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**Unformatted text preview: **FINA 3403 Corporate Valuation
HKUST
Spring 2017-2018
Valuation Using Multiples
Gina Kao
Corporate Valuation Why use multiples
• There are limitations of DCF DCF: Assume WACC
based on targeted
capital structure ▫ Many unknown items – unknown history, growth projection
▫ May need adjust many accounting treatments, e.g., R&D,
depreciation method. • It is another approach for valuation
▫ It assumes the comparable transactions are truly comparable
to the investment being evaluated
▫ Pervasive, easy to communicate
check, find out
▫ Help to find the weak spots of DCF cross
the problem in DCF/
Multiples assumptions Corporate Valuation 2 Why use multiples
Multiples can assist in:
• Testing the plausibility of forecasted cash flows.
• Identifying disparities between a company’s
performance and those of its competitors.
• Identifying which companies the market believes are
strategically positioned to create more value than
other industry players. Corporate Valuation 3 What are multiples
What you are
paying for the
asset (MV of
Equity, EV) Multiple = What you are
getting in return
(Earning, EBIT,
EBITDA, BV)
EV (market approach) = MVE +(MV of Debt – Excess cash)
= MVE + Net Debt
Corporate Valuation 4 How do the multiples work?
• Multiples (ratios) are calculated by scaling price or value
by some observable variable or characteristic
• We can value a security by multiplying the appropriate multiple (usually obtained from “comparable” firms)
with the observable characteristic to get an estimated
price Corporate Valuation 5 Advantages of using multiples
• Easy to understand and communicate
• Less assumptions needed and easy to calculate
• Help to make value judgments – relative value
• Reflects current market pricing information for
comparable firms Corporate Valuation 6 The downside of multiples
• Simplistic: combining many value drivers in a point
estimate, it is difficult to disaggregate the effects of
different drivers on value.
• Measure value at a single point in time, not fully
capture the dynamic nature of business and
competition
• Difficult to compare (e.g. different accounting
policies, taxes, capital structure etc.)
price and earnings -->
no capital structure can
be seen Corporate Valuation big company has big
debt, so that they have
higher interest 7 Types of multiples Multiples will be seen
at the exam but not all Enterprise Multiples
Multiples based on EV
Value Multiples EV/EBITDA
EV/EBIT
EV/Sales Enterprise
Value (EV) Non-operating
assets (Excess Cash) Debt Equity Equity Multiples
Multiples based
on Equity Value
(Price)
P/E
P/B
P/S
Price Multiples Corporate Valuation 8 EV multiples vs Equity multiples
Lots of Assumptions Enterprise Value Multiples Equity Multiples More relevant to Enterprise
DCF looks at operating
value More relevant to Equity Value Less affected by accounting
policy differences Affected by accounting policy
DIV, share repurchases, no
differences
need to focus on WACC In accounting, there
are some write-off,
nonoperating expenses Less affected by capital structure More familiar to investors
Enables the user to exclude non- Include the value of non-core
core assets
assets and thus less subjective
assumptions needed
Corporate Valuation 9 Industry
specific
multiples
practical use of
multiples in different
industries Corporate Valuation e.g. the company will give rent
instead of DIV to large shareholder
(to convince the shareholder that
they can secure the stable income)
every year 10 Why multiples vary
• Difference in the quality of business
▫ different value drivers - e.g. quality of management,
branding, strategies • Accounting differences
▫ Not affect cash flow but affect profit, e.g. amortization, tax
rules
for some PE • Fluctuations in cash flow or profits
▫ Exceptional items • Mispricing e.g. currency under-priced: buy; overpriced: sell ▫ Distinguish the difference arising from the fundamentals or
mispricing
Corporate Valuation 11 Price to Earnings (P/E) Ratio
P/E = ℎ ℎ which kind of industry you will use p/e to
evaluate?
- the CF is more stable, or at least they
have earnings
- for start up they don't have earnings they
cannot use P/E • Price
▫ is usually the most recent share price
▫ is sometimes the average price for the year • Earnings per share (EPS) EPS = NI / # of shares
A: P=10; EPS = -1; p/e =-10
B: P=10; EPS=-2; p/e = -5
which one is better?
From number, -5 is better than -10; but in
reality sense: A lost less!
