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**Unformatted text preview: **Aswath Damodaran 1 VALUATION: PACKET 2 RELATIVE VALUATION, ASSET-‐BASED VALUATION AND PRIVATE COMPANY VALUATION Aswath Damodaran Updated: January 2015 The Essence of relaMve valuaMon? 2 ¨ ¨ In relaMve valuaMon, the value of an asset is compared to the values assessed by the market for similar or comparable assets. To do relaMve valuaMon then, we need to idenMfy comparable assets and obtain market values for these assets ¤ convert these market values into standardized values, since the absolute prices cannot be compared This process of standardizing creates price mulMples. ¤ compare the standardized value or mulMple for the asset being analyzed to the standardized values for comparable asset, controlling for any diﬀerences between the ﬁrms that might aﬀect the mulMple, to judge whether the asset is under or over valued ¤ Aswath Damodaran 2 RelaMve valuaMon is pervasive… 3 ¨
¨ Most asset valuaMons are relaMve. Most equity valuaMons on Wall Street are relaMve valuaMons. ¤
¤
¤ ¨ Almost 85% of equity research reports are based upon a mulMple and comparables. More than 50% of all acquisiMon valuaMons are based upon mulMples Rules of thumb based on mulMples are not only common but are o^en the basis for ﬁnal valuaMon judgments. While there are more discounted cashﬂow valuaMons in consulMng and corporate ﬁnance, they are o^en relaMve valuaMons masquerading as discounted cash ﬂow valuaMons. ¤
¤ The objecMve in many discounted cashﬂow valuaMons is to back into a number that has been obtained by using a mulMple. The terminal value in a signiﬁcant number of discounted cashﬂow valuaMons is esMmated using a mulMple. Aswath Damodaran 3 Why relaMve valuaMon? 4 “If you think I’m crazy, you should see the guy who lives across the hall” “ Jerry Seinfeld talking about Kramer in a Seinfeld episode 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
Aswath Damodaran 4 The Market ImperaMve…. 5 ¨ RelaMve valuaMon is much more likely to reﬂect market percepMons and moods than discounted cash ﬂow valuaMon. This can be an advantage when it is important that the price reﬂect these percepMons as is the case when ¤
¤ ¨ ¨ ¨ the objecMve is to sell a security at that price today (as in the case of an IPO) invesMng on “momentum” based strategies With relaMve valuaMon, there will always be a signiﬁcant proporMon of securiMes that are under valued and over valued. Since porbolio managers are judged based upon how they perform on a relaMve basis (to the market and other money managers), relaMve valuaMon is more tailored to their needs RelaMve valuaMon generally requires less informaMon than discounted cash ﬂow valuaMon (especially when mulMples are used as screens) Aswath Damodaran 5 MulMples are just standardized esMmates of price… 6 Market value of equity Market value for the firm
Firm value = Market value of equity
+ Market value of debt Multiple = Revenues
a. Accounting
revenues
b. Drivers
- # Customers
- # Subscribers
= # units Numerator = What you are paying for the asset
Denominator = What you are getting in return Earnings
a. To Equity investors
- Net Income
- Earnings per share
b. To Firm
- Operating income (EBIT) Aswath Damodaran Market value of operating assets of firm
Enterprise value (EV) = Market value of equity
+ Market value of debt
- Cash Cash flow
a. To Equity
- Net Income + Depreciation
- Free CF to Equity
b. To Firm
- EBIT + DA (EBITDA)
- Free CF to Firm Book Value
a. Equity
= BV of equity
b. Firm
= BV of debt + BV of equity
c. Invested Capital
