RELATIVEVALUATION

ProfessorLiuYang
MGMT231C
UCLAAndersonSchool

RelativeValuationisPervasive
2

MostvaluationonWallStreetarerelativevaluations

About85%ofequityresearchreportsand50%ofthe
About
85% of equity research reports and 50% of the
acquisitionvaluationsarebasedonrelativevaluation

WhiletherearemoreDCFvaluationsinconsultingand
corporatefinance,theyoftenusecomponentsfrom
relativevaluation
TheterminalvalueinasignificantnumberofDCF
g
valuationsisestimatedusingamultiple.
TheobjectiveinmanyDCFvaluationsistobackintoa
numberthathasbeenobtainedbyusingamultiple.

MGMT 231C: Relative Valuation

WhatisRelativeValuation?
3

Thevalueofanassetiscomparedtothevalues
assessed by the market for similar or comparable
assessedbythemarketforsimilarorcomparable
assets.

Todorelativevaluation,weneedto
1. Identifycomparableassetsandobtainmarketvalues
2.
3.

fortheseassets,
Convertmarketvaluesintostandardizedvalue
k
l
i
d di d l
(multiples),and
Comparethemultipleforcomparableassetsandthe
assetbeinganalyzed,controllingforanydifferences
MGMT 231C: Relative Valuation

TypesofMultiples
4

Quantity
EBITDA

x
x

Multiple
EV/EBITDA

=Value
EV

Terminology
EBITDA M l i l
EBITDAMultiple

EBIT
EPS
Sales
BV ofAsset
# of
Customers
Sq. Ft.

x
x
x
x
x

EV/EBIT
P/EPS
EV/Sales
EV/BVA
EV/#
Customer
EV/Sq.Ft.

EV
P
EV
EV
EV

EBITMultiple
PERatio
SalesMultiple
BookMultiple
CustomerMultiple

EV

Sq.Ft.Multiple

MGMT 231C: Relative Valuation

TradingversusTransactionMultiples
5

Tradingmultiplesarebasedonasetofcomparable
publicly traded firms
publiclytradedfirms.

Transactionmultiplesarebasedonpricesthat
havebeenpaidforcomparablefirmsinamerger
oracquisition.

Thetransactionmultipleusuallyexceedsthe
tradingmultipleduetopotentialsynergybetween
theacquirerandthetarget.
MGMT 231C: Relative Valuation

Example:TradingMultiples
6

Company

EV(in$m)

EV/SALES

EV/EBITDA

EV/EBIT

Starbucks

$17,070

1.75x

12.78x

22.10x

McDonalds

$75,620

3.39x

10.07x

11.94x

Yum!Brands

$19,110

1.76x

9.11x

12.37x

BurgerKing

$3,320

1.33x

7.74x

10.01x

$420

1.41x

11.29x

20.69x

Peets Coffee

Source: Yahoo! Finance (Jan. 12th 2010)

MGMT 231C: Relative Valuation

Example:TransactionMultiples
7

Date
Target
Announced
4/24/2008

Acquirer

Wendy's
Triarc CosInc
International

1/16/2007

8/16/2007

EV
(in$m)
(in
$m)

EV/
EBITDA

EV/
EBIT

2,680

9.31

15.60

Smith&
Wollensky

Landry's
Restaurants

88

10.66

27.13

RARE
Hospitality

Darden
Restaurants

1,370

11.81

17.53

MGMT 231C: Relative Valuation

PriceEarningsRatio:Definition
8

PE=PriceperShare/EarningsperShare

Price:

Currentpriceortheaverageprice

EPS=Earnings/#ofshares

Earnings

Timeframe:earningsinthemostrecentfinancialyear(CurrentPE),
q
(
g ),
p
g
inthelast4quarters(TrailingPE),andexpectedearningsinthenext
fiscalyear(ForwardPE)

Numberofshares

Currentsharesoutstanding(PrimaryEPS)orallpossibleshares
(DilutedEPS)
MGMT 231C: Relative Valuation

PERatio:DescriptiveStatistics
9

CurrentPE=18.91
TrailingPE=17.48
ForwardPE=20.04

MGMT 231C: Relative Valuation

PERatio:TheFundamentals
10

Assumethatafirmhasastablegrowthrateg andacostof
equityke
P0 =

FCFE0 (1 + g ) E0 (1 RR ) (1 + g )
=
ke g
ke g

1+g
P0

= (1 RR )
E0
ke g
**RR:ReinvestmentRate

Otherthingsheldequal,PEratiowillbehigherfor
h h
h ld
l
ll b h h f

Highergrowthrate
Lowercostofequity(orlowerrisk)
Lowerreinvestmentneeds
MGMT 231C: Relative Valuation

