What are the 3 major valuation methodologies?
Public Company Comparables (Public Comps), Precedent Transactions and the Discounted Cash Flow Analysis.Public Comps and Precedent Transactions are examples of relative valuation(based on market values), while the DCF is intrinsic valuation (based on cash
Can you walk me through how you use Public Comps and Precedent Transactions?
First, you select the companies and transactions based on criteria such as industry, financial metrics, and geography (see the next question).Then, you determine the appropriate metrics and multiples for each set - for example, revenue, revenue growth, EB
How do you select Comparable Companies or Precedent Transactions?
The 3 main criteria for selecting companies and transactions:1.Industry classification2.Financial criteria (Revenue, EBITDA, etc.)3.GeographyFor Precedent Transactions, you also limit the set based on date and often focus on transactions within the past 1
For Public Comps, you calculate Equity Value and Enterprise Value for use in multiples based on companies' share prices and share counts... but what about for Precedent Transactions? How do you calculate multiples there?
They should be based on the purchase price of the company at the time of the deal announcement. For example, a seller's current share price is $40.00 and it has 10 million shares outstanding. The buyer announces that it will pay $50.00 per share for the s
How would you value an apple tree?
The same way you would value a company: by looking at what comparable apple trees are worth (relative valuation) and the present value of the apple tree's cash flows (intrinsic valuation). Yes, you could build a DCF for anything - even an apple tree.
When is a DCF useful? When is it not so useful?
A DCF is best when the company is large, mature, and has stable and predictable cash flows (think: Fortune 500 companies in "boring" industries). Your far-in-the-future assumptions will generally be more accurate there. A DCF is not as useful if the compa
What other Valuation methodologies are there?
Liquidation Valuation - Valuing a company's Assets, assuming they are sold off and then subtracting Liabilities to determine how much capital, if any, equity investors receive. �LBO Analysis - Determining how much a PE firm could pay for a company to hit
When is a Liquidation Valuation useful?
It's most common in bankruptcy scenarios and is used to see whether or not shareholders will receive anything after the company's Liabilities have been paid off with the proceeds from selling all its Assets.It is often used to advise struggling businesses
When would you use a Sum of the Parts valuation?
This is used when a company has completely different, unrelated divisions - a conglomerate like General Electric, for example. If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division, and a techn
When do you use an LBO Analysis as part of your Valuation?
Clearly, you use this whenever you're analyzing a Leveraged Buyout - but it is also used to "set a floor" on the company's value and determine the minimumamount that a PE firm could pay to achieve its targeted returns.You often see it used when both strat
How do you apply the valuation methodologies to value a company?
display ranges in football field graph. To do this, you need to calculate the minimum, 25th percentile, median, 75thpercentile, and maximum for each set (2-3 years of comps and the transactions,for each different multiple used) and then multiply by the re
Can you walk me through how to calculate EBIT and EBITDA? How are they different?
EBIT is just a company's Operating Income on its Income Statement; it includes not only COGS and Operating Expenses, but also non-cash charges such as Depreciation & Amortization and therefore reflects, at least indirectly, the company's Capital Expenditu
What about how you calculate Unlevered FCF (Free Cash Flow to Firm) and Levered FCF (Free Cash Flow to Equity)?
Unlevered FCF = EBIT * (1 - Tax Rate) + Non-Cash Charges - Change in Operating Assets and Liabilities - CapExWith Unlevered FCF, you're excluding interest income and expenses, as well as mandatory debt repayments.Levered FCF = Net Income + Non-Cash Charge
What are the most common Valuation multiples? And what do they mean?
Enterprise Value / Revenue: How valuable is a company in relation to its overall sales.�Enterprise Value / EBITDA: How valuable is a company in relation to its approximate cash flow.�Enterprise Value / EBIT: How valuable is a company in relation to the pr
How are the key operating metrics and valuation multiples correlated? In other words, what might explain a higher or lower EV / EBITDA multiple?
Usually, there is a correlation between growth and valuation multiples. So if one company is growing revenue or EBITDA more quickly, its multiples for both of those may be higher as well.However, math also plays a role and sometimes companies with extreme
Why can't you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?
If the metric includes interest income and expense, you use Equity Value; if it excludes them (or is "before" them), you use Enterprise Value.EBITDA is available to allinvestors in the company - not just common shareholders. Similarly, Enterprise Value is
What would you use with Free Cash Flow multiples - Equity Value or Enterprise Value?
Trick question. For Unlevered Free Cash Flow (Free Cash Flow to Firm), you would use Enterprise Value, but for Levered Free Cash Flow (Free Cash Flow to Equity) you would use Equity Value (see the diagram above).Remember, Unlevered Free Cash Flow excludes
Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?
Warren Buffett once famously asked, "Does management think the tooth fairy pays for capital expenditures?"He dislikes EBITDA because it hides the Capital Expenditures companies make and disguises how much cash they require to finance their operations.In s
What are some problems with EBITDA and EBITDA multiple? And if there are so many problems, why do we still use it?
First, it hides the amount of debt principal and interest that a company is paying each year, which can be very large and may make the company cash flow-negative; as mentioned above, it also hides CapEx spending, which can also be huge.EBITDA also ignores
The EV / EBIT, EV / EBITDA, and P / E multiples all measure a company's profitability. What's the difference between them, and when do you use each one?
P / E depends on the company's capital structure, whereas EV / EBIT and EV / EBITDA are capital structure-neutral. Therefore, you use P / E for banks, insurance firms, and other companies where interest is critical and where capital structures tend to be
Could EV / EBITDA ever be higher than EV / EBIT for the same company?
No. By definition, EBITDA must be greater than or equal to EBIT because to calculate it, you take EBIT and then add Depreciation & Amortization, neither of which can be negative (they could, however, be $0, at least theoretically).Since EBITDA is always g
What are some examples of industry-specific multiples?
Technology (Internet): EV / Unique Visitors, EV / Pageviews�Retail / Airlines: EV / EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization & Rental Expense)�Oil & Gas: EV / EBITDAX (Earnings Before Interest, Taxes, Depreciation, Amortization
When you're looking at an industry-specific multiple like EV / Proved Reserves or EV / Subscribers (for telecom