Relative_or_Comparable_Valuation

7/30/2019 Relative_or_Comparable_Valuation

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> Concept, Pros & Cons

> Process of Valuation

> LTM & Calendarization

> Adjustments to Financials

> Calculating Diluted Shares

> Concept of Enterprise Value

> Equity Multiples

> Enterprise Multiples

> Benchmarking

> Fair Value Range

> Common Pitfalls

> Snapshots

> Interview Questions

> Recommended Reading

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2/21

> In the real world it is vdifficult to find compcompanies

> Myopic - Focus on qu

results rather than th> Fair Value based on p

comparison may implexuberance will alwaybiased valuations irreIntrinsic value

> Many Analysts use Cothe down cycle while in the upturn. IndicatiComps are likely to unstocks when fundamethe up cycle and vice-

Comparables / Relative Valuation / Trading Comparables / Comps / CompCo is a method of valuing companies undValue is derived based on a comparison of Multiples within a set of peers under current market conditions.

> Captures Market Sentiment> Works best in the short run

(between quarterly results)> Quick & easier to apply & explain

than fundamental approacheslike DCF> More relevant when

inflow/outflow of funds changesor is expected to changesignificantly

> Very popular among InvestmentBanks, Brokerage houses &Mutual Funds. Implying that thisis one of the ways in which themajority decide fair value (forthe short run)

The Classic Question:Is a low P/E better or a high one?

Most would say the former! However, that

may not always be correct.

The answer lies in a Comparable Analysis

which helps figure out whether the higherP/E stock is overvalued or valued highly as

a result of superior expected performance!

Among other things, a Comparable Analysis

aims to determine fair value based on

current & expected fundamental performance,

Intangibles like quality of management,

brand value, market share and track record

in terms of TRS Total Return to

Shareholders. Stocks trading at a higher

multiple usually tick mark one or more ofthe above conditions

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3/21

The process of Comparable Valuation is fairly uncomplicated. It is a mix of both art & science. The Science lies incalculations and determining which company should command a higher value while determining fair value is an a

Identifying the ComparableUniverseThe Industry or Sector maynot be comparable as a

result of different products& markets implying differentfundamental performanceand hence differentvaluation. It is for this reasonthat one must look at theSub-Sector.E.g. Industry > MetalsSector >AlloysSub Sector > Non FerrousAlloys

Spreading CompsMaking calculations> Margins & Ratios> Last Twelve months

> Fully Diluted shares> Enterprise Value> 3yr CAGR sales & PATEquity Multiples> P/E, PEG, P/B, P/FCFEEnterprise Multiples> EV/Sales, EV/EBITDA,

EV/EBIT, EV/FCFFSector Specific Multiples> EV/EBITDAR, EV/Ton,

EV/Subscriber, EV/Plane,EV/Employee, EV/branch

BenchmarkingCompanies with SimilarSales, Market cap, Marginsand other Performance

Metrics must be indentifiedto determine closestcomparable companies andthus benchmark themagainst the company inquestion

Determining Fair VBenchmarking wouarrive at a range ofmultiples. Average

Multiples of such cwould help determfair value of the coquestion while HigLowest Multiples wto determine a rang

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4/21

A.k.a. Trailing Twelve Months (TTM) sometimes also referredto as Latest Twelve Months.LTM Data1 is simply calculated for the purpose of using thelatest available data as the Data from annual fiscal resultscould be one or more quarter older.The calculation is very simple and involves extracting latest

available Annual results along with latest & correspondingprevious years 9 months resultsAnnual Sales as on 31-Mar-09 >> Rs.1,200CrsLast 9 months ended 31-Dec-09 >> Rs.1,000CrsPrevious 9 months ended 31-Dec-08 >> Rs.800CrsLTM = 1200 + 1000 800 = Rs.1,400Crs

Note: 1This holds true for Income Statement items only.

Balance Sheet Data is cumulative and hence LTM will give

flawed results. Secondly, In India, B/S & C/F are not

made available quarterly!

Company results are always reported as per Fiscal yended as decided by the management. In India, it is31-Mar. A Calendar year CY (Jan-Dec) is way of re-companies that have different fiscal years. The procalled Calendarization.