Example:ImpliedPE(StableGrowth)
11

FirmAexpectstohaveastablegrowthrateof5%anda
reinvestmentrateof50%.Ithasanestimatedbetaof1.The
riskfreerateis6%andmarketriskpremiumis5.5%.
WhatisitsimpliedPEratiobasedonDCF?
Costofequity=6.0%+1(5.5%)=11.5%
PE=(1 RR)(1+g)/(ke g)
=(1 50%)(1+5%)/(11.5% 5%)=8.07
ThefirmistradingataPEof12.Wouldyourecommendto
buyitsstocks?

MGMT 231C: Relative Valuation

Example:ImpliedPE(TwoStageGrowth)
12

FirmBexpectstohavehighgrowthinthefirst5years,followed
bystablegrowthwiththefollowinginformation:
First5yearsAfter5years
GrowthRate
25%
5%
Reinvestment
80%
50%
Beta
1.2
1.0
Riskfreerate=6%
Marketriskpremium=5.5%
EstimatetheimpliedPEratioforFirmB.FirmBiscurrently
tradingataPEof22,wouldyourecommendtobuyits
stocks?
MGMT 231C: Relative Valuation

Costofequity(hg)=6.0%+1.2(5.5%)=12.6%
Costofequity(sg)=6.0%+1(5.5%)=11.5%
CurrentEarningg
$1
Growth
Reinvest
Year
rate
Earning
ment
1
25%
1.25
80%
2
25%
1.56
80%
3
25%
1.95
80%
4
25%
2.44
80%
5
25%
3.05
80%
6

5%

3.20

50%

FCFE
0.25
0.31
0.39
0.49
0.61

Terminal
Value

24.65

1.60

Ke
12.6%
12.6%
12.6%
12.6%
12.6%

PV
0.22
0.25
0.27
0.30
13.95

11.50%
PE=

15.00

MGMT 231C: Relative Valuation

PERatios:DirectComparison
14

Chooseagroupof
comparable firms, and
comparablefirms,and
CalculatetheaveragePE
ratioforthisgroup,
PE>average(PE)
overvalued
PE<average(PE)
undervalued

CompanyName
TrailingPE
CocaColaBottling
29.18
Molson Inc 'A'
MolsonInc.
A
43 65
43.65
AnheuserBusch
24.31
CorbyDistilleries
16.24
ChaloneWineGroup
21.76
AndresWines'A
8.96
TodhunterInt'l
8.94
BrownForman'B'
10.07
Coors(Adolph)'B'
23.02
PepsiCo,Inc.
33.00
C
CocaCola
C l
44 33
44.33
BostonBeer'A'
10.59
WhitmanCorp.
25.19
Mondavi(Robert)'A'
16.47
CocaColaEnterprises
37.14
HansenNaturalCorp
9.70
IndustryMean
22.66
IndustryMedian
22.39

PERatio:OtherFactors
15

CompanyName
CocaColaBottling
M l
MolsonInc.Ltd.'A'
I L d 'A'
AnheuserBusch
CorbyDistilleriesLtd.
ChaloneWineGroupLtd.
AndresWinesLtd.'A'
TodhunterInt'l
BrownForman'B'
Coors(Adolph)'B'
PepsiCo,Inc.
CocaCola
BostonBeer'A'
WhitmanCorp.
Mondavi(Robert)'A'
CocaColaEnterprises
HansenNaturalCorp

TrailingPE Exp.Growth STDEV(RET)

21.98
9.50%
20.58%
43 65
43.65
15 50%
15.50%
21 88%
21.88%
24.31
11.00%
22.92%
16.24
7.50%
23.66%
21.76
14.00%
24.08%
8.96
3.50%
24.70%
8.94
3.00%
25.74%
10.07
11.50%
29.43%
23.02
10.00%
29.52%
33.00
10.50%
31.35%
44.33
19.00%
35.51%
10.59
17.13%
39.58%
25.19
11.50%
44.26%
16.47
14.00%
45.84%
37.14
27.00%
51.34%
9.70
17.00%
62.45%

PERatios:RegressionApproach
16

Incontrasttothedirectcomparisonapproach,the
informationintheentirecrosssectionoffirmscanbeused
topredictPEratios.

