share price Revenue
Market capitalization EBITDA
Net debt EPS
Enterprise value Analyst estimates

d. Calculate the comparable ratios

*The main ratios included in a comparable company analysis are:

EV/Revenue P/NAV
EV/Gross Profit P/B
EV/EBITDA
P/E

e. Use the multiples from the comparable companies to value the company in
question.
- take the average or median of the comparable companies’ multiples and then apply
them to the revenue, gross profit, EBITDA, net income, or whatever metrics they
included in the comps table.

*ADVANTAGE: they are always current, and it’s easy to find financial information on
public companies.

2. Precedent Transaction Analysis- method of valuing companies by looking at historical

transactions where entire companies were bought or sold (mergers and acquisitions).

- These transactions show what an investor was willing to pay for the entire company.
Precedents also use ratios, such as EV/EBTIDA.

- Precedents are useful for valuing an entire business (including a takeover premium or
control premium), but can quickly become out of date, and the information can be
difficult to find.

- commonly prepared by analysts working in investment banking, private equity, and

corporate development.

Steps:

1. #1 Search for relevant transactions

2. Analyze and refine the available transactions
 3. Determine a range of valuation multiples (most common our EV/EBITDA and
EV/Revenue)
4. Apply the valuation multiples to the company in question.
5. Graph the results (with other methods) in a football field

Comps Vs Precednts

Comps are usually current while precedents took place in past and include takeover premium.

The main differences are:

- Takeover premium (included in precedents – not in comps)

- Timing (precedents quickly become old– comps are current)
- Available information (difficult to find for precedents– readily available for comps)

DCF vs Precedents

- Discounted Cash Flow (DCF) analysis is a form of an intrinsic valuation performed by

building a financial model in Excel. Unlike relative methods, it does not take into
account what any other businesses are worth.

LEVERAGE BUYOUT

- a transaction where a company is acquired using debt as the main source of

consideration.
- occur when a private equity (PE) firm borrows as much as they can from a variety of
lenders (up to 70 or 80 percent of the purchase price) and funds the balance with
their own equity.
- The purpose of leveraged buyouts is to allow companies to make large acquisitions
without having to commit a lot of capital.
- company being acquired are often used as collateral for the loans, along with the
assets of the acquiring company.
- Conducted for 3 main reasons:
1.  take a public company private
2. spin-off a portion of an existing business by selling it.
3. to transfer private property, as is the case with a change in small business
ownership.
4.