Private and Confidential

Relative Valuation

Equity Analyst Training Program

Prepared by: Dheeraj Vaidya

dheerajvaidya@corporatebridge.net
dheerajvaidya@gmail.com

Private and Confidential – Not for Circulation

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 Discussion topics

 Enterprise Value Multiple

 EV/EBITDA
 EV/Sales
 EV/EBIT
 EV/FCF
Relative Valuation

 EV/Capacity

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Relative Valuation

Enterprise Value Multiple

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 EV Multiple – EV/EBITDA

 Measure that indicates the value of the overall company, not just equity

Enterprise Value
 EV/EBITDA 
EBITDA
 Best fit
Relative Valuation

 Unaffected by differences in depreciation policy

 Unaffected by differences in capital structure
 Affected by a firm’s level of capital intensity (measured as depreciation as a percentage of EBITDA)
• All things being equal, higher capital intensity results in a lower EV/EBITDA multiple

• Most useful in comparing companies with a selected peer group that has a comparable level of capital intensity

 In which of the following two sectors can we use EV/EBITDA multiple?

Sector 2
Sector 1

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 Equity Multiple – EV/EBITDA

 LionBridge

Importance of EBITDA as
an operating
Relative Valuation

performance measure

 Bell Canada

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 Equity Multiple – EV/EBITDA

 Comparison of stocks with the market, comparison across stocks and comparison of sector
with the market are unlikely to be meaningful
 EV/EBITDA multiples could be used for relative valuation of
 Oil companies
 Auto companies
Relative Valuation

 Capital Intensive business with high levels of depreciation and amortization

 EV/EBITDA cannot be used when the current cash flow is negative

 Use normalized EBITDA or a forward multiple, instead

 Consider what happens if a company issues shares and uses the money it raises to
pay off its debt
 What is the impact to P/E ratio?
 What is the impact to EV/EBITDA ratio?

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 EV Multiple – EV/Sales

 Equivalent to its equity counterpart, price to sales, where company has no debt
Enterprise Value
 EV/Sales 
Total Sales
 EV/Sales is important because
Relative Valuation

 Least susceptible to accounting differences

 Useful when accounting differences are extreme
 Profit or cash flow figures are unrepresentative or negative

 EV/Sales is useful in identifying restructuring potential

 Net margin is the key driver
 Low profitability would result in low value for a given level of sales

 EV/Sales should not be used for companies with variable, periodic sales such as property
developers
 Caveats
Sales Volatility
 Typically applied to Technology firms with negative cash flows
 But these companies have highly volatile sales as well
Revenue recognition policies
 Use of Gross revenue versus Net revenues
 Treatment of customers where customer has right of return
 Long-term contracts accounted for under percentage of completion or completed contract methods

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 EV Multiple – EV/EBIT and EV/FCF

EV/EBIT
 EBIT is a better measure of ‘free’ (post-maintenance capital spending) cash flow than EBITDA
 more comparable where capital intensities differ

Enterprise Value
EV/EBIT 
 pre exceptional EBIT
Relative Valuation

 EBIT affected by accounting policy differences for depreciation

 EV/EBIT is most useful where there are relatively small differences in accounting treatment of
depreciation among comparables
 EBIT is a post goodwill figure.
 Goodwill adjustment however does not apply to financial statements reported under US GAAP

EV/FCF
 EV/FCF is preferable to EV/EBITDA for comparing companies within a sector
 Comparing across sectors or markets where companies have widely varying degrees of
capital intensity
 Multiple cannot be used when current cash flow is negative
 Caveat
 Use of historic FCF can be problematic because of fluctuations in cash flow items can cause it to be highly
volatile, making EV/FCF a less useful multiple

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 EV Multiple – EV/Capacity

 Core EV/units of capacity (such as tonnes of cement capacity) or another revenue-generating

unit (such as subscribers)
 Compare the implied value of productive assets (e.g. tonnes of cement capacity, fixed
telephone lines) to enable comparison across firms operating within the same industry
 Value can be compared to the cost of replacing the asset on a gross basis or after factoring in
depreciation to adjust for the remaining life of the asset in use
Relative Valuation

 Implied market value can be calculated for each revenue generating unit such as subscribers.
 EV/Capacity useful for
 Oil companies (EV/boe)
 Telecom companies (EV/subscriber)
 Cement (EV/ per ton of cement capacity)

 Caveat
 Tell us nothing about the relative underlying profitability of the assets
 Do they give any other clues about the drivers behind differences in value
 They do not tell us why the (unit of capacity, customer, etc) is valued as it is, nor what the appropriate
value should be

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Relative Valuation

Sum up..

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