EstimatethepredictedPEratiobasedonamultivariate
regression,withthePEratioasthedependentvariable,
andproxiesforrisk,growthandpayoutformingthe
independentvariables.

Comparetheactual PEratiowiththepredicted PEratio.

IfactualPE>predictedPE Overvalued(sell)
IfactualPE<predictedPE Undervalued(buy)
MGMT 231C: Relative Valuation

Example:PERegression
17

ThisisbasedonUSstocksinJan,2008
Dependentvariable:CurrentPE
Rsquare=

0.419

t
3.00

Significance
0.003

35.40

0.000

4.73

0.000

1.15

0.249

Model
Coefficent
Constant
2.741
ExpectedgrowthinEPS(for
0.669
thenext5years)(in%)
y
)(
)
Payoutratio(in%)
0.090
Beta(from3yrregression)
0.021
*Payoutratio=1 ReinvestmentRate
MGMT 231C: Relative Valuation

Example:PERegression(cont.)
18

Walmarthasanexpectedgrowthrateof11.46%,a
betaof0.28andareinvestmentrateof74%.Estimate
WalmartsthepredictedPEratio.

PredictedPE=2.741+0.669(11.46)+0.09(100 74)

+0.02(0.28)=10.44

WalmartiscurrentlytradingataPEof15.Whatis
yourrecommendationonitsstocks?

MGMT 231C: Relative Valuation

ProblemswithRegressionMethodology
19

TheOLSregressionassumesalinearrelationship
betweenPEratiosandfinancialproxies,andthatmight
notbeappropriate.

ThebasicrelationshipbetweenPEandfinancial
variablesmightnotbestable.Ifitshiftsfromyearto
year,thepredictionsfromthemodelmaynotbe
reliable.

Theindependentvariablesarecorrelatedwitheach
other.Theresultingmulticollinearity problemmakes
thecoefficientsfromtheregressionsunreliable.
MGMT 231C: Relative Valuation

PEGRatio:Definition
20

PEG=PE/ExpectedGrowthRateinEarnings(in%)

TheEPSusedinthedenominatorofthePEratio
shouldbethebaseonwhichgrowthisestimated.

Nodoublecounting:Iftheestimateofgrowthin
EPS i f
EPSisfromthecurrentyear,itwouldbemisleading
h
i
ld b
i l di
touseforwardEPSincomputingPEG.

MGMT 231C: Relative Valuation

AdjustingforGrowth
21

P/E(Trailing)
GOOG
MSFT
McDonalds
Starbucks

27.19
16.66
15.73
22.83

Exp. Growth
(5 )
(5yr)
20.91%
11.00%
9.43%
16.57%

PEG
1.30
1.51
1.67
1.38

Source:YahooFinance(Jan4th.2009)

MGMT 231C: Relative Valuation

PEGRatio:Distribution
22

Mean(PEG)=1.42

MGMT 231C: Relative Valuation

Example:PEGRatio DirectComparison
23

CompanyName
CocaColaBottling
Molson Inc. Ltd. 'A'
MolsonInc.Ltd.
A
AnheuserBusch
CorbyDistilleriesLtd.
ChaloneWineGroupLtd.
AndresWinesLtd.'A'
TodhunterInt'l
BrownForman'B'
Coors(Adolph)'B'
PepsiCo,Inc.
CocaCola
BostonBeer'A'
WhitmanCorp.
Mondavi(Robert)'A'
CocaColaEnterprises
HansenNaturalCorp
IndustryMean
IndustryMedian

TrailingPE
21.98
43.65
24.31
16.24
21.76
8.96
8.94
10.07
23.02
33.00
44.33
10.59
25.19
16.47
37.14
9.70
22.21
21.98

Exp.Growth
9.50%
15.50%
11.00%
7.50%
14.00%
3.50%
3.00%
11.50%
10.00%
10.50%
19.00%
17.13%
11.50%
14.00%
27.00%
17.00%
13%
12%

STDEV(RET)
20.58%
21.88%
22.92%
23.66%
24.08%
24.70%
25.74%
29.43%
29.52%
31.35%
35.51%
39.58%
44.26%
45.84%
51.34%
62.45%
33%
30%

PEG
2.31
2.82
2.21
2.17
1.55
2.56
2.98
0.88
2.30
3.14
2.33
0.62
2.19
1.18
1.38
0.57
1.95
2.19

PEGRatio:TheFundamentalFactors
24

Assumeafirmhasstablegrowthrateg andacostof
equity ke .
equityk
P0 =

E 0 (1 RR ) (1 + g)
ke g

PEG =

P0 /E
g

(1 RR) (1 + g )
g (k e g )

Thesamefactors,growth,risk,andreinvestmentratios
continuetoaffectPEGratio.