= BV of equity + BV of debt - Cash 6 The Four Steps to DeconstrucMng MulMples 7 ¨ Deﬁne the mulMple ¤ ¨ Describe the mulMple ¤ ¨ Too many people who use a mulMple have no idea what its cross secMonal distribuMon is. If you do not know what the cross secMonal distribuMon of a mulMple is, it is diﬃcult to look at a number and pass judgment on whether it is too high or low. Analyze the mulMple ¤ ¨ In use, the same mulMple can be deﬁned in diﬀerent ways by diﬀerent users. When comparing and using mulMples, esMmated by someone else, it is criMcal that we understand how the mulMples have been esMmated It is criMcal that we understand the fundamentals that drive each mulMple, and the nature of the relaMonship between the mulMple and each variable. Apply the mulMple ¤ Deﬁning the comparable universe and controlling for diﬀerences is far more diﬃcult in pracMce than it is in theory. Aswath Damodaran 7 DeﬁniMonal Tests 8 ¨ Is the mulMple consistently deﬁned? ¤ ¨ ProposiMon 1: Both the value (the numerator) and the standardizing variable ( the denominator) should be to the same claimholders in the ﬁrm. In other words, the value of equity should be divided by equity earnings or equity book value, and ﬁrm value should be divided by ﬁrm earnings or book value. Is the mulMple uniformly esMmated? The variables used in deﬁning the mulMple should be esMmated uniformly across assets in the “comparable ﬁrm” list. ¤ If earnings-‐based mulMples are used, the accounMng rules to measure earnings should be applied consistently across assets. The same rule applies with book-‐value based mulMples. ¤ Aswath Damodaran 8 Example 1: Price Earnings RaMo: DeﬁniMon 9 PE = Market Price per Share / Earnings per Share ¨ There are a number of variants on the basic PE raMo in use. They are based upon how the price and the earnings are deﬁned. Price: EPS: Aswath Damodaran is usually the current price is someMmes the average price for the year EPS in most recent ﬁnancial year EPS in trailing 12 months Forecasted earnings per share next year Forecasted earnings per share in future year 9 Example 2: Staying on PE raMos 10 ¨ Assuming that you are comparing the PE raMos across technology companies, many of which have opMons outstanding. What measure of PE raMo would yield the most consistent comparisons? a.
b.
c. d. Price/ Primary EPS (actual shares, no opMons) Price/ Fully Diluted EPS (actual shares + all opMons) Price/ ParMally Diluted EPS (counMng only in-‐the-‐money opMons) Other Aswath Damodaran 10 Example 3: Enterprise Value /EBITDA MulMple 11 ¨ The enterprise value to EBITDA mulMple is obtained by nejng cash out against debt to arrive at enterprise value and dividing by EBITDA. Enterprise Value Market Value of Equity + Market Value of Debt - Cash
=
EBITDA
Earnings before Interest, Taxes and Depreciation
1.
2. Why do we net out cash from ﬁrm value? What happens if a ﬁrm has cross holdings which are categorized as: ¤
¤ Minority interests? Majority acMve interests? Aswath Damodaran 11 Example 4: A Housing Price MulMple 12 The bubbles and busts in housing prices has led investors to search for a mulMple that they can use to determine when housing prices are gejng out of line. One measure that has acquired adherents is the raMo of housing price to annual net rental income (for renMng out the same house). Assume that you decide to compute this raMo and compare it to the mulMple at which stocks are trading. Which valuaMon raMo would be the one that corresponds to the house price/rent raMo? a.
Price Earnings RaMo b.
EV to Sales c.
EV to EBITDA d.
