GROUP 4

Relative Valuation
What is relative valuation models?
A type of business valuation method that analyzes the value of a company to the value of its
competitors or industry peers in order to determine the financial worth of such a company is termed
the Relative Valuation Model. It makes use of multiples, averages, ratios, and benchmarks to
determine a company's worth. It is also used by investors to make informed decisions before buying a
company's stock. This model serves as an alternative to the Absolute Value Model, which without
taking a company's competitors or industry peers into consideration, tries to analyze a company's real
value based on its estimated future cash flows discounted to their present value.

What is the difference between relative valuation models and absolute valuation
models?
In a Relative Valuation Model, a company's peers and competitors are taken into
consideration before analyzing and determining its value. In an Absolute Valuation Model, on the
other hand, no consideration is given to a company's competitors before analyzing and determining
its value. While the absolute model which is expressed as a plain dollar amount gives little detail
about its relative value, the relative model gives more details by taking a multiple analysis approach
which involves; identifying comparable assets, conversion of market values into standardized values
relative to a key statistic and applying the valuation multiple to the key statistic of the asset being
valued.

How does it help companies/investors to make a better decision

Relative valuation is a much quicker process and certainly helps when as an investor you
want to screen and shortlist the stocks for building the consideration set of potential investments OR
for finding if an existing investment of yours is over-valued compared to its peers and should be sold
off.

Advantage and Disadvantages of Relative Valuation Models

Using comparable is easy, but it can lead to misuse and manipulation. Especially when we are
comparing one company to another or a group of others. The bias we have towards different
companies or sectors can lead to subjective choices, and what you consider comparable to others
might not, which leads to comparison errors as these assumptions about what you consider
comparable are often unsaid.

Another issue with using multiples for valuation is it builds in errors that the market might be
making in valuing any of the comparable companies. For example, if the market has overvalued all
computer software companies, then using the average or median PE ratio of these companies will
lead to us overvaluing the company.

The pros of using relative valuation are that it is quick, easy to use, and gives you a great
starting point to determine if you want to continue by digging in finding an intrinsic value of the
company. As with any valuation technique, there are benefits and issues, but our job is to understand
those issues and consistently deal with them.

References:
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model-definition
2 types of Relative Valuation Models
What is Comparable Company Analysis
Comparable company analysis, or called as “Comps”, is a valuation methodology
that looks at ratios of similar public companies and uses them to derive the value of another
business. This analysis operates under the assumption that similar companies will have
similar valuation multiples, such as EV/EBITDA. Analysts compile a list of available statistics
for the companies being reviewed and calculate the valuation multiples in order to compare
them. Comps is commonly used in many cases such as when the company cannot be valued
with another method if it is to be used in the terminal value assumption or to use the data to
compare businesses.
With comparable company analysis, firm size financial ratio (relative to the
industry), historical profitability, operational ratios and valuation multiples are usually taken
into consideration. In order to conduct a comparable company analysis, a group is assembled
that consists of comparable companies which is commonly called as “peer group.” The peer
group is critical to the usefulness of an analysis. The analysis will often use trailing
performance metrics and future performance metrics.

Advantages of using Comparable Company Analysis (CCA):

1. It is relatively easy to perform, and the data for them is usually relatively widely available.
2. It is easier to communicate across a variety of market participants.
3. Comps provides a reasonable valuation range unlike other valuation methods such as DCF which
are dependent upon an entire array of assumptions.
4. It provides a useful way to assess market assumptions of fundamental characteristics baked into
valuations.
5. It makes it easier to determine a benchmark value based on the multiples used in the firm
valuation.

Disadvantages of using Comparable Company Analysis (CCA):

1. It may not provide accurate results when there are a few comparable companies.
2. It can be difficult to find appropriate comparable companies for various reasons.
3. It is influenced by temporary market conditions or non-fundamental factors.

Example:
Markus is a financial analyst. He is asked to perform a comparable company analysis of six
manufacturing companies. Markus creates an Excel spreadsheet, and he uses the following inputs to
calculate the following multiples:
Multiples:

Markus finds that the six companies have an average:

 EV/Sales 3.98, and companies C, E and F are above average, whereas companies A, B, and D
are below average.
 EV/EBITDA 6.17, and companies C, D, and F are above average, whereas companies A, B, and
E are below average.
 P/E 6.01, and companies C, D, and F are above average, whereas companies A, B, and E are
below average.
 P/BV 2.04 and companies D and F are above average, whereas companies A, B, C, and E are
below average,
 P/CF 3.68 and companies C, D, and F are above average, whereas companies A, B, and E are
below average.
He has also calculated the minimum and the maximum values for each multiple to
determine, which companies have the highest values, and which companies have the lowest values.

References:
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What is Precedent Transactions Analysis

Precedent transaction analysis is a valuation method in which the historical
transactions price paid for similar companies is considered an indicator of a company’s value.
Precedent transaction analysis also creates an estimate of what a share of stock would be
worth in the case of an acquisition.

