Relative Valuation: Business Valuation Article


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A Business Valuation Article: Relative Valuation uses the valuation ratios of Comparable publicly traded companies and applies that ratios to the comapny being valued subject to necessary adjustments.
Key Issues in Relative Valuations- a) Peer Selection, b) Current Multiples or Forward Multiples, c) Adjustments to the Value...

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Relative Valuation: Business Valuation Article

  1. 1. What is relative Valuation? Disadvantages of Using Relative MultiplesRelative Valuation uses the valuation ratios of Comparable publicly x Simplistic: A multiple has a great deal of information into a singletraded companies and applies that ratio to the company being valued number. By combining many value drivers into a point estimate,subject to necessary adjustments. The valuation ratio typically multiples may make it difficult to disaggregate the effect ofexpresses the valuation as a function of a measure of financial different drivers, such as growth, on value. The danger is that thisperformance or Book Value Multiples (e.g. Revenue, EBITDA, EBIT, encourages simplistic – and possibly erroneous – interpretation.Earnings per Share or Book Value). x Static: A multiple represents a snapshot of where a firm is at aThis technique hinges upon the efficient market theory which indicates point in time, but fails to capture the dynamic and ever-evolvingthat the price of exchanged securities in the market reflects all readily nature of business and competition.available information, as well as the supply and demand effects ofeducated and rational buyers and sellers. In other words, the market is x Difficult to compare: Multiples are primarily used to makecontinuously evaluating each company and expressing that valuation in comparisons of relative value. But comparing multiples alwaysbids and offers for its stock. challenging, because there are so many reasons that multiples can differ, not all of which relate to true differences in value. For Advantages of Using Relative Multiples example, different accounting policies can result in diverging multiples for otherwise identical operating businesses.x Usefulness: Valuation is about judgment, and multiples provide a framework for making value judgments. When used properly, Key Issues in Relative Valuation multiples are robust tools that can provide useful information about x Peer Selection how similar assets are placed in the market. x Current Multiples or Forward Multiples x Adjustments to the Valuex Simplicity: Their very simplicity and ease of calculation makes multiples an appealing and user-friendly method of assessing value. Issue 1 - Peer Selectionx Relevance: Multiples focus on the key statistics that other investors For Relative valuations, identification of appropriate peers is a use. Since investors in aggregate move markets, the most prerequisite. Peers taken should be as close as possible to the commonly used statistics and multiples will have the most impact. company being valued. It is preferred that the peer companies should These factors, and the existence of wide-ranging comparables, have a similar:- help explain the enduring use of multiples by investors despite the rise of other methods. Most Valuation in stock markets are done x Business model, through this method. x Accounting policies, x Growth pattern x Return on Capital Invested x Financial and operational risk. In case peers in the domestic country are not available, then global peers can also be taken but subject to certain adjustments which are discussed in Issue 3.
  2. 2. Therefore, to select the peer group of a company, it is important to Issue 3 - Adjustments to the Valueunderstand the business of the company being valued. Normally thepeer group will be based on companies from the same industry. Valuation derived from relative valuation method is based on a certainSelecting the most appropriate peer group is thus not easy task. multiples like EBITDA/Sales or Profit etc. It does not take into consideration other factors which are not reflected by the earnings Issue 2 - Current or Forward Multiples such as:-Generally to the latest financials of the company a prevailing market x Surplus/Non Operating assetsmultiple of the comparable companies is applied to arrive at the value Surplus Assets/ Non Operating Assets does not reflect itsof the company being valued. However while valuing early stage value in the operating earnings of the company. Therefore thecompanies whose values of financials in future years are considered Fair Market Value of such Assets should be separately addedas they provide a much better picture of the true value potential of the to the Value derived through other valuation methodologies tofirm. arrive at the value of the company. However it is pertinent to mention herein that the InvestorsThe second limb then remains of Multiples of Comparable may not be willing to pay for these surplus/ Non OperatingCompanies. Assets which may call for reorganization of the company.x Current Multiple of Peer Companies – Incase the peer companies x Adjustments for Global peers are mature as on the valuation date, their prevailing valuation If the valuation of a company is based on comparison with the multiple may be applied to the forward stabilized financials of the global peers, then it should be adjusted for some differences company being valued . such as:- This will yield value of the company for the year for which earnings are taken. Therefore this value has to be discounted back to get the x Difference of tax rate in the 2 countries. forward present value of the company. x Difference in Growth & Inflation rate of the 2 countries x Difference between the levels of competition in the 2 (Discounting can be done using the cost of capital of the countries. company or the cost of equity for the time period for which x Difference in the country risk of the 2 companies forward earnings are taken.) x Difference of Accounting Treatment in the 2 companiesx Forward Multiple of peer companies-Forward Multiple of peer Thus there are many changes that are required to be made when companies is applied when the entire Industry is in evolving stage choosing global peers & therefore domestic peers are always and no Comparable Mature company exist on the Valuation date. preferred for relative valuations since they are more comparable. In this case there is no need for discounting. Forward looking Earnings are generally preferred for valuation purposes. Valuation is generally done with a forward looking view and the value of a Our Comments: company depends more upon how much in the future could the company/business earn than how much it has earned till date. A key benefit of Relative Valuation analysis is that the methodology is Therefore Forward Multiples are preferred more than Current based on the current market stock price. The current stock price is Multiples. generally viewed as one of the best valuation metrics because markets are considered somewhat efficient. But applying multiples is not a straight forward technique and many considerations have to be kept in mind when valuing a company. Sanity check is advised by using other valuation methods as well.
  3. 3. Contact us @ An Online Venture of D-28, South Extension –I, New Delhi-110 049 For any clarifications or Professional Valuation Advisory, feel free to contact: Mr. Chander Sawhney Mr. Maneesh Srivastava Asst. Vice President Manager M: +91 9810557353 M: +91 9871026040 Ph: 011-40622252 Ph: 011-40622255 Email: Email: maneesh@indiacp.comFor Free Online Biz Valuation and more Research Based Valuation Information, Please Visit Our Dedicated Valuation Portal @ or mail us @ info@corporatevaluations.inDisclaimer:-All rights reserved. This is a Research based publication, Information in this publication is in summary form and is therefore intended for general guidance only. Itis not intended to be a substitute for detailed research or the exercise of professional judgment. Neither nor any other member of theCorporate Professionals organization accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in thispublication. On any specific matter, reference should be made to the appropriate advisor.Reprinted (or adapted) with permission. Distribution of this material via the internet does not constitute consent to the redistribution of it in any other form or by anyother person or entity. This excerpted article, or any part thereof, may not be reproduced or copied in any form or by any means- graphic, electronic, ormechanical- without the prior written permission of Corporate Professionals.Our Valuation Services: Business Valuation | Investment Valuation | M&A Valuation and Swap Ratio | Fairness Opinions | ESOP Valuation| Tax Valuation | FDI & ODI Valuation | Valuation for Regulatory Reporting | Build/Review Financial Models © 2012, Corporate Professionals. All rights reserved