The issue starts with Financial Projections itself w

made on FY basis so as to make it comparable to wcompany will report in future. The only way to makcomparable to other companies that have differenYears is to calendarize (restate in Jan-Dec terms) adquarterly results and subtract corresponding quartLTM. However, in case of Annual Forecasts one mato proportionally alter it.

E.g. If Company A has a FY of 31-Mar.

Sales for FY 2009 are Rs.1,200Crs while that ofFY 2010E are Rs.1400Crs

CY2010E Sales = (3/12*1200) + (9/12*1500)

= Rs.1350Crs (Sales from Jan-Dec 2010)

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5/21

Company reported formats are not consistent acrosscompanies and hence may create distortions when makingcomparisons. Secondly, items which cannot be forecastedwith reasonable accuracy must be excluded. Such items arenon-operational and usually non-recurring in nature.

When calculating multiples it is essential to captureoperational/sustainable performance only. This is becausevalue cannot be consistently created through non-operationalmeans. Companies that have higher non-operationalgains/losses will have a greater risk resulting in a higher andunstable beta. This will increase the Cost of Equity therebyincreasing the speed of the treadmill and making ValueCreation through beating market expectations more difficult!

Note: These adjustments pertain to fundamentals alone. Inthe real world analysts often make adjustments to the

multiples as well. Such arbitrary assumptions are

specific to every analyst resulting from their expertise

& experience!

Although one may have to make more adjustmentsthe ones mentioned, below are a few general guide

> Extraordinary Gains/Losses/write ups/write doSuch items are non-recurring in nature and typicarelated to Foreign Exchange, one time write ups/

losses due to strikes/lock-outs etc. Such losses madded back and a reverse treatment of such gainbe made

> Accounting anomalies1

Inventory adjustments LIFO to FIFODeferred taxes The most popular accountingshenanigan used by companies to smoothen incLeases A capital cost and hence should be exclufrom EBIT to reflect true Operational or Asset Eff

Capitalizing vs Expensing This can have a signifiimpact on earnings and hence distort related mu

1Discussed in C

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6/21

Many companies provide ESOPs to employees as a non-cashincentive. Such options when executed threaten to diluteEarnings as More no. of shares chase Earnings. As an analyst youare required to calculate the maximum damage to existingshareholders through such conversions.The Treasury Stock Method assumes that proceeds from all In-The-Money (ITM) options shall be used to buyback shares in abid to minimize dilution!

Step 1 Extract No. of Outstanding shares from Annual

Report (or latest quarterly result)

Step 2 Extract No. of Exercisable options in each Tranche

from latest Annual report

Step 3 Calculate No. of options In-The-Money i.e.

options which have an strike price lower than CMP

Step 4 Calculate No. of shares that can be bought back as

a result of the exercised options (i.e. Treasury Shares)Step 5 Add Exercised options & subtract Treasury stock to

derive Fully Diluted shares

CMP INR 345

No. of

Options

(in Lacs)

Weighted

Avg. Strike

Price

ITM

Options

(in lacs)

Proceeds

from

Conversion

4,325 INR 238 4,325 1,029,350

6,236 INR 267 6,236 1,665,0128,793 INR 290 8,793 2,549,970

2,465 INR 356 0 0

8,576 INR 390 0 0

No. of Shares 19,354

O/S Shares

Add ITM Options

Less Treasury Stock

Fully Diluted Shares

1,

1,

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7/21

ST& LT

Debt

Other Non

Equity Claims

Market Value

of Equity

Minority

InterestLe

Excess

Enter

Val

A.k.a. Total Enterprise Value (TEV) or Firm Value (FV)Suppose you were to buy a Company which hadDebt worth Rs.1,000Crs, Cash of Rs.500Crs & Market Value of equity asRs.4,500Crs. What would you pay for it?The Answer >> Rs.5,000Crs (= 4,500 + 1,000 500)How?? Say, you just paid for the Equity, what about the debt that you assume(become liable to pay)? So it must be added. While cash can be used to paydown debt and is hence subtracted!Enterprise Value represents the Value of the company (and not just theEquity!). It is a metric used to determine the value payable for buying theentire firm.

Calculation = MV of Equity + Debt + Other Non Equity Claims Excess

Cash & Cash Equivalents

or MV of Equity + Net Debt

Where Net Debt = Debt + Other Non Equity Claims Excess Cash & Cash

Equivalents

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8/21

The guiding principle for calculating a multiple is that theNumerator and Denominator must be consistent i.e. if theNumerator represents Value paid by Equity the denominatormust reflect a fundamental/financial item available to Equity.Equity Multiples measure value available to Equity Shareholdersalone.The Numerator of course, is Current Market Price or MarketCapitalization. For the Denominator, starting from the top of theIncome Statement the only item available to Equity is PAT(and PBT if there are no preference dividends)

Equity Multiples (more specifically the P/E multiple) are

more popular on the street while bankers usually prefer

Enterprise Multiples as they reflect performance of the

entire firm at an operating level.

Other things being equal a Lower Multiple indicates a cheaperstock!

> P/E or PER (Variant | CPE = P/CEPS)Calculated as CMP/Diluted EPS. It is a poor mEPS can be easily masked through Incomesmoothing1 measures while Sales, EBITDA &still tougher to manipulate! Secondly, P/E doreflect the effect of leverage.

> M/B or P/B or (Variant P/ABV = P/AdjustedCalculate as Diluted Market Capitalization/Bvalue. Where Book Value = Share Capital + RP/B is more stable as compared to P/E and hpreferred metric for the BFSI sector

> PEG or PE/EG (Price to Earnings/Earnings Calculated as PE/Expected Earnings Growth CAGR). As a substitute one may also use histearnings growth.

> P/FCFECalculated as Diluted Market Capitalization/Flows to Equity . Price paid for sustainable ca

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9/21

Enterprise Multiples measure value available to the wholeEnterpriseThe Numerator is the Enterprise Value as calculated beforewhile the Denominator can only include Sales, Gross Profit,EBITDA and EBIT. If one went further down and included itemslike PBT or PAT it would go against the principle of consistency asdiscussed in the previous slide!Items like Interest or preference dividend are not payable by theentire firm but are cost of providing capital that are to be borneby Equity Claimholders.

Bottom-Line: Enterprise value is Capital Neutral i.e. It

measures efficiency of the Assets deployed rather than a

particular type of capital and so the denominator must also

be Capital Neutral!

Other things being equal a Lower Multiple indicates a cheapercompany!

> EV/SalesThe metric is used for companies that have ybreak even or have faced an unexpected losoperational earnings

> EV/EBITDAThe most commonly used multiple by bankemetric captures operational efficiency of the

> EV/EBITAlthough bankers say that EBIT creates noisforming a fair picture as depreciation may baffected by accounting methods. We still bein Capital intensive sectors like Cement the mmakes more sense than EV/EBITDA as EV/EBcaptures asset efficiency as well!

> Sector Specific Multiples

EV/Ton, EV/EBITDAR, EV/Subscriber, EV/SqftEV/Store, EV/Employee, EV/Plane, EV/branch

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10/21

Benchmarking is the process of comparing companies in thepeer set with the target company. It involves comparingfinancial & market performance along with other relevantnumbers. Benchmarking is part Art part Science. The Science liesin correct calculations while forming a story about thecompanys current and expected performance is Art! A bankersjob is to sell a company more than what it is worth and there liesthe art The Story!

The First step of course is to filter the data into

Tiers/Classes of similar Sales For e.g. Bracket 1

>Rs.10,000Crs , Bracket 2 Rs.5,000-10,000Crs, Bracket 3

Rs.1,000-5,000Crs etc.

The Second step involves a complete performance comparison

to extract companies that are similar to the Target

The Third Step involves excluding outliers on the basis of

performance or extreme Multiples

> Sales, EBITDA & PAT growthHigher numbers indicate superior scaling ucapabilities, competitive advantages andmanagement quality or leveraging parent ccontacts to secure orders

>MarginsHigher Margins indicate competitive advanterms of brand value, geographical advant

>ROE, ROCE, Debt Ratio & ATOReflect profitability & Efficiency of the FirmEquity. A higher ROE with a low ROCE indicgood use of leverage

>Promoter HoldingA higher number indicates promoter confidin turn leads to greater investor confidence

in a higher multiple. A very low number on hand may have a higher multiple too as a respeculation of a takeover!

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Step 1 Calculate Average Multiple of closest comparables

Step 2 Multiply the figure thus arrived at to the

appropriate financial metric (for LTM or Forward basis)

E.g. Average EV/EBITDA of comparable companies is 4.5x this

will be multiplied by the Targets LTM EBITDA of say

Rs.1,500 to arrive at an implied LTM EV of Rs.6,000Crs

Suppose the Target has a Net Debt of Rs.3500Crs and 50Cr

Diluted Shares it implies a per Share Value Rs.125=((6,000-3,500)/50). The Same may also be done on a forward

basis using Consensus Estimate where the above metrics

can be taken as an average of Analyst estimates.

To Calculate Forward Multiples one simply needs to divide

the CMP or EV by the appropriate Forward metric.

E.g. Calculating Forward P/E

CMP Rs.500, Forward earnings in year1E >> 50, year2E >> 75

(where E indicates Estimated). The Forward P/E in Year1E& Year2E is 10x(=500/50) & 6.67x(=500/75) respectively.

> The benchmarking process leaves only the closely comparable companies. Now, the ausually takes an average of multiples and udetermine the Fair Value of the Target. Theof setting a range is usually taken as Low &multiples of the closest comparable group.But what if one of the companies has a fairmultiple than the others?

> In such a case one may take an average of tand add & subtract an arbitrary number to range of value. Or simple exclude the comphas a starkly different multiple!

For e.g. IF Min and Max of the closest co

group is 7.5x & 12.5x the Fair range for

Target company is the same 7.5x-12.5x. Ho

the analyst perceives this to be very widchoose to calculate an average i.e. 10x

(=(7.5+12.5)/2). Now to derive a range he

add & subtract 0.5x from it i.e. Range =

10.5x !

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12/21

One can very easily go wrong with Multiples because of theirdeceptively simple way of Calculation/Application.Below are a few commonly made errors.

> Treatment of Non Recurring Items

One needs to make adjustments to EPS by adjusting for

non-recurring items as they do not reflect sustainable

income. As a rule of thumb any item that cannot beforecasted with reasonable accuracy must be adjusted

for. Such adjustments will usually make the stock more

expensive i.e. will result in a higher multiple!

> Incorrect EV calculation

EV represents the Value of the entire Enterprise and

hence one should include debt and non equity claims of

all kind e.g. Preference shares, Convertible Debt/FCCBs,

& Deferred tax liability

> Incorrect Analysis

A higher multiple may be a result of rumors (i.e.speculation) rather than fundamental performance. The

analyst must try to identify why particular stocks trade

at substantial premiums or discounts through regular

scanning of news pieces and research reports

> Sales, EBITDA & EBIT are more stableAlthough Window Dressing is a common pis more pronounced in EPS rather than itemavailable for the Enterprise!

> Capital Neutral & Reflect Operational EffEV multiples reflect operational performanchence can be used to compare firms with dCapital Structures.

>Reflect Selling price of the FirmEquity value can be very misleading for a baM&As are not about buying stocks but abocompanies. Equity Analysts primarily focus next Qtr EPS number. Whereas for bankersmakers) and Credit Analysts quality of earnlong term sustainable profitability is more i

>What if a company is loss making?If a company is loss making all Equity multipprove useless! Thats when one may use theor EV/EBITDA multiple to judge fair value.

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13/21

all figures in Rs. Crores all fig

Company Name Sales

Other

Operating

Income

Total

Operational

Revenues EBITDA D&A EBIT

Reported

PAT

Other

Income

Extra-

ordinary

Items

Adj.s

to PAT Adj. PAT

Market

Cap

Net

Debt STD LTD

Minority

Interest

Pref

Capital

Con-

vertible

Debt C

ACC 8,421 173 8,594 2,571 342 2,229 1,546 106 - 106 1,440 17,270 (166) 368 450 - - - 9

Grasim 19,653 - 19,653 5,895 962 4,933 2,809 255 - 255 2,554 23,161 4,146 864 3,395 - - - 1

Gujarat Ambuja 6,926 109 7,035 1,928 282 1,646 1,226 150 - 150 1,076 20,713 (229) 486 166 - - - 8

India Cements 3,694 34 3,728 963 225 738 410 3 - 3 407 4,025 2,177 274 1,988 - - -

Dalmia Cement 2,114 25 2,139 602 128 474 179 (26) - (26) 205 2,040 2,512 229 2,338 - - -

Ultratech Cement 7,001 66 7,066 2,169 379 1,790 1,174 58 - 58 1,116 13,726 2,760 723 2,142 - - - 1Shree Cement 3,493 16 3,509 1,515 347 1,169 983 60 (45) 15 968 7,684 1,024 - 1,496 - - - 4

Madras Cement 2,865 11 2,876 1,305 182 1,123 398 8 - 8 390 2,966 2,915 490 2,463 - - -

JK Cements 1,742 - 1,742 481 68 412 242 3 - 3 239 1,342 540 101 564 - - - 1

JK Lakshmi Cements 1,414 - 1,414 335 73 262 228 12 - 12 216 919 411 35 703 - - - 3

EV calculationLTM ended 8th-Apr-10

Note: The data above is an illustration only!

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14/21

Note: The output sheet must also include Forward multiples based on Consensus Estimates as discussed in Slide 9.

www.finaticsoComparable Valuation | Output Sheet

Promoter

Stake

Company CMP52 week

Low

52 week

High

Diluted Shares

(in crores)

Capacity

(in Crore

tons per

annum)

Sales PAT 31-Mar-09 EBITDA EBITAdj.

PATEV/Sales EV/EBITDA EV/EBIT EV/Ton P/E A

ACC 920.05 365.00 903.60 18.771 2.263 8% -4% 46.21% 30% 26% 17% 2.0x 6.7x 7.7x $168 11.2x

Grasim 2,834.50 872.00 2,938.00 8.171 4.880 18% 24% 25.50% 30% 25% 13% 1.4x 4.6x 5.5x $124 8.2x

Guja ra t Ambuja 135.35 56.00 357.00 153.030 2.200 18% 3% 46.00% 27% 23% 15% 2.9x 10.6x 12.4x $207 16.9x

Indi a Cements 138.90 45.00 298.00 28.981 1.295 9% -3% 27.37% 26% 20% 11% 1.7x 6.4x 8.4x $106 9.8x

Da lmi a Ceme nt 252.00 67.20 219.85 8.094 0.900 45% 18% 56.60% 28% 22% 10% 2.1x 7.6x 9.6x $112 11.4x

Ultra te ch Ce ment 1,104.05 678.00 1,346.00 12.432 2.190 25% 63% 54.78% 31% 25% 16% 2.3x 7.6x 9.2x $167 11.7x

Shree Cement 2,205.55 320.00 1,790.00 3.484 0.683 59% 216% 65.56% 43% 33% 28% 2.5x 5.7x 7.5x $284 7.8x

Ma dra s Ce me nt 124.65 55.25 128.70 23.797 1.100 35% 66% 42.00% 45% 39% 14% 2.0x 4.5x 5.2x $119 7.5x

JK Cements 191.85 31.25 141.35 6.993 0.750 20% 63% 69.78% 28% 24% 14% 1.1x 3.9x 4.6x $56 5.5x

JK Lakshmi Cements 75.75 31.00 149.20 12.137 0.475 28% 48% 44.48% 24% 19% 15% 0.9x 4.0x 5.1x $62 4.0x

Median - - - - - 22% 36% 46.11% 29% 24% 15% 2.0x 6.1x 7.6x $122 9.0x

Average - - - - - 27% 49% 47.83% 31% 26% 15% 1.9x 6.2x 7.5x $141 9.4x

Max - - - - - 59% 216% 69.78% 45% 39% 28% 2.9x 10.6x 12.4x $284 16.9x

Min - - - - - 8% -4% 25.50% 24% 19% 10% 0.9x 3.9x 4.6x $56 4.0x

LTM ELTM Margins LTM Enterprise Multiples3 yr CAGR

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15/21

Is Comparable valuationbetter than DCF ?

