Lecture 9. Multiples

Transcription

1 Lecture 9 Multiples

2 Using Multiples in Valuation Value multiples are collected from comparable companies Multiple = Market Price Indicator V = Multiple from comparables x Indicator of company Typical market values: Share Price (P), Equity Value (M) Enterprise Value (EV) Typical indicators: Earnings (E), EITDA, Cash Flow (CF), Sales (S), ook Value of Equity (), Typical multiples: EV/EITDA, EV/EIT, P/E, P/, P/S, P/CF, PEG (P/E to earnings growth) 2

3 Consistency and attention to detail is key in rather simple multiples analysis Every analyst has their own judgements on the multiples, so multiples often differ across sources Use same definitions for the company and its peers If you did not compute the multiples yourself, at least find out how they were computed Things where an analyst needs to make a pick when computing multiples: gross vs. net debt, CFO vs CF, common vs. total equity, unadjusted or adjusted financial statements, undiluted or diluted EPS 3

4 Two different definitions for equity ratio (Equity plus non-controlling interests)/(total assets less advance payments received) (Equity plus depreciation reserve*(1 tax rate))/(total sum of the balance sheet advances received) Source: Company annual reports 4

5 Practical judgements when doing valuation based on multiples Which multiples to use? EV/EITDA, EV/EIT, and P/E most common Always have several multiples with different indicators for a balanced perspective Whih peers to pick? How many peers and multiples? First understand business model, then pick relevant peer selection criteria (product mix/geo mix/size/sales growth/profitability/integrated vs. pure-play etc.), and finally peers Owners and management have an incentive to position the company along with higher-valued peers, such as being a hightech company Preference of relevance over number of peers 3 may be on the short side, more than 12 is definitely too much Adjustments, time-period, and averaging? Leaving out extraordinary items and standardizing accounting practices is good if you have the time Trailing vs. forward multiples, smoothed averages Simple average is biased*, use median *Source: 5

6 Amazon P/E from 213 to 217 Q: why P/E is not shown for parts of the data? Q: how would you use current P/E of 255 in your analysis? *Source: ycharts.com 6

7 Price to Earnings (P/E) Consistency: Price of common stock and Earnings available to common stock (after Minority interest and after Preferred stock) P/E = Price of Common Stock (P) Earnings Per Share (EPS) In EPS, the number of shares refers to outstanding common shares, excluding any potential treasury stocks Q: why treasury stocks are excluded? Common adjustments: Diluted EPS more comparable Non-recurring components can be taken away Differences in accounting practices corrected (e.g., clean surplus applied consistently) 7

8 Common variations to vanilla P/E Industries and companies can be cyclical, have negative earnings, or face transitions, then different versions can be better in finding the true intrinsic value and comparability Low base (earnings barely above zero) can also distort analysis Variations to P/E: Using trailing 12 months, fiscal year, actual or corrected earnings Trailing P/E averaged over several years Leading P/E using analyst consensus earnings forecast for ongoing or next fiscal/calendar year PEG = (P/E)/Growth rate is popular practical investor metric: what is the price of earnings growth? 8

9 Price to ook (P/) Consistency: Price of common stock is related to book value of equity belonging to common shareholders (no preferred stock or Minority interest). P Price of Common Stock (P) ook ValuePer Share (PS) Market Capitalization (MV) ook Valueof Common Equity (VE) In PS the number of shares is the number of outstanding shares belonging to common shareholders (no Treasury stock) Practioner variant: deduct Intangible assets, especially Goodwill, from the book value Academic variant: Tobin s q, where instead of use replacement value of assets In-class assignment: show that P/ = (P/E) x ROE 9

10 Stockmann P/ Q: why is Stockmann P/ so low? Q: what could an arbitrageour do in theory to increase valuation? Source: Kauppalehti.fi, accessed 13/1/217 1

11 11 P/ and fundamentals Valuation results can be communicated as implied P/ as DDM and AEM have analytical connection to P/ For derivation, use: Gordon s formula E 1 = ROE x b = g/roe Plug AEM into P to get: g r g ROE g r g r P e e e ) ( ROE(1- g/roe) ) ( DIV ) (1 ) ( 1 ) (1 ) ( PV r r ROE r r ROE P earnings Abnormal t t e t e t t t e t e t