**Think about the meaning behind the number ▫ Earnings per share in most recent four quarters or 12 months
(TTM: Trailing Twelve Months or LTM: Last Twelve Months)
▫ Earnings per share in most recent financial year Forward P/E: use future earnings per share (e.g. next year)
Corporate Valuation 12 Price to Earnings (P/E) Ratio Is higher P/E better than lower P/E?
e.g. P/E of Company A = 10; B = 15;
given the same EPS, the market is willing
to pay more for B (maybe because the
growth prospect is better)
Low P/E --> cheaper --> maybe because
the prospect is declining (doesn't mean
it's good) • Measure how much investors are willing to pay for a
dollar of a company’s current or future earnings.
• Companies with higher P/E ratios than their peers
tends to have higher earnings growth expectations
• Usually high growth firms will have a higher P/E than
that of mature firms
• Different industries or markets will have different P/E
ratios higher p/e higher g higher growth -->
higher P/E Zero Beta Strategy, assume A and B are in similar
sector
Beta(P) = Wa*beta(a) + Wb*beta(b)
E(rp) = Wa E(ra) + Wb E(rb) Buy underprice and sell overprice --> gain with zero
risk (arbitrage) Corporate Valuation 13 World Market P/E Source:
Corporate Valuation 14 SIMILAR with the
EXAM Example: paper products company in reality, you have to
consider which
comparable you use
(average/medium?)
i.e. outliers should be
filtered / it's valuable?
OC Company Symbol Price EPS P/E Kimberly-Clark Corp KMB 63.41 3.55 17.88 International Paper Co IP 39.89 0.71 56.18 Stora Enso Oyi SEO 13.85 0.68 20.22 UPM-Kymmene Oyj UPM 19.38 1.24 15.65 Georgia-Pacific Corp GP 34.68 2.30 15.07 Meadwestvaco Corp MWV 31.47 0.61 51.42 Average
Corporate Valuation 29.40
15 one qs on midterm Example: paper products company
• Boise Cascade Corporate (BCC) is a multinational
distributor of office supplies, paper and packaging
products, office furniture, and building materials
• Its latest earnings per share were $1.71
• If BCC is comparable to the “average” large paper and
paper products company, what is its share value? => $1.71 x 29.4 = $50.27 Corporate Valuation 16 Limitations with P/E
• P/E is not relevant for companies with little or no
earnings.
• P/E mix operating and non-operating (and
extraordinary) income and expense items
• Influenced by the company’s leverage
• Influenced by the accounting discrepancies EV --> discounted by
WACC, WACC will be
affected by capital
structure Corporate Valuation 17 if everything hold constant, risk
higher, p/e will drop P/E Ratio for stable growth firm if company has
constant payout, higher
payout will lead to
higher p/e •With dividend discount model (constant growth)
•P/E ratio
0 (1+)
0 ×(1−)(1+)
0 = − = −
1-b = payout ratio
b = retention ratio 0 × (1 − )(1 + )
0
(1 − )(1 + ) − =
=
0
0 − unless mentioned •Forward P/E
b: retention ratio : cost of equity
Corporate Valuation 0 × (1 − )(1 + )
0
(1 − ) − =
=
1
1 − g: long-term growth rate = b x ROE
P: Price per share g = b* ROE
even g is higher but risk is higher, not necessary have higher PE P/E Ratio and Fundamentals
midterm we never know the
current market p/e is
correct or not, unless
market is efficient (OC)
To spot out which company is cheaper,
then check DCF, any special items, then
look at the chart (ST),
--> meaning that in reality, you cannot rely
on single measure to make decision due
to the market inefficiency • Other things held equal,
▫ Higher growth firms have __higher___ P/E
higher, cost of equity (ke) is
▫ Higher risk firms have _lower____ P/E risk
higher, p/e lower
▫ Firms with lower reinvestment needs (therefore higher
reinvest -->
payout ratio) will have _higher____ P/E lower
higher payout -->
higher p/e e.g. Well-positioned firms with competitive advantages, intellectual
property, patents, and managerial expertise are able to generate
both higher rates of return on new investment, as well as
opportunities to reinvest more of their earnings.
Corporate Valuation 19 Example
• Deutsche Bank had earnings per share of 46.38 DM in
current year, and paid out 16.50 DM as dividends.
• The growth rate in earnings and dividends, in the long
term, is expected to be 6%.