Advantages
- This method help provide a general assessment of the market’s demand for a particular asset and an
approximate valuation of the asset.
-assists in figuring out the premiums and multiples payable in a particular industry.
Disadvantages
- Although it benefits from using publicly available information, the amount and quality of the
information relating to transactions can sometimes be limited. This can make drawing conclusions
difficult.
-Buyers cannot emulate the market conditions, which prevailed in the past. Thus, any valuation
derived from past transactions is not always as accurate because conditions in the market may have
changed drastically since then.

Example:
Maybe you find a set of 10 similar, recent transactions in the industry of the company you’re valuing.

The acquirers in these transactions paid TEV / Revenue multiples between 2x and 3x and TEV / EBITDA
multiples between 8x and 14x.

Since your company has Revenue of $1,000 and EBITDA of $200, its implied Enterprise Value based on
Precedent Transactions is:

Implied Value from Revenue Multiples: $2,000 – $3,000

Implied Value from EBITDA Multiple: $1,600 – $2,800
Since the company’s Enterprise Value is currently $2,500, which is right in the middle of these ranges,
we’d say it’s “appropriately valued.”

References:
[Link]
%20transaction%20analysis%20is%20a,the%20case%20of%20an%20acquisition.

Difference Between Intrinsic Value

and Relative Valuation Models
Intrinsic and relative values can both assist investors in determining a firm's current
market value and determining if the company is under-or over-valued, two important
methods for assigning a monetary value to a business. Intrinsic valuation is one of the types
of intrinsic business valuation models, and some investors might be familiar with this since it
is a method for determining the intrinsic value of a company. While relative valuation
considers a variety of multiples, a DCF model discounts a company's future free cash flow
projections, which is accomplished through the use of a necessary annual fee. Finally, an
analyst will arrive at a present value estimate, which can be utilized to assess the investment
opportunity. If the DCF value is greater than the investment's cost, the opportunity may be
worthwhile.

In intrinsic valuation, you evaluate a company based on future cash flows, while
relative valuation bases it on how similar companies are priced. Additionally, in intrinsic
valuation, you estimate the expected cash flows for each asset or asset class, discount them
back at a risk-adjusted discount rate, and arrive at an intrinsic value for each asset. For
relative values, look for similar assets that have sold in the recent past and estimate a value
for each asset in the business. You can use either relative or intrinsic valuation to value a
company in pieces. Whichever one you use will be determined by your identity and the
reason for performing the sum of the parts valuation. If you are a long-term, passive
investor, you may be looking for market missteps that will be addressed over time. If so, you
should intrinsically value each item. But if you are an activist investor looking to buy or
modify the company, you should focus on relative valuation since you want the company to
split up and gain value.
Example
 Assume that Company ABC's stock is now trading at $20 per share. The company
recently introduced a new product line, redesigned its packaging, and hired several new
managers from a competitor. Even though these modifications may not appear on the
financial statements of the company, they may increase Company ABC's competitive edge in
important areas. As a result, investors may evaluate the stock's intrinsic value at $50 per
share, or $30 more than its present price.

At each point in time, there is no single intrinsic value for a stock; they fluctuate
according to investor. The needed margin of safety of an investor, which is a risk metric equal
to the amount by which a stock's price is below its intrinsic value, dictates the stock price the
investor finds appealing. If the investor's needed margin of safety is 70%, the investor would
consider purchasing the stock only if it traded at or below $15.

References:
[Link]

What is EV
Enterprise value is the measure of the total value of a company. It is metric used
to measure the value of a company for a takeover. This is also used as more
comprehensive alternative to equity market capitalization.

Computation for Enterprise Value

EV=MC+Total Debt-C

>Where MC is the Market Capitalization which is equal current stock price multiplied by the
number of outstanding shares;
>Total Debt which is equal to the sum of short and long term debt;
>and C or Cash and cash equivalent which are liquid assets of the company

How does EV help investors?

Enterprise Value provides as more accurate takeover valuations as it includes
the company’s debt in calculation. With this, it helps investors to decide if the company
is to be bought or not.

Advantages and Disadvantages of EV

The advantage of Enterprise value is, it is more reliable and accurate source for
investors. While a disadvantage of this is companies with large amount of debts will be
affected as those debt will be used to skew them even though the debt will be used to
foster growth.

References:
[Link]
%20value%20(EV)%20is%20a%20measure%20of%20a%20company's%20total,on%20the
%20company's%20balance%20sheet.
What is EBITDA
Earnings before interest, taxes, depreciation, and amortization or EBITDA for short is
a financial metric that is used to measure a business's performance prior to the impact of
financing decisions. It approximates a business's operating results on a cash flow basis. For
each of these reasons, it is one of the most preferred methods for examining an entity's
results. When evaluating profitability using EBITDA, items such as debt financing and
depreciation and amortization (D&A) charges are excluded.

