ComparativeAnalysis

ComparativeAnalysis - 15.535 Class#5 Comparative Analysis...

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15.535 Class #5 “Comparative Analysis” 15.535 - Class #5 1
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Announcements • Assignment #1: – Hand in at start of class on Tuesday, Feb, 25 th . – 2 page memo (any format) – Complete individually or in group of up to 3 people • Valuation Projects (Post tomorrow at NOON): – Teams, company choices & due diligence matches can be found on Sloanspace. 15.535 - Class #5 2
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Recap From Prior Classes • DCF Analysis Equity Valuation All valuation models based on DCF framework. Key is to estimate future cashflows. Earnings are generally the starting point and then we can back out cashflows. Abnormal Earnings (or EBO or Residual Income) Valuation is a DCF-based model that relies on accounting earnings. – Strengths and weaknesses of abnormal earnings • Recap of “Back of Envelope Valuation” of Dell Draw time-line! Summary of Assumptions 15.535 - Class #5 3
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Today- Comparative Analysis • Valuation Comparisons (Multiples analysis): Compare market price (stock price) to a benchmark of fundamental value (i.e. cashflows) • Financial Ratio Comparisons 15.535 - Class #5 4
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Valuation Comparison: DCF Limitations What if firm has: Unknown history, Unknown implementation timing Unfathomable market, Unknown competition, Untested product, Unknown cost structure, Unknown market acceptance Projecting an unknown growth trajectory …. DCF is tough! Other DCF Limitations: DCF may miss growth options, options to expand, options to redirect You may need to adjust projections for GAAP expense treatment of R&D, customer acquisition costs, selected L/T marketing, etc. All difficult! 15.535 - Class #5 5
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Equity Valuation Analysis: What Do Analysts Use? (Asquith et al, 2001) Earnings Multiple 99% P-E 97% Relative P-E 35% Revenue Multiple 15% Price-to-Book 25% CF Multiple 13% DCF 13% EVA 2% “Model” 4% 15.535 - Class #5 6
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CASE FOR MULTIPLES: You wish to value Target (retailer): Find benchmark firms: ie Walmart, JCPenny, Sears Assume market correctly sets competitors’ stock prices. Assume all firms have the same risk (systematic & industry). Assume cashflow growth is similar for all the firms. – Assume accounting techniques to calculate earnings (or book equity or sales or EBITDA) are similar for all the firms. Implication: the P/E model (perpetuity or growing perpetuity) is the same for competitors and Target Corp. A Multiples Valuation Approach: Take average P/E of competitors Multiply by Target’s EPS of obtain the predicted price of Target. 15.535 - Class #5 7
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Overview of Comparative Analysis Use of Multiples: Is stock price too high/low relative to a measure of future cash flows? (Implicit is a DCF model) Method is simple to implement: No detailed multi-year forecasts necessary. Steps:
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ComparativeAnalysis - 15.535 Class#5 Comparative Analysis...

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