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VALUATION
Unit 2 – Comparable Company Analysis
Overview:
In this lesson, different financial ratios as a tool will be discussed and illustrated to
help students assess the relationship of each drivers and show how these tools could
actually simplify the decision making of investors.
Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Define the financial ratios to compare company performance.
2. Describe the use of financial ratios in estimating entity value and investments.
3. Apply the financial ratios in decision making.
Course Materials:
The following factors are considered in determining the value in comparable company
analysis:
Financial Ratios:
To illustrate, Payaman Co. is a listed company with the market value per share of
Php12.00 and reported earnings per share of Php 4.00. Using the equation above, the
P/E ratio is Php 3.00 which means that Payaman can create 3x the value of what it earns.
Book-to-Market ratio – determines the appreciation of the market to the value of the
company as oppose to the value it reported under its Statement of Financial Position.
Though it has limitation because some values incorporated in this ratio does not represent
the true value of the company. It can be computed as:
To illustrate, Payaman Co. reported a book value per share of Php35.00 and with a market
value per share of Php12.50. the book-to-market ratio is 2.80.
Dividend-Yield ratio – describes the relationship between the dividends received per
share and the appreciation of the market on the price of the company. It is also known as
dividend multiple. This theory assumes that the value of the firm is affected by the
dividends the company pays.
To illustrate, Starlight Inc. declared and paid dividends of Php1.50 per share and their
market value per share is Php12.50. Based on the foregoing, the dividend yield ratio is
0.12 which means that for every Php1.50 dividends they pay, it will translate into 12% of
the market value of the equity.
EBITDA per share is derived by dividing EBITDA into outstanding share for common
equity or ordinary share. To illustrate, Starlight Inc. reported EBITDA per share of Php6.00
and the market value per share being Php12.00. Given the equation the EBITDA Multiple
is 2 (2=Php12.0/Php6.0).
Economic Value Added (EVA) – the most conventional way to determine the value of
the asset is through its economic value added. It is the most convenient for this is
assessing the ability of the firm to support its cost of capital with its earnings. It is the
excess of the earnings after deducting the cost of capital. The assumption is that the
excess shall be accumulated for the firm and the higher the excess the better. Elements
that must be considered in using EVA are:
To illustrate, Starlight Inc. projected earnings to be Php350 Million per year. The board of
directors decided to sell the company for Php1,500 Million with a cost of capital appropriate
for this type of business is 10%. With the given data, the EVA is Php200 Million (Php350
Million - (Php1,500 Million x 10%)). This result means that the value offered by the
company is reasonable for the level of earnings it realized on an average and sufficient to
cover for the cost for raising the capital.
Activities/Assessments:
1. Compute for the price earnings ratio if the earnings per share is Php5.50.
Year Market Value per Share P/E ratio
1 27.500
2 30.250
3 22.000
4 17.875
5 28.875
2. Lovesky Co. declared dividends of Php2.00 per share for their performance last year. After
the declaration of dividends, the market value per share increased to Php45.00 per share.
What is the dividend yield ratio of Lovesky Co.?
4. Conservative Inc. is exploring an investment that will required Php750 Million that would
yield and annual earnings of Php185 Million. If the company required rate of return for
the company is 12%, how much is the Economic Value Added (EVA)?
References:
Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero