REL ATIVE

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)
– Property, Equipment, and Land (appraisal value)
– Intangibles.
• Book value of equity vs market value of equity
RELATIVE VALUATION

• What is relative valuation?

• What is the logic underlying relative valuation?
• Using comparables
WHAT IS RELATIVE
VALUATION?
• Relative to revenues or cash flows
• Relative to Earnings
• Relative to the Book Value of Equity
RELATIVE TO REVENUE

• Price/Sales (PS)
• Value/Sales (VS)
• Usually used in valuing retailing firms
 RELATIVE TO EARNINGS
• Price/Earnings Ratio (PE)
• Trailing Price/Earnings Ratio (trailing PE)
– A trailing PE is 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.
RELATIVE TO THE BOOK
VALUE OF EQUITY
• Price/Book Value (PBV)
• Market to book Value (MB)
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
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
WHAT IS LOGIC UNDERLYING
RELATIVE VALUATION? P/E
RATIO
• Think about a basic DCF model (Gordon’s Growth Model)
DPS1
Value of Equity P0 =
re − g n
• Divide both sides by earnings per share

P0 DPS1 1
= = PE
EPS0 EPS0 re − g n
P0 1
= (Payout Ratio) (1+g n ) = PE
EPS0 re − g n
COMPARING TWO PE RATIOS
ACROSS FIRMS ASSUMES …
• Identical payout ratio → similar managerial characteristics
• Identical cost or equity → similar capital structure
• Identical expected stable-growth rate → in the same
industry
WHAT IS LOGIC UNDERLYING RELATIVE
VALUATION? PRICE TO BOOK VALUE
DPS1
Value of Equity P0 =
re − g n
• Divide both sides by book value of equity

P0 DPS1 1
= = PBV
BV0 BV0 re − g n
P0 EPS1 DPS1 1
= = PBV
BV0 BV0 EPS1 re − g n
P0 1
= ROE0 (Payout Ratio) (1+g n ) = PBV
BV0 re − g n
COMPARING TWO PB RATIOS
ACROSS FIRMS ASSUMES …
• Identical payout ratio → similar managerial characteristics
• Identical cost or equity → similar capital structure
• Identical expected stable-growth rate → in the same
industry
• Identical ROE → similar operational activities, organizational
structure, and facing similar risks
WHAT IS LOGIC UNDERLYING RELATIVE
VALUATION? PRICE TO SALES
DPS1
Value of Equity P0 =
re − g n
• Divide both sides by sales

P0 DPS1 1
= = PS
Sales0 Sales0 re − g n
P0 EPS1 DPS1 1
= = PS
Sales0 Sales0 EPS1 re − g n
P0 1
= Gross Profit Margin 0 (Payout Ratio) (1+g n ) = PS
Sales0 re − g n
COMPARING TWO PS RATIOS
ACROSS FIRMS ASSUMES …
• Identical payout ratio → similar managerial characteristics
• Identical cost or equity → similar capital structure
• Identical expected stable-growth rate → in the same industry
• Identical Gross profit margin → similar operational activities
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)
REMEMBER TO CONTROL FOR
DIFFERENCES BETWEEN FIRMS
• Growth
• Payout
• Risk
• ROE
• Profit Margin
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
PE = 0 + 1 growth + 2 payout + 3risk + 
– Use coefficient values from regression and attributes for the
firm to predict the correct multiple for the firm.
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