In most cases DCF & Comps are complimentary i.e. one provides a sanity check to the otHowever, in times of conflict it is better to rely on DCF. This is because Comps do not atarrive at Intrinsic value, implying that the market could easily stretch valuations based This is because one cannot substantiate whether Infosys is correctly trading at an Earninof 35x unless one can test it through at least one or more methods that Value a companits Fundamentals. DCF ties Stock Value to fundamentals whereas Comps are driven by S& Consensus Estimates! This also implies that when more money chases few stocks theyprimarily by demand-supply gap rather than fundamentals ! In such times the broader mon Comps rather than DCF.

Which approach has morelongetivity ?

DCF Value is driven by Fundamental performance which does not change drastically betquarters. However, Multiples change every second indicating a very short life. Hence, Cobetter suited between quarters while DCF should be relied upon for a longer horizon sa

How does one forecastShare Price with Comps ?

Typically Average of LTM multiples of closest comparable companies are multiplied by tConsensus Estimate of the appropriate fundamental metric (the denominator).E.g. Average of LTM adjusted P/E of closest comparable companies is 10x and Consensuof adjusted EPS for next year is Rs.12 implying a forward price of Rs.120 (=10 x 12

How does one determinea forward multiple?

Although there are several formulas available to Forecast Multiples. The analyst typicallyCurrent Market Cap or Enterprise value by the appropriate consensus estimate.E.g. Current Share Price is Rs.100 and Consensus EPS estimate is Rs.25, implying that Fis 4x (=Rs.100/25).

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16/21

What are ConsensusEstimates ?

Consensus Estimates are Average (or Median) estimates for fundamentals or Multiples entire universe of estimates for a given company. These are made available at BloombeThomson-Reuters, Zacks, Yahoo Finance, Google Finance etc.

Why do we use ConsensusEstimates ?

Unlike DCF, the Comparable approach aims to capture market sentiment. Among other market sentiments are driven by Consensus Estimates and hence they primarily drive mu

Why not use FY data

instead of LTM ?

Fiscal Year (FY) data may be older by a quarter or more. Implying that it is stale and doesinfluence current traded multiples/prices.

Why Calendarize ?Calendar Year (CY) data is used to re-base companies with different FY endings. E.g. Comwith Mar, Sep, Dec ended results can only be compared if they have a common base i.e.

Why are adjustmentsmade to fundamentals ?

Non-Recurring items like Other Income, Extraordinary gains/losses and other one time itcannot be forecasted with reasonable accuracy and should be excluded since they dist

Such gains should be subtracted and losses be added back to reflect sustainable income

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17/21

What factors/metrics areused to arrive at theclosest comparable

companies ?

To start with, when possible one should look at the Sub-Sector and not Sector or Industthat, one should look at companies with very similar products/product mix. Secondly, Sabe given more weight than Market Cap else valuation will result in circular reasoning. Thmay use Geographic presence, Degree of Revenue Concentration, Capacity, Margins, ROLeverage ratios etc. to arrive at the tightest range of companies.

How does one determinea Fair Value range

Once the process of benchmarking has been carried out one may use the Min & Max of range to determine a Fair Value range

Why and How are DilutedShares Calculated ?

Diluted Shares are calculated to reflect maximum possible no. of shares coming into thea result of conversion of debt, warrants & ESOPs. Such dilution is a threat to existing shaas their stake gets diluted and hence will reduce Share Price. The Treasury Stock Methodthe most popular approach used. It assumes that proceeds from all In-The-Money (ITM)used to buyback shares so as to minimize dilution

Can P/E or EV Multiples benegative ? If Yes ,What

should be done ?

