Multiplies

Multiplies - FINA 537 Equity Valuation Professor Laura...

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1 FINA 537 Equity Valuation Professor Laura Xiaolei Liu Valuation Using Multiples
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2 Limitation of DCF What if firm has: ¾ Unknown history ¾ Projecting an unknown growth trajectory …. DCF is tough! Other DCF Limitations: ¾ DCF is hard to specifically capture options to redirect ¾ You may need to adjust accounting treatment, like expense treatment of R&D, depreciation method. All difficult!
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3 Valuation Using Multiples • Multiples or ratios are calculated by scaling price by some observable variable or characteristic (e.g. price to earnings or price to book value) • If we know the appropriate value for the multiple (usually obtained from “comparable” firms) we can value a security by multiplying the ratio times the observable characteristic to obtain an estimate of price
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4 Large Paper and Paper Products Companies 29.40 Average 51.42 0.61 31.47 MWV Meadwestvaco Corp 15.07 2.30 34.68 GP Georgia-Pacific Corp 15.65 1.24 19.38 UPM UPM-Kymmene Oyj 20.22 0.68 13.85 SEO Stora Enso Oyi 56.18 0.71 39.89 IP International Paper Co 17.88 3.55 63.41 KMB Kimberly-Clark Corp P/E EPS Price Symbol Company
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5 Answer • Boise Cascade Corporate (BCC) is a multinational distributor of office supplies, paper and packaging products, office furniture, and building materials • Its earnings per share last year were $1.71 • If BCC is comparable to the “average” large paper and paper products company, its share value would be estimated at P=E×(P/E)=$1.71×29.40=$50.27
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6 Advantages of Using Multiples • Valuation with a multiple is quick, simple and can be accomplished with few assumptions • It is easy to understand and easy to present to clients and customers • Reflects current market prices for comparable firms and thus current market conditions
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7 The Downside of Multiples • Although valuation with multiples requires few explicit assumptions, the implicit (or underlying) assumptions are not transparent and can lead to bias, manipulation, and inconsistent valuations
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8 Value Drivers Price can be standardized using a common variable such as earnings, revenue, cash flows, book value. ¾ Earnings Multiples ± Price/Earnings per share (PE) and variants ± Value/EBIT ± Value/EBITDA ± Value/Sales ± Value/Cash Flow ¾ Book Value Multiples ± Market value of Equity/Book Value of Equity ± Market value of Assets/Book Value of Assets ± Market value of Assets/Replacement Cost (Tobin’s Q) ¾ Industry Specific Variable (Price/kwh, Price per ton of steel…)
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9 Key Questions in Practice • Decide which multiple to use • Find the “comparable” firms To do these, we need to understand the multiples
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10 The Three Steps to Understanding Multiplies • Calculate the multiple ¾ Multiple needs to be calculated uniformly and consistently • Describe the multiple ¾ Understand the cross-sectional distribution of the multiple • Analyze the multiple ¾ Understand the fundamentals that drive each multiple
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11 Calculate Multiples Uniformly • The PE multiple is price per share divided
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Multiplies - FINA 537 Equity Valuation Professor Laura...

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