COMPUTATION
EBITDA is computed as follows:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

or
EBITDA = Operating Profit + Depreciation + Amortization

After computing the EBITDA, its margin can be derived from this formula - EBITDA/ TOTAL REVENUE

How does EBITDA help investors

Since EBITDA reflects a company's financial performance and determines its
business value, that leaves a better figure of operational profitability which can help
investors to effectively compared it to other company's EBITDA, and make a rational decision
in investing.

Advantages and Disadvantages of EBITDA

EBITDA has been desensitized as a language that most companies are familiar with
which can help in effectively comparing business valuation; it also provides an accurate
illustration of a firm's performance since it eliminates elements like interest rates, tax rates,
depreciation and amortization; lastly, enables investors to fully focus on a company’s
baseline profitability. Meanwhile, since EBITDA ignores capital expenditure, it may allow
companies to bypass problems in their statements and can hide some risks in company's
performance.

Advantages
•Somehow, EBITDA is similar to P/E RATIO but the advantage is that it is Neutral to Capital Structure,
unlike to Price-Earning Ratio.
•EBITDA demonstrates how effectively continuous businesses generate cash flow. Additionally, it
indicates the cash flow's value.
•It can demonstrate to potential investors whether the company is a viable leveraged buyout
prospect. EBITDA can paint a picture of overall growth. This can demonstrate how effectively the
business concept is operating.
•When a business is acquired, the debt is not passed to the purchaser. As a result, a buyer will be
unconcerned about the business's financing at the time of sale.

Disadvantages
•Depreciation is not included in EBITDA (it is brought back for calculation reasons) and might cause
distortions for businesses with a high level of fixed assets.
•Using EBITDA may preclude you from obtaining a loan for your firm. Loans are estimated based on
the actual financial performance of a business.
•Fails to account for a variety of costs
•EBITDA disregards or conceals high-interest financial obligations.
• It does not reflect the true value of a company’s liquid assets or real income.

Example
JKL Ltd. is looking to acquire a subsidiary. They are looking at two possible companies to purchase, but
they want to review both of the companies' EBITDA information before making a decision. JKL Ltd. is
interested in a company that has healthy operations and profit. They are prepared to take on some
debt and inherit depreciating assets in exchange for a profitable business.
Company A has shared its income statement with JKL Ltd. in order to determine EBITDA:
• Net income: $1,572,000
• Interest expenses: $35,000
• Taxes: $10,900
• Depreciation: $100,000
• Amortization: $57,600

Using NET INCOME FORMULA:

EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization
=$1,572,000+$10,900+$35,000+$100,000+$57,600
• EBITDA = $1,775,500
Company B has also shared its income statement with JKL Ltd. in order to determine EBITDA:
• Net income: $1,034,000
• Interest expenses: $98,000
• Taxes: $14,000
• Depreciation: $200,000
• Amortization: $100,900
Using NET INCOME FORMULA:
• EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization
=$1,034,000+$14,000+$98,000+200,000+100,900
• EBITDA = $1,446,900

JKL Ltd. decides to buy Company A based on this information. It earns more money and has a greater
EBITDA than Company B. This means JKL Ltd. will spend less money repaying Company A's debts than
Company B's, resulting in a more profitable subsidiary.

SOURCES:
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What is EV/EBITDA
EV/EBITDA is used as a valuation metric to compare the relative value of different businesses.
It is a ratio that compares a company's Enterprise Value (EV) to its Earnings Before Interests, Taxes,
Depreciation, and Amortization (EBITDA).
Advantages:
- with publicly available information, it is easy to calculate
- widely used and referenced in the financial community
- works well for valuing stable, mature businesses with low capital expenditures
- it is good for comparing relative values of different businesses

Disadvantages:
- it may not be a good proxy for cash flow
- does not take into account capital expenditures
- hard to adjust for different growth rates
- hard to justify observed "premiums" and "discounts"
HOW TO COMPUTE
STEPS TO CALCULATE EV/EBITDA OF A COMPANY:
1. Pick an industry (i.e. the beverage industry, as in our example)
2. Find 5-10 companies that you believe are similar enough to compare
3. Research each company and narrow your list by eliminating any companies that are too different to
be comparable (i.e. too big/small, different product mix, different geographic focus, etc.)
4. Gather 3 years of historical financial information for each company (i.e. revenue, gross profit,
EBITDA, and EPS)
5. Gather current market data for each company (i.e. share price, number of shares outstanding, and
net debt)
6. Calculate the current EV for each company (i.e. market capitalization plus net debt)
7. Divide EV by EBITDA for each of the historical years of financial data you gathered
8. Compare the EV/EBITDA multiples for each of the companies
9. Determine why companies have a premium or discounted EV/EBITDA ratio
10. Make a conclusion about what EV/EBITDA multiple is appropriate for the company you’re trying to
value

References:
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[Link]

Searched by:
Leader:
Velasquez, Giddel Ann Kristine E.
Members:
Rochelle Agbay
Hermma Camu
Cijay Castro
Marichelle Garcia
Margelyn Librodo
Lovely De Salas
Jamie Santos