A negative P/E indicates that EPS is negative (loss making company). EV can be negativecash component is relatively higher than Debt + Market Cap. Negative EVs usually occurs

Exuberance i.e. when markets crash and Market Value goes below fair value. A negativeseen in the BFSI sector as they are cash rich and during bearish phases they may trade wtheir fair value. In both the above situations one may use P/B as it is more stable. Howevstartups or companies that have accumulated losses even P/B will be negative!In such extreme situations one is left with no choice but to use P/Sales!

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18/21

Can Share Price becalculated through EV

multiples

Yes. One simply calculate EV and then subtract Net Debt to arrive at Equity value and finby diluted shares to arrive at Value per share.E.g. Company A has an implied EV/EBITDA of 5.5x and estimated EBITDA of Rs.1000,Current Net debt of Rs.2,500 and 300 diluted shares.Its EV = 5.5 x 1,000 = 5,500 and Equity Value = 5,500-2,500 = Rs.3,000while Value per share = Rs.3,000/300 = Rs.30

Why is Minority Interestincluded in EV ?

Consolidated Statements represent Sales, EBITDA , EBIT etc. contributed by Minorities aone does not include Minority interest, the Value of the Enterprise will be understated a

will appear cheaper than it actually is!

Why is Excess CashSubtracted from EV ?

Excess Cash (not Operating Cash!) is subtracted as it may be used to pay down debt. In the Cash available is a source and not an application of funds! Ideally, one must use all CEquivalents while not including minimum required cash (i.e. Operating Cash)

Why not use EV/PAT orP/EBITDA?

While calculating a multiple the numerator must be consistent with the denominator. EVthe value created by (or belonging to) the entire firm, hence, the denominator must be

available for all i.e. Sales, EBITDA, EBIT & FCFF. However, After EBIT all other items like IPreference dividends, Minority interest etc. are payments made to particular claimholdehence not available for the entire firm. Therefore, EV/PAT or P/EBITDA are inconsistent.One exception to the rule is P/Sales which is used in the Retail sector!

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19/21

Why are Sector SpecificMultiples used ?

Efficiency in each sector is driven by specific metrics. For e.g. in the Hotel industry EV/EBnot reflect the additional EV created as a result of 500 rooms added. In such cases a secmultiple proves superior. EV/room indicates how well has the company used each roo

increase Enterprise Value. Secondly, it acts as an indicator of premium/discount over liqucost. E.g. if a room costs Rs.5Lacs to build and a company has 10,000 such rooms itsvalue is Rs.500Crs (although it is just a ball park number!)

What are the mostpopular Multiples ?

The most popular multiples are P/E, P/B, EV/EBITDA, and P/CEPS [Cash EPS = (PAT + DepShares] in that order. In the service sector EV/EBITDAR is the norm. Where R indicates expense and is a significant expenditure in the sector. It is added back as it is a charge pparticular claimholder to fund assets and hence treated as debt. Irrespective of whetheleases/rents/buys assets its EV will remain same! (Remember: EV is Capital Neutral!)

List of Sector SpecificMultiples

1Although the multiple defies the principle of consistency it is popular for sectors where breakevens a2BOE = Barrel of Equivalent (One Barrel = 159litres) 3EBITDAX, where X = Exploration

Sector Recommended Multiple Sector Recommended Mul

Healthcare EV/Bed Airlines EV/Plane or EV/Pass

Hospitality EV/Room Cement/Steel et EV/Ton

Retail EV/Sq.ft & P/Sales1

Multiplex EV/Screen

Telecom EV/Subscriber Print Media EV/SubscriberIT & ITES EV/Employee Infrastructure P/B, EV/NAV, EV/IC

BFSI P/B Oil & Gas EV/BOE2

& EV/EBITD

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20/21

1.Mckinsey Valuation 4th Edition Tim Koller, Marc Goedhart & David Wessels

2. Investment banking Joshua Pearl & Joshua Rosenbaum3.Stock Valuation: A guide to Wall Streets most popular models Scott Hoover

1. The right Roles of Multiple in valuation Mckinsey Quarterly2. The Conundrums of Comparable Company Multiples Howard E. Johnson

3. The Trouble with Earnings & PE multiples Alfred Rappaport & Michael J. Mauboussin

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21/21

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Relative_or_Comparable_Valuation

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