Multiplies - FINA 537 Equity Valuation Professor Laura...

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1 FINA 537 Equity Valuation Professor Laura Xiaolei Liu Valuation Using Multiples
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!
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
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
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
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
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
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…)
9 Key Questions in Practice Decide which multiple to use Find the “comparable” firms To do these, we need to understand the multiples
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
11 Calculate Multiples Uniformly The PE multiple is price per share divided by earnings per share. But: ¾ Is the price the current price (usually yes) or an average of lagged prices? ¾ Is EPS taken from the last fiscal year (yielding

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