12 Price to Sales (P/S) P/S is suitable when you have almost no data. On the other hand, the metric has very little information value P/S relates price to Top Line which is positive for most companies P/S = Share Price Net Sales per share Net Sales = Total Sales Customer Discounts Returns Use Gordon s formula and D = E (1-b) to get: Net profit margin Payout ratio Sales growth P S (E / S)(1 b)(1 r g g) In-class assignment: show that P/S = (P/E) x Net profit margin 12

13 Price to Cash Flow (P/CF) P/CF relates Price to Cash Flow which is not dependent on accounting choices, unlike any metric connected to earnings P CF Share Price Cash Flow per Share where Cash Flow is (CFA): CF = EPS + Noncash Charges (Depreciation, Amortization, etc.) per share [simple approximation] Many variants to CF metric, but whatever variant it is, it must be a flow to equity P/FCFE can be connected to fundamentals by P FCFE 1+ g r g e 13

14 Enterprise Value to EITDA (EV/EITDA) Consistency: Enterprise value (Net debt plus equity (Including Preferred stock) ) is related to profit available for both debt and equity (incl. Pref.Stock) holders. EITDA is also an approximation of Cash flow from operations EV EITDA where EnterpriseValue EarningseforeInterest,Taxes, Depreciation and Amortization Enterprise Value * (CFA) = Equity + Net debt = (Market value of common equity + Market value of preferred stock + Minority interest) + (Market value of debt) (Excess cash) If (Excess) Cash = then Enterprise Value = Firm Value 14

15 Implicit assumptions when using key multiple cash-flow based ratios P/S Same size (Sales) Same Same sales margin growth (EITDA/ (g) Sales) Same relative investment requirement (DA/Sales) Same capital structure (r e ) Same business risk (WACC) Same definition of accounting earnings (EPS) P/E EV/EITDA EV/EIT P/CF 15

16 P/E Multiples and key ratios: what explains the valuation of Monster? 25,5 22,3 2,8 59,3 P/S P/ 3,8 2,1 2,3 8,9 6,1 8,8 6,5 15,5 Company Sales growth 1 % -3,2 % Gross margin 61,7 % 55,5 % Operating margin 24 % 15 % Debt to equity 1,47 1,9 3,8 % 58,5 % 19 % 1,19 9,5 % 58,9 % 32 % No debt Source: Yahoo! Finance & Market Realist. June 23,

17 Comparison of key multiples valuation metrics Multiple Strengths Challenges P/E EPS actively followed and forecasted Widely used Direct link to DDM and ROE P/ Can be used even if EPS < ook value is stable Connection to Fama&French, DDM, AEM and P/E P/S Can be used even if EPS < More stable than P/E P/CF CF less subject to manipulation than earnings Not affected by accounting policy differences CF more stable than earnings EPS can be negative or zero making P/E unusable Hard to distinguish Recurring and Nonrecurring earnings Hard to compare internationally ook values do not account for human capital and brands ook values may differ due to strategy Share repurchases distort P/ Not consistent: sales refers to enterprise, share price to equity Profitability not taken into account Revenue recognition practices may distort comparisons EPS + Noncash charges is not right for working capital FCFE can be negative EV/EITDA EITDA is often positive when EPS is negative More consistent than P/E for varying leverages EITDA is less dependent on accounting policies than Net Profit EITDA is not treating working capital properly Different Fixed Capital may distort analysis 17

18 Venture capital method solves for fraction of demanded ownership ased on target return r VC for Venture Capitalist in exit at T. 1. Project how much VC initial investment I VC () should be worth at the end I VC (T). We get I VC (T) = I VC ()(1 + r VC ) T 2. Project what is the EITDA(T) and estimate Enterprise Value EV(T) with multiples = (EV/EITDA) EITDA(T). 3. Calculate Equity Value E(T) = EV(T) Interest-earing Debt + (Excess) Cash 4. Calculate which part k Venture Capitalist has to own of equity to get I VC (T). We have k = I VC (T)/E(T) 5. Now we know E() = I VC ()/k 18

19 VC terminology and example Post-Money Value of Equity = E() Pre-Money Value of Equity = E() I VC () Example. If I VC () = 1, EITDA(T) = 5, EV/EITDA = 5, T = 5, Debt(T) = 34, Cash(T) = 2, r VC = 4% then I VC (T) = 1(1 +.4) 5 = EV(T) = 5 x 5 = 25 E(T) = = 218 k = 537.8/218 =.247 Post-Money Value of Equity = 1/.247 = 44.9 Pre-Money Value of Equity = =