EV to EBIT Aswath Damodaran 12 DescripMve Tests 13 ¨ ¨ What is the average and standard deviaMon for this mulMple, across the universe (market)? What is the median for this mulMple? ¤ ¨ How large are the outliers to the distribuMon, and how do we deal with the outliers? ¤ ¨ ¨ The median for this mulMple is o^en a more reliable comparison point. Throwing out the outliers may seem like an obvious soluMon, but if the outliers all lie on one side of the distribuMon (they usually are large posiMve numbers), this can lead to a biased esMmate. Are there cases where the mulMple cannot be esMmated? Will ignoring these cases lead to a biased esMmate of the mulMple? How has this mulMple changed over Mme? Aswath Damodaran 13 1. MulMples have skewed distribuMons… 14 PE Ra&os for US stocks: January 2015 700. 600. 500. 400. Current Trailing 300. Forward 200. 100. 0. 0.01 To 4 To 8 8 To 12 12 To 4 16 Aswath Damodaran 16 To 20 20 To 24 24 To 28 28 To 32 32 To 36 36 To 40 40 To 50 50 To 75 75 To 100 More 14 2. Making staMsMcs “dicey” 15 Current PE Trailing PE Forward PE Number of firms 7887 7887 7887 Number with PE 3403 3398 2820 Average 72.13 60.49 35.25 Median 20.88 19.74 18.32 Minimum 0.25 0.4 1.15 Maximum 23,100. 23,100. 5,230.91 Standard deviation 509.6 510.41 139.75 Standard error 8.74 8.76 2.63 Skewness 31. 32.77 25.04 25th percentile 13.578 13.2 14.32 75th percentile 33.86 31.16 25.66 Aswath Damodaran 15 3. Markets have a lot in common : Comparing Global PEs 16 PE Ra&o Distribu&on: Global Comparison in January 2015 25.00% 20.00% Aus, Ca & NZ 15.00% US Emerg Mkts Europe 10.00% Japan Global 5.00% 0.00% 0.01 To 4 To 8 8 To 12 12 To 4 16 Aswath Damodaran 16 To 20 20 To 24 24 To 28 28 To 32 32 To 36 36 To 40 40 To 50 50 To 75 75 To 100 More 16 3a. And the diﬀerences are someMmes revealing… Price to Book RaMos across globe – January 2013 17 Aswath Damodaran 17 4. SimplisMc rules almost always break down…6 Mmes EBITDA was not cheap in 2010… 18 Aswath Damodaran 18 But it may be in 2015, unless you are in Japan, Australia or Canada 19 EV/EBITDA: A Global Comparison -‐ January 2015 25.00% 20.00% US 15.00% A,C & NZ Emerg Mkts Europe 10.00% Japan Global 5.00% 0.00% <2 2 To 4 4 To 6 6 To 8 8 To 10 To 12 To 16 To 20 To 25 To 30 To 35 To 40 To 45 To 50 To 75 To More 10 12 16 20 25 30 35 40 45 50 75 100 Aswath Damodaran 19 AnalyMcal Tests 20 ¨ What are the fundamentals that determine and drive these mulMples? ¤ ¨ ProposiMon 2: Embedded in every mulMple are all of the variables that drive every discounted cash ﬂow valuaMon -‐ growth, risk and cash ﬂow paverns. How do changes in these fundamentals change the mulMple? ¤ ¤ The relaMonship between a fundamental (like growth) and a mulMple (such as PE) is almost never linear. ProposiMon 3: It is impossible to properly compare ﬁrms on a mulMple, if we do not know how fundamentals and the mulMple move. Aswath Damodaran 20 A Simple AnalyMcal device 21 Equity Multiple or Firm Multiple
Equity Multiple Firm Multiple 1. Start with an equity DCF model (a dividend or FCFE
model) 1. Start with a firm DCF model (a FCFF model) 2. Isolate the denominator of the multiple in the model
3. Do the algebra to arrive at the equation for the multiple 2. Isolate the denominator of the multiple in the model
3. Do the algebra to arrive at the equation for the multiple Aswath Damodaran 21 I . PE RaMos 22 ¨ To understand the fundamentals, start with a basic equity discounted cash ﬂow model. ¤ With the dividend discount model, P0 = DPS1
r − gn ¤ Dividing both sides by the current earnings per share, P0
Payout Ratio*(1+ g n )
= PE=
EPS0
r-gn ¤ If this had been a FCFE Model, Aswath Damodaran FCFE1
r − gn
(FCFE/Earnings)*(1+ g n ) P0 = P0
= PE=
EPS0 r-gn 22 Using the Fundamental Model to EsMmate PE For a High Growth Firm 23 ¨ The price-‐earnings raMo for a high growth ﬁrm can also be related to fundamentals. In the special case of the two-‐stage dividend discount model, this relaMonship can be made explicit fairly simply: " (1+g)n %
EPS0 *Payout Ratio*(1+g)*$1−
n '
n
# (1+r) & EPS0 *Payout Ratio n *(1+g) *(1+g n )
P0 =
+
r-g
(r-g n )(1+r)n ¤ For a ﬁrm that does not pay what it can aﬀord to in ¨ dividends, subsMtute FCFE/Earnings for the payout raMo. Dividing both sides by the " earnings per share: Aswath Damodaran (1 + g)n %'
Payout Ratio * (1 + g) * $ 1 −
#
(1+ r) n &
P0
Payout Ratio n *(1+ g) n * (1 + gn )
=
+
EPS0
r -g
(r - g n )(1+ r) n 23 A Simple Example 24
¨ Assume that you have been asked to esMmate the PE raMo for a ﬁrm which has the following characterisMcs: Variable High Growth Phase Stable Growth Phase Expected Growth Rate 25% 8% Payout RaMo 20% 50% Beta 1.00 1.00 5 years Forever a^er year 5 Riskfree rate = T.Bond Rate = 6% Number of years Required rate of return = 6% + 1(5.5%)= 11.5% Aswath Damodaran "
(1.25)5 %
.20*(1.25)*$1−
5'
5
P0
# (1.115) & .50*(1.25) *(1.08)
=
+
= 28.75
EPS0
.115-.25
(.115-.08)(1.115)5 24 a. PE and Growth: Firm grows at x% for 5 years, 8% therea^er 25
PE Ratios and Expected Growth: Interest Rate Scenarios
180 160 140 Ratio 100 PE 120 80 r=4%
r=6%
r=8%
r=10% 60 40 20 0
5% 10% 15% 20% 25% 30% 35% 40% 45% 50% Expected Growth Rate Aswath Damodaran 25 b. PE and Risk: A Follow up Example 26
PE Ratios and Beta: Growth Scenarios
50
45
40
35 g=25%
g=20%
g=15%
g=8% 25 PE Ratio 30 20
15
10
5
0
0.75 1.00 1.25 1.50 1.75 2.00 Beta Aswath Damodaran 26 Example 1: Comparing PE raMos across Emerging Markets-‐ March 2014 (pre-‐ Ukraine) 27 Russia looks really cheap, right? Aswath Damodaran 27 Example 2: An Old Example with Emerging Markets: June 2000 28 Country PE Ratio Argentina
Brazil
Chile
Hong Kong
India
Indonesia
Malaysia
Mexico
Pakistan
Peru
Phillipines
Singapore
South Korea
Thailand
Turkey
Venezuela 14
21
25
20
17
15
14
19
14
15
15
24
21
21
12
20 Aswath Damodaran Interest
Rates
18.00%
14.00%
9.50%
8.00%
11.48%
21.00%
5.67%
11.50%
19.00%
18.00%
17.00%
6.50%
10.00%
12.75%
25.00%
15.00% GDP Real
Growth
2.50%
4.80%
5.50%
6.00%
4.20%
4.00%
3.00%
5.50%
3.00%
4.90%
3.80%
5.20%
4.80%
5.50%
2.00%
3.50% Country
Risk
45
35
15
15
25
50
40
30
45
50
45
5
25
25
35
45 28 Regression Results 29 ¨ The regression of PE raMos on these variables provides the following – PE = 16.16 R Squared = 73% Aswath Damodaran -‐ 7.94 Interest Rates + 154.40 Growth in GDP -‐ 0.1116 Country Risk 29 Predicted PE RaMos 30 Country PE Ratio Argentina
Brazil
Chile
Hong Kong
India
Indonesia
Malaysia
Mexico
Pakistan
Peru
Phillipines
Singapore
South Korea
Thailand
Turkey
Venezuela 14
21
25
20
17
15
14
19
14
15
15
24
21
21
12
20 Aswath Damodaran Interest
Rates
18.00%
14.00%
9.50%
8.00%
11.48%
21.00%
5.67%
11.50%
19.00%
18.00%
17.00%
6.50%
10.00%
12.75%
25.00%
15.00% GDP Real
Growth
2.50%
4.80%
5.50%
6.00%
4.20%
4.00%
3.00%
5.50%
3.00%
4.90%
3.80%
5.20%
4.80%
5.50%
2.00%
3.50% Country
Risk
45
35
15
15
25
50
40
30
45
50
45
5
25
25
35
45 Predicted PE
13.57
18.55
22.22
23.11
18.94
15.09
15.87
20.39
14.26
16.71
15.65
23.11
19.98
20.85
13.35
15.35 30 PE raMos globally: July 2014 31 Aswath Damodaran 31 Example 3: PE raMos for the S&P 500 over Mme 32 PE Ra&os for the S&P 500: 1969-‐2014 50.00 45.00 On Jan 1, 2015 PE = 17.95 Normalized PE -‐ = 24.16 CAPE = 21.62 40.00 35.00 30.00 PE 25.00 Normalized PE 20.00 CAPE 15.00 10.00 0.00 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 5.00 Aswath Damodaran 32 Is low (high) PE cheap (expensive)? 33 ¨ A market strategist argues that stocks are expensive because the PE raMo today is high relaMve to the average PE raMo across Mme. Do you agree? a.
b. Yes No If you do not agree, what factors might explain the higher PE raMo today? ¨ Would you respond diﬀerently if the market strategist has a Nobel Prize in Economics? ¨ Aswath Damodaran 33 E/P RaMos , T.Bond Rates and Term Structure 34 Earnings to Price versus Interest Rates: S&P 500 16.00% 14.00% 12.00% 10.00% 8.00% Earnings Yield T.Bond Rate 6.00% Bond-‐Bill 4.00% 2.00% 0.00% -‐2.00% Aswath Damodaran 34 Regression Results 35
¨ ¨
There is a strong posiMve relaMonship between E/P raMos and T.Bond rates, as evidenced by the correlaMon of 0.65 between the two variables., In addiMon, there is evidence that the term structure also aﬀects the PE raMo. In the following regression, using 1960-‐2014 data, we regress E/P raMos against the level of T.Bond rates and a term structure variable (T.Bond -‐ T.Bill rate) E/P = 3.47% + 0.5661 T.Bond Rate – 0.1428 (T.Bond Rate-‐T.Bill Rate) (4.93) (6.15) (-‐0.67) R squared = 40.94[% ¨ Going back to 2008, this is what the regression looked like: E/P = 2.56% + 0.7044 T.Bond Rate – 0.3289 (T.Bond Rate-‐T.Bill Rate) (4.71) (7.10) (1.46) R squared = 50.71% The R-‐squared has dropped and the T.Bond rate and the diﬀerenMal with the T.Bill rate have noth lost signiﬁcance. How would you read this result? Aswath Damodaran 35 II. PEG RaMo 36
¨ ¨ PEG RaMo = PE raMo/ Expected Growth Rate in EPS ¤ For consistency, you should make sure that your earnings growth reﬂects the EPS that you use in your PE raMo computaMon. ¤ The growth rates should preferably be over the same Mme period. To understand the fundamentals that determine PEG raMos, let us return again to a 2-‐stage equity discounted cash ﬂow model: " (1+g)n %
EPS0 *Payout Ratio*(1+g)*$1−
n '
n
# (1+r) & EPS0 *Payout Ratio n *(1+g) *(1+g n )
P0 =
+
r-g
(r-g n )(1+r)n ¨ Dividing both sides of the equaMon by the earnings gives us the equaMon for the PE raMo. Dividing it again by the expected growth ‘g: " (1+g)n %
Payout Ratio*(1+g)*$1−
