Key Rule #4: Trade-Offs and Correlations Advantages and Disadvantages of Different Methodologies: Methodology Name: Public Comps Precedent Transactions Discounted Cash Flow Analysis Advantages: • Based on real data as opposed to future assumptions • Based on what real companies have actually paid for other companies • Not as subject to market fluctuations • Theoretically sound since it’s based on ability to generate cash flow Disadvantages: • There may not be true comparables • Less accurate for thinly traded stocks or volatile companies • Data can be spotty (especially for private co. acquisitions) • There may not be truly comparable transactions • Subject to far- in-the-future assumptions • Less useful for fast- growing, unpredictable companies
Investment Banking Interview Guide Access the Rest of the Interview Guide 17 / 58 And then for the more “exotic” methodologies: • Liquidation Valuation: Good because it ignores “noise” in the market and determines value based on Assets and Liabilities; but it’s not useful for most healthy companies because it tends to produce extremely low values. • M&A Premiums Analysis: Same issues as with Precedent Transactions. Also, you can’t use acquisitions of private companies for this because premiums only apply to public companies with stock prices. • Future Share Price Analysis: Good because it tells you how much a company might be worth, theoretically, 1-2 years into the future; but bad because of its dependence on assumptions. • Sum of the Parts: Good because it more accurately values diversified, conglomerate-type companies; but bad because often you lack the appropriate data for each division. • Leveraged Buyout (LBO) Analysis: Good because it sets a “floor” on valuation by determining the minimum amount a PE firm could pay to achieve its returns; bad because it gives a relatively low / “floor” number rather than a wide range of values. Remember that interviews have shifted more and more to understanding the concepts as opposed to reciting facts and formulas – so these trade-offs are likely to come up in interview questions. Comparing Expected Values from Different Methodologies There are few rules here because so much depends on assumptions and it’s very difficult to directly compare methodologies. Here’s what we can say: • Precedent Transactions vs. Public Comps: Transactions tend to be higher due to the control premium, i.e. the premium the buyer pays to acquire the seller. But not always, as you saw from the valuation graph above for a real company.
Investment Banking Interview Guide Access the Rest of the Interview Guide 18 / 58 • Discounted Cash Flow: It’s hard to draw conclusions about its value, but tends to be the most variable of the methodologies because of its dependence on future assumptions.
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- Fall '14
- Valuation, ........., Ebitda