MGMT 231C: Relative Valuation

EVEarningMultiples
25

WhilePEratioslookatthemarketvalueofequity
relative to earnings to equity investors EV/Earning
relativetoearningstoequityinvestors,EV/Earning
ratioslookatthemarketvalueoftheoperatingassets
(EnterpriseValue)relativetooperatingearnings.
EBITDAMultiple:EV/EBITDA
EBITMultiple:EV/EBITorEV/EBIT(1t)
FCFFMultiple:EV/FCFF
p
/

Enterprisevalue=MVD+MVE Cash&Cash
equivalent
MGMT 231C: Relative Valuation

Example:EarningMultiples
26

MCICommunicationshadanEBITof$3,356millionin
1994 and a net income after tax of $855 million.
1994andanetincomeaftertaxof$855million.

Ithadcapitalexpendituresof$2,500millionand
depreciationof$1,100million,anditsworkingcapital
increasedby$250million.

TheEnterpriseValueofMCIisabout$15,577million.
p
,

CalculatetheEBITDA,EBIT,EBIT(1t),andFCFFmultiples
MGMT 231C: Relative Valuation

Example:EarningMultiples(cont.)
27

EBIT=3,356
EBIT (1 t) = 3 356 (1 0 36) = 2 148
EBIT(1t)=3,356(10.36)=2,148
EBITDA=3,356+1,100=4,456
FCFF=EBIT(1t) (CapEx DA) NWC
=2,148 (2,500 1,100) 250=498
EV/EBITDA=15,577/4,456=3.50
EV/EBITDA
= 15 577 / 4 456 = 3 50
EV/EBIT=15,577/3,356=4.64
EV/FCFF=15,577/498=32.28
MGMT 231C: Relative Valuation

AdvantagesofUsingEBITDAMultiple
28

Itcanbecomputedevenforfirmsarereportingnet
losses.

Forfirmsthatrequireasubstantialinvestmentin
infrastructure,EBITDAmultipleseemstobemore
appropriatethanthePEratio.

EBITDAmeasurescashflowsfromoperationsthatis
y
y p
g
beforeanydiscretionaryspending.

EBITDAisindependentofdebtlevel,andtherefore
allowsforcomparisonacrossfirmswithdifferent
financialleverage.
MGMT 231C: Relative Valuation

EV/EBITDAMultiple
29

EV/EBIT=6.14
EV/EBITDA=5.05

MGMT231C:RelativeValuation

TheDeterminantsofEV/EBITDA
30

Assumeastablegrowthmodel,thenwehave
EV =

FCFF(1 + g )
1+g
[(EBITDA DA )(1 t) + DA Capex NWC]
=
WACC g WACC g

EV
1+g
(1 t) Capex + NWC DA(t)
=

EBITDA
EBITDA WACC g

EV/EBITDAratioishigherforfirmswith
/
g

Lowerrisk
Highergrowth
Lowerreinvestmentneeds
Higherdepreciationandlowertaxrate
MGMT 231C: Relative Valuation

SalesMultiples
31

EV/Sales:TheEnterpriseValueper$ofsales

Fundamentalfactors
FCFF(1 + g)

(WACC g )
Sales(Op.Margin)(
1 t )(
1 RR )(1 + g )
=
(WACC g )

EV =

EV
(Op.Margin)(
1 t )(
1 RR )(
1 + g)
=
(WACC g )
Sales
MGMT 231C: Relative Valuation

BookMultiples
32

Bookmultipleforequityorfirm

MVE/BVEorEV/BVA

Determinantsofbookmultiples
P0 =

E1 (1 RR ) (BV0 ROE) (1 RR )
P
ROE(1 RR )
=
0 =
ke g
ke g
BV0
ke g

SinceRR = g/ROE,
Si
/ROE we have
h
P0
ROE [1 g/ROE] ROE g
=
=
BV0
ke g
ke g
MGMT 231C: Relative Valuation