VALUATION:PACKET2RELATIVEVALUATION,ASSET-BASEDVALUATIONANDPRIVATECOMPANYVALUATIONAswathDamodaranUpdated:September20169/2016

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Test1:Areyoupricingorvaluing?

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Test2:Areyoupricingorvaluing?

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TheEssenceofRelativeValuation(Pricing)

¨ Inrelativevaluation,thevalueofanassetiscomparedtothevaluesassessedbythemarketforsimilarorcomparableassets.

¨ Todorelativevaluationthen,¤ weneedtoidentifycomparableassetsandobtainmarketvaluesfortheseassets

¤ convertthesemarketvaluesintostandardizedvalues,sincetheabsolutepricescannotbecomparedThisprocessofstandardizingcreatespricemultiples.

¤ comparethestandardizedvalueormultiplefortheassetbeinganalyzedtothestandardizedvaluesforcomparableasset,controllingforanydifferencesbetweenthefirmsthatmightaffectthemultiple,tojudgewhethertheassetisunderorovervalued

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Relativevaluationispervasive…

¨ Mostassetvaluationsarerelative.¨ MostequityvaluationsonWallStreetarerelativevaluations.

¤ Almost85%ofequityresearchreportsarebaseduponamultipleandcomparables.

¤ Morethan50%ofallacquisitionvaluationsarebaseduponmultiples¤ Rulesofthumbbasedonmultiplesarenotonlycommonbutareoften

thebasisforfinalvaluationjudgments.¨ Whiletherearemorediscountedcashflowvaluationsin

consultingandcorporatefinance,theyareoftenrelativevaluationsmasqueradingasdiscountedcashflowvaluations.¤ Theobjectiveinmanydiscountedcashflowvaluationsistobackintoa

numberthathasbeenobtainedbyusingamultiple.¤ Theterminalvalueinasignificantnumberofdiscountedcashflow

valuationsisestimatedusingamultiple.

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Whyrelativevaluation?

“IfyouthinkI’mcrazy,youshouldseetheguywholivesacrossthehall”

JerrySeinfeldtalkingaboutKramerinaSeinfeldepisode

“A little inaccuracy sometimes saves tons of explanation”H.H. Munro

“ If you are going to screw up, make sure that you have lots of company”

Ex-portfolio manager

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TheMarketImperative….

¨ Relativevaluationismuchmorelikelytoreflectmarketperceptionsandmoodsthandiscountedcashflowvaluation.Thiscanbeanadvantagewhenitisimportantthatthepricereflecttheseperceptionsasisthecasewhen¤ theobjectiveistosellasecurityatthatpricetoday(asinthecaseofan

IPO)¤ investingon“momentum” basedstrategies

¨ Withrelativevaluation,therewillalwaysbeasignificantproportionofsecuritiesthatareundervaluedandovervalued.

¨ Sinceportfoliomanagersarejudgedbaseduponhowtheyperformonarelativebasis(tothemarketandothermoneymanagers),relativevaluationismoretailoredtotheirneeds

¨ Relativevaluationgenerallyrequireslessinformationthandiscountedcashflowvaluation(especiallywhenmultiplesareusedasscreens)

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Multiplesarejuststandardizedestimatesofprice…

Numerator = What you are paying for the asset

Denominator = What you are getting in return

Market value of equity Market value for the firmFirm value = Market value of equity

+ Market value of debt

Market value of operating assets of firmEnterprise value (EV) = Market value of equity

+ Market value of debt- Cash

Revenuesa. Accounting revenuesb. Drivers- # Customers- # Subscribers= # units

Earningsa. To Equity investors - Net Income - Earnings per shareb. To Firm - Operating income (EBIT)

Book Valuea. Equity= BV of equityb. Firm= BV of debt + BV of equityc. Invested Capital= BV of equity + BV of debt - Cash

Multiple =

Cash flowa. To Equity- Net Income + Depreciation- Free CF to Equityb. To Firm- EBIT + DA (EBITDA)- Free CF to Firm

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TheFourStepstoDeconstructingMultiples

¨ Definethemultiple¤ Inuse,thesamemultiplecanbedefinedindifferentwaysbydifferent

users.Whencomparingandusingmultiples,estimatedbysomeoneelse,itiscriticalthatweunderstandhowthemultipleshavebeenestimated

¨ Describethemultiple¤ Toomanypeoplewhouseamultiplehavenoideawhatitscrosssectional

distributionis.Ifyoudonotknowwhatthecrosssectionaldistributionofamultipleis,itisdifficulttolookatanumberandpassjudgmentonwhetheritistoohighorlow.

¨ Analyzethemultiple¤ Itiscriticalthatweunderstandthefundamentalsthatdriveeachmultiple,

andthenatureoftherelationshipbetweenthemultipleandeachvariable.¨ Applythemultiple

¤ Definingthecomparableuniverseandcontrollingfordifferencesisfarmoredifficultinpracticethanitisintheory.

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DefinitionalTests

¨ Isthemultipleconsistentlydefined?¤ Proposition1:Boththevalue(thenumerator)andthestandardizingvariable(thedenominator)shouldbetothesameclaimholdersinthefirm.Inotherwords,thevalueofequityshouldbedividedbyequityearningsorequitybookvalue,andfirmvalueshouldbedividedbyfirmearningsorbookvalue.

¨ Isthemultipleuniformlyestimated?¤ Thevariablesusedindefiningthemultipleshouldbeestimateduniformlyacrossassetsinthe“comparablefirm” list.

