In Relative Valuation, Companies are valued on the basis of how similar or comparable companies and assets are priced in the market place. You employ a series of financial ratios in order to figure out the value. The most popular ratio used in called as the Price Earning Ratio

1. Valuation Methods
Relative Valuation approach

2. strategyrev.com
Recapitulating the Valuation methods
 Asset based method
 Income based approach
 Market based
approach
When you employ the Asset based technique of
valuation, it essentially throws up the following 2
potential values for a specific Company
1. Book Value
2. Adjusted Net Asset Value
https://www.youtube.com/watch?v=fesDRsJ6hHU

3. strategyrev.com
Definition(s) in the asset based approach of valuation
 Relative valuation is a method that compares a Company’s value to that of its nearest
competitors and peers from the industry to assess the financial worth of the Company
 How does it work? – it employs various financial ratios to calculate the value of the
Company (based on the value of other companies that are comparable)
 Comparable means – similar size, similar products, operating framework, risk and returns
 Other important factors
The ratios used for relative valuation also helps us understand if the stock is “over valued” or “under valued”
While there are various ratios in the “relative valuation” method, the one that is most popularly used is called
as the PRICE EARNINGS RATIO

4. strategyrev.com
Examples of Comparable Firms / Companies

5. strategyrev.com
Price Earning Ratio
 PE ratio = Market price of a share / Earnings per share
Lets assume that there is a publicly traded Company X and this Company has an Earnings per
share of $1 and has a market price of $ 12 then the price earning ratio is 12 i.e. 12 / 1 = 12
How do you interpret PE ratio
What PE essentially means is that for $ 1 earning of the Company the market is willing to pay $12
for the share / stock of this Company..
You need to look at the PE ratios for similar companies and see if the PE for X is higher /lower
than industry average
If it is then we can say that the stock is over valued since its earnings are less and the stock is
over priced and vice versa

6. strategyrev.com
How do you value a Company use PE multiples
 Step 1 – look for 4~5 Companies that are comparable to the firm that you
intend to value and get their PE ratios
 Step 2 – Calculate the average / median PE for these Companies
 Step 3 – Lets assume that the avg PE multiple for these companies is 13.5
 Step 4 – Get the Earnings per share for the Company that you wish to
value; assume that it is 2.5
 Step 5 – multiple 13.5 X 2.5 (Value of the Stock of the Company)
VALUE OF THE COMPANY = VALUE OF ITS SHARE

7. strategyrev.com
Why use PE ratio for valuation
 Simple method – DCF and others require complex calculation and
forecasting of income and cash flows
 Drawback – since we are using market multiples, we have to assume that
the market prices are fair and correct and there is no bias