• The cost of equity is assumed to be 11.64%
• What are Deutsche Bank’s P/E and forward P/E? Corporate Valuation 20 Example--Answer
Firstly, find out the DIV
payout ratio b= (46.38-16.50)/46.38 =29.88/46.38=0.64 P/E
0
0 = (1−)(1+) (1−0.64)(1+0.06)
= −
0.1164−0.06 =6.766
P/E * EPS = Price Implied P0=6.766x $46.38=313.81 Forward P/E
0
1 = (1−)
(1−0.64)
= − 0.1164−0.06 =6.383 Implied P0=6.383x $46.38x 1.06=313.81 Corporate Valuation 21 Case in Practice
• Facebook was traded at P/E of 91 , which the sector
P/E was around 15.38.
• What are the reasons that Facebook’s P/E is so high
comparing to the same sector P/E?
=> 1. longer length of high growth period
2. maintain low dividend payout ratio (close to zero)
3. be able to maintain the return of the reinvested
earning
Corporate Valuation 22 Case in Practice Corporate Valuation Last Year Data (16 Fall) Facebook has higher p/e than industry, as:
1. higher growth
2. the non-constant period will be longer
than others (because of the C.A.) 23 ROE can been inflated by capital
structure
In Finance, we should take look of ROIC
and WACC BIDU has higher P/E than IBM, but in ROE; IBM > BIDU; Why?
BIDU give investor lower return
g = ROE * b --> (1-payout)*ROE
IBM: Lower beta, Lower discount rate, Higher ROE, Higher growth
BIDU is not as mature as IBM, BIDU has higher growth opportunity
and they don't pay DIV
Strange--> look at some fundamental! Case in Practice
Sep 30
2015
Price EPS P/E
ratio Mkt
Cap
(B) Div. GOOGL 622.61 19.89 31.31 428.03 0.00 BIDU 136.68 5.21 26.24 48.51 YNDX 10.77 0.68 15.74 3.56 YHOO 28.26 6.89 4.10 28.08 MSFT 43.44 1.46 29.77 352.65 IBM 142.47 15.01 FB 86.67 AAPL
TWTR ROE Beta Revenue Net
Income EBITDA 14.57 0.90 66,001.00 13,928.00 21,476.00 29.20 1.84 7,702.33 1,922.49 2,634.48 33.26 2.71 766.70 257.04 299.13 29.03 1.32 4,618.13 6,474.28 843.94 1.24 14.36 0.90 93,580.00 12,193.00 34,129.00 9.49 142.39 4.25 90.89 0.71 92,793.00 15,752.00 25,350.00 0.95 91.02 253.94 0.00 11.34 0.76 12,466.00 109.06 8.66 12.60 634.49 1.82 33.61 0.81 25.59 -0.95 17.34 0.00 -17.57 0.00 2,940.00 6,237.00 182,795.0
39,510.00 60,503.00
0
1,403.00 -577.82 -330.70 Compare to Google, FB has a lower ROE but higher P/E => This could be due to a lower risk of
FB (lower beta) or a higher growth rate of FB.
Compare to Microsoft, Google has lower dividend (zero) payout and a similar beta => Google
could have a higher growth rate (higher ROE and b)
Corporate Valuation 24 An under valued company …
• An undervalued asset would be one
▫ With a low PE (it is cheap)
▫ With high expected growth in earnings
▫ With low risk (and a low cost of equity)
▫ With high ROE • When there is a cheap stock, ask the key questions:
▫ What is the expected growth in earnings?
▫ What is the risk in the stock?
▫ How efficiently does this company generate it growth? Corporate Valuation 25 Another approach to get PE ratio:
A regression approach
• In contrast to the “comparable firm” approach, the
information in the entire cross-section of firms can be
used to predict PE ratios
• Multiple regression = + 1 + 2 + 3 ▫ π: Dividend Payout Ratio
▫ Beta: Beta of the stock, proxy for risk (r)
▫ EGR: Earnings growth rate over the previous five years
Corporate Valuation 26 Example using regression
• Regression result for stocks listed on the Value Line
Database:
P/E = 18.69 - 0.4262 PAYOUT- 0.5082 BETA+ 0.0695 EGR
• You are attempting to value the equity of a firm. It has the
payout ratio is 30%, the current earning per share is $0.5.
The earnings in the past 5 years had grown 25% per year
and are expected to maintain the same growth rate. It has
beta of 1.15. What should the price per share be for this
firm?
If you know P/E, you
will know the next year
earnings so as the
price Corporate Valuation 27 Example -- Answer
• P/E = 18.69 - 0.4262 PAYOUT- 0.5082 BETA+ 0.0695
EGR
• P/E = 18.69 – 0.4264x0.30.5082x1.15+0.0695x0.25=17.99
• P =17.99 x $0.5 = $9.00 Corporate Valuation 28 Problems with the regression methodology
• Independent variables are correlated with each other
• The assumption that a liner relationship between P/E
and fundamentals may not be appropriate
• The basic relationship between P/E and the financial
variables itself is not stable Corporate Valuation 29 PEG Ratio for high growth
company • The PEG ratio is the ratio of PE to expected growth in
earnings per share.
• = P/EPS
P0 = D1/(ke-g), if we
look at PE we can find
the implied g in the
formula / ℎ this is estimated g high-growth company --> higher
PE but higher risk
PEG: high growth industry is
more preferred than mature
industry • The calculation of annual growth rate should be
consistent among comparable firms.
• If P/E < g or PEG is lower means the stock is more likely to
be undervalued (i.e. P/E changes lower than the growth
rate changes).
• PEG is more suitable to be used for high growth industry.
implied g< estimated g Corporate Valuation 30 PEG Ratios and Fundamentals multiple is another tool
(easier and faster tool) than
DCF
Lazy analysts: do multiples
only lol • Factors affect P/E ratios will affect PEG ratios.
• Other thing held equal,
▫ High risk companies will have lower PEG ratios (with the
same growth rate-- Higher risk, lower PE)
▫ Companies that can attain growth more efficiently by
investing less in better return projects will have _higher PEG
ratios that grow at the same rate
▫ Companies with very low or very high growth rates will tend
to have _higher_ PEG ratios than firms with average growth
denominator is
rates. This bias is worse for low growth stocks. when
very high/small --> the
change will have huge
effect Corporate Valuation 31 if the company is not frequently traded
in the market, you don't know the rate,
how can you find the value of the
bond? Price to Book Ratio (P/B) If you don't have MV, look at the BV
as proxy • = = ℎ ℎ ▫ Use for companies’ balance sheets are reasonable
reflections of the market value of their asset, e.g. financial
institutions, banks (more capital intensive industry) Corporate Valuation 32 P/B Ratio: Stable Growth Firm
higher risk, lower book
value × 1 − =
= − − • The Price-book equity ratio of a stable firm is determined by
difference between _the return on equity and the required
rate of return on its equity
: 1 = Corporate Valuation 1
0 33 Proof: P/B Ratio: Stable Growth Firm
1
1 =
0
0 = 1 1
= − − 1 1
× × 0 − 0
1
=
=
=
0
0 − − 0 1 − =
0 − the company which
has higher ROE, will
have higher BV Corporate Valuation g = 1 − 1
= 1 − 1
= > 1 x Payout = 1 - g
34 P/B and Fundamentals
you expect in the
future, you will have
the gain • A Firm with P/B> 1 means its ROE > .
• Firms have high ROE tends to sell above book value
• Should draw attentions when a firm with low PB but
high ROE or high PB with low ROE
• Compare” with the median for the sector in to decide
the “high” or “low. Corporate Valuation 35 e.g. Amazon has lower ROE but higher P/B
than Alibaba
possible reason: higher beta (higher risk!),
higher discount rate Case in Practice
Company name Goldman Sachs
Gro...
JPMorgan Chase &
Co.
Morgan Stanley
Sumitomo Mitsui F...
Societe Generale ...
Virtu Financial Inc
Evercore Partners...
Interactive Broke... p/b = (ROE-g)/(ke-g)
p/b can be higher because higher ke
g = b*ROE (ROE higher, g is higher) Price Earnings
per share P/E ratio Price-tobook ratio Return on
avg equity 170.52 10.57 16.13 0.95 7.47 67.52 5.9 11.44 1.12 10.35 32.07
6.47
7.27
13.87
52.08
35.92 2.18
1.08
1.03
1.06
1.29
1.52 14.71
6.01
7.05
13.1
40.5
23.68 0.91
0.63
0.45
14.73
4.09
2.66 8.58
11.15
6.23
6.55
8.12
6.01 3.08
1.41 16.58
13.91 3.19
1.04 8.06
7.80 mean
median Higher ROE but low PB could be undervalued
Corporate Valuation 36 Price to Sales Ratio
P/S ratio =
▫
▫
▫
▫
▫ = ℎ ℎ Use when firms or their peers don’t have positive earning
Useful for start-ups industries (no positive income) p/e cannot be used
Yet, they can call the
clients
and check the
It is relatively difficult to manipulate
sales record
It is not as volatile as price-earnings multiples
Provides a convenient handle for examining the effects of
changes in pricing policy and other corporate strategic
to evaluate the marketing campaign
decisions. tool
if believing the marketing is LT +ve impact
--> P/S increase (willing to pay more to buy
your shares)
(refers to next page bullet pt.) Corporate Valuation 37 P/S Ratio: Stable Growth Firm
0
0 = 1 − 0 = 1
0 − 0 ×(1+)/0
= − = × (1+) − • The key determinant of price-sales ratios is the profit
margin.
• Lower (expected) Profit Margin will lower the P/S directly
• Lower growth rate will lower the P/S indirectly
• Evaluate the branding (pricing strategy) Corporate Valuation 38 Case in Practice
they are not stable
companies, the risk
varies Price Baidu has lower PM and lower P/S than
baba
GOOGL and EBay has similar operating
Margin, but EBay has lower P/S (Ebay has
higher beta = risk which reduced the price
and Net PM Earnings
Price-toper share sales ratio Return on
investment Operating
margin Alibaba Group
Hol... 101.85 2.80 16.76 30.21 27.88 Amazon.Inc. 822.96 4.01 3.65 2.16 2.09 Apple Inc. 117.63 8.56 2.71 28.23 30.48 Baidu 175.51 13.49 6.17 33.49 17.58 31.89 1.67 4.19 9.04 25.57 57.42 2.10 5.24 12.96 23.28 75.29
0.00010 1.17
-1.24 6.06
0.00 1.25
-18.20 0.43
-20.25 53.08 0.21 23.63 5.78 7.85 41.44 -5.19 7.94 -9.37 -95.58 eBay Inc
Microsoft
Corpora...
SINA Corp
Subaye Inc
Weibo Corp
(ADR)
Yahoo! Inc.
Corporate Valuation 39 EV/ EBITDA price multiples you believe the market
valuation + − ℎ
= • EV = Price per share x shares outstanding plus interestbearing debt (ST and LT) less cash (excess cash)
• The multiple can be computed even for firms that are
reporting net losses, since EBITDA are usually positive.
• For firms that have significant noncash expenses (i.e.
depreciation).
• It is less affected by any changes in capital structure. When the
company swaps debt for equity, EBITDA is unchanged because
it is pre-interest. (EV will changes due to tax shields, signaling
MM1: buy back will
etc.)
affect the capital
structure Corporate Valuation 40 EV/ EBITDA
• EBITDA multiples provide a good valuation tool for
businesses in which most of the value comes from a
firm’s existing assets.
• EBITDA multiples are used primarily for the valuation
of stable, mature businesses.
• EBITDA multiples are much less useful for evaluating
businesses whose values come mainly from future
growth opportunities. Corporate Valuation 41 EV/ EBITDA and stable growth
• 0 = 1
− FCF1 = EBIT (1-t) - (Cex - Depr) - Δ Net Working Capital = (EBITDA - Depr) (1-t) - (Cex - Depr) - Δ Net Working Capital = EBITDA (1-t) + Depr (t) - Cex - Δ Net Working Capital
EBITDA (1−t) + Depr (t) − CAPEX − Δ Working Capital
0 = − = Corporate Valuation (1−t) + Depr (t) Δ Working Capital
−
− − 42 EV/ EBITDA and Fundamentals
Determinant 1. Tax Rate 2. Cost of Capital 3. Depreciation/EBITDA 4. Growth and Capital
Expenditures/EBITDA Corporate Valuation Effect on Value/EBITDA
multiple Implications
FCF = 1-t --> tax rate
•Firms with large net operating losses
increase, value drop
should sell for higher Value/EBITDA
As tax rate increases,
multiples.
multiple decreases.
•As tax rates increase, Value/EBITDA
multiples should go down.
•Firms which are riskier and use lower
As cost of capital increases,
leverage should have lower
multiple will decrease.
Value/EBITDA multiples.
only if depr. is deductible
As depreciation increases
•For a given level of capital
as a proportion of ...

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- Fall '16
- Gina Kao
- Valuation, P/E ratio, Corporate Valuation, Stable Growth Firm, PEG ratio