¤ Ifearnings-basedmultiplesareused,theaccountingrulestomeasureearningsshouldbeappliedconsistentlyacrossassets.Thesameruleapplieswithbook-valuebasedmultiples.

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Example1:PriceEarningsRatio:Definition

PE=MarketPriceperShare/EarningsperShare¨ ThereareanumberofvariantsonthebasicPEratioinuse.Theyarebaseduponhowthepriceandtheearningsaredefined.Price: isusuallythecurrentprice

issometimestheaveragepricefortheyearEPS: EPSinmostrecentfinancialyear

EPSintrailing12monthsForecastedearningspersharenextyearForecastedearningspershareinfutureyear

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Example2:StayingonPEratios

¨ AssumingthatyouarecomparingthePEratiosacrosstechnologycompanies,manyofwhichhaveoptionsoutstanding.WhatmeasureofPEratiowouldyieldthemostconsistentcomparisons?a. Price/PrimaryEPS(actualshares,nooptions)b. Price/FullyDilutedEPS(actualshares+alloptions)c. Price/PartiallyDilutedEPS(countingonlyin-the-money

options)d. Other

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Example3:EnterpriseValue/EBITDAMultiple

¨ TheenterprisevaluetoEBITDAmultipleisobtainedbynettingcashoutagainstdebttoarriveatenterprisevalueanddividingbyEBITDA.

1. Whydowenetoutcashfromfirmvalue?2. Whathappensifafirmhascrossholdingswhichare

categorizedas:¤ Minorityinterests?¤ Majorityactiveinterests?

Enterprise ValueEBITDA

=Market Value of Equity + Market Value of Debt - Cash

Earnings before Interest, Taxes and Depreciation

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Example4:AHousingPriceMultiple

Thebubblesandbustsinhousingpriceshasledinvestorstosearchforamultiplethattheycanusetodeterminewhenhousingpricesaregettingoutofline.Onemeasurethathasacquiredadherentsistheratioofhousingpricetoannualnetrentalincome(forrentingoutthesamehouse).Assumethatyoudecidetocomputethisratioandcompareittothemultipleatwhichstocksaretrading.Whichvaluationratiowouldbetheonethatcorrespondstothehouseprice/rentratio?a.PriceEarningsRatiob.EVtoSalesc.EVtoEBITDAd.EVtoEBIT

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DescriptiveTests

¨ Whatistheaverageandstandarddeviationforthismultiple,acrosstheuniverse(market)?

¨ Whatisthemedianforthismultiple?¤ Themedianforthismultipleisoftenamorereliablecomparisonpoint.

¨ Howlargearetheoutlierstothedistribution,andhowdowedealwiththeoutliers?¤ Throwingouttheoutliersmayseemlikeanobvioussolution,butifthe

outliersalllieononesideofthedistribution(theyusuallyarelargepositivenumbers),thiscanleadtoabiasedestimate.

¨ Aretherecaseswherethemultiplecannotbeestimated?Willignoringthesecasesleadtoabiasedestimateofthemultiple?

¨ Howhasthismultiplechangedovertime?

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1.Multipleshaveskeweddistributions…

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100.

200.

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0.01To4 4To8 8To12 12To16 16To20 20To24 24To28 28To32 32To36 36To40 40To50 50To75 75To100 100andover

PERatios:UScompaniesinJanuary2016

Current Trailing Forward

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2.Makingstatistics“dicey”

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CurrentPE TrailingPE ForwardPENumberoffirms 7480 7480 7480NumberwithPE 3,344. 3,223. 2,647.Average 59.42 46.04 29.63Median 18.53 18.29 16.98Minimum 0.11 0.28 0.15Maximum 32,269.00 6,900.00 2,748.00Standarddeviation 777.02 256.06 81.27Standarderror 13.44 4.51 1.58Skewness 37.27 19.9 18.7425thpercentile 11.88 12.32 13.175thpercentile 30.25 29.52 24.28

US firms in January 2016

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3.Marketshavealotincommon :ComparingGlobalPEs

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0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

US Europe Japan EmergingMarkets Aus,NZ&Canada Global

TrailingPERatiosbyRegion

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3a.Andthedifferencesaresometimesrevealing…PricetoBookRatiosacrossglobe– January2013

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4.Simplisticrulesalmostalwaysbreakdown…6timesEBITDAwasnotcheapin2010…

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Butitmaybein2016,unlessyouareinJapan,AustraliaorCanada

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0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

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EV/EBITDAMultiplesinJanuary2016

US Europe Japan EmergingMarkets Aus,NZ&Canada Global

Average 25thperc. Median 75thperc.UnitedStates 439.06 7.70 11.80 28.00Europe 98.53 6.73 10.12 16.55Japan 69.64 4.67 7.20 11.59EmergingMarkets 112.64 6.76 11.91 28.07Aus,NZ&Canada 77.17 5.24 8.85 15.77Global 148.16 6.43 10.58 21.67

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AnalyticalTests

¨ Whatarethefundamentalsthatdetermineanddrivethesemultiples?¤ Proposition2:Embeddedineverymultipleareallofthevariablesthat

driveeverydiscountedcashflowvaluation- growth,riskandcashflowpatterns.

¨ Howdochangesinthesefundamentalschangethemultiple?¤ Therelationshipbetweenafundamental(likegrowth)andamultiple

(suchasPE)isalmostneverlinear.¤ Proposition3:Itisimpossibletoproperlycomparefirmsonamultiple,

ifwedonotknowhowfundamentalsandthemultiplemove.

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ASimpleAnalyticaldevice

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