n '
n
# (1+r) & Payout Ratio n *(1+g) *(1+g n )
PEG=
+
g(r-g)
g(r-g n )(1+r)n Aswath Damodaran 36 PEG RaMos and Fundamentals 37 ¨ Risk and payout, which aﬀect PE raMos, conMnue to aﬀect PEG raMos as well. ¤ ImplicaMon: When comparing PEG raMos across companies, we are making implicit or explicit assumpMons about these variables. ¨ Dividing PE by expected growth does not neutralize the eﬀects of expected growth, since the relaMonship between growth and value is not linear and fairly complex (even in a 2-‐stage model) Aswath Damodaran 37 A Simple Example 38
¨ Assume that you have been asked to esMmate the PEG raMo for a ﬁrm which has the following characterisMcs: Variable High Growth Phase Stable Growth Phase Expected Growth Rate 25% 8% Payout RaMo 20% 50% Beta 1.00 1.00 ¨ Riskfree rate = T.Bond Rate = 6% ¨ Required rate of return = 6% + 1(5.5%)= 11.5% ¨ The PEG raMo for this ﬁrm can be esMmated as follows: "
(1.25)5 %
0.2 * (1.25) * $1−
5'
0.5 * (1.25)5 *(1.08)
# (1.115) &
PEG =
+
= 115 or 1.15
5
.25(.115 - .25)
.25(.115-.08) (1.115) Aswath Damodaran 38 PEG RaMos and Risk 39 Aswath Damodaran 39 PEG RaMos and Quality of Growth 40 Aswath Damodaran 40 PE RaMos and Expected Growth 41 Aswath Damodaran 41 PEG RaMos and Fundamentals: ProposiMons 42 ¨ ProposiMon 1: High risk companies will trade at much lower PEG raMos than low risk companies with the same expected growth rate. ¤ ¨ ProposiMon 2: Companies that can avain growth more eﬃciently by invesMng less in bever return projects will have higher PEG raMos than companies that grow at the same rate less eﬃciently. ¤ ¨ Corollary 1: The company that looks most under valued on a PEG raMo basis in a sector may be the riskiest ﬁrm in the sector Corollary 2: Companies that look cheap on a PEG raMo basis may be companies with high reinvestment rates and poor project returns. ProposiMon 3: Companies with very low or very high growth rates will tend to have higher PEG raMos than ﬁrms with average growth rates. This bias is worse for low growth stocks. ¤ Corollary 3: PEG raMos do not neutralize the growth eﬀect. Aswath Damodaran 42 III. Price to Book RaMo 43
¨ Going back to a simple dividend discount model, DPS1
P0 =
r − gn
¨ Deﬁning the return on equity (ROE) = EPS0 / Book Value of Equity, the value of equity can be wriven as: BV0 *ROE*Payout Ratio*(1+ g n )
P0 =
r-gn
P0
ROE*Payout Ratio*(1+ g n )
= PBV=
BV0
r-g
n If the return on equity is based upon expected earnings in the next Mme period, this can be simpliﬁed to, P0
ROE*Payout Ratio = PBV=
BV0
r-g
¨ Aswath Damodaran n 43 Price Book Value RaMo: Stable Growth Firm Another PresentaMon 44 ¨ ¨ This formulaMon can be simpliﬁed even further by relaMng growth to the return on equity: g = (1 -‐ Payout raMo) * ROE SubsMtuMng back into the P/BV equaMon, P0
ROE - g n
= PBV=
BV0
r-gn ¨ ¨ The price-‐book value raMo of a stable ﬁrm is determined by the diﬀerenMal between the return on equity and the required rate of return on its projects. Building on this equaMon, a company that is expected to generate a ROE higher (lower than, equal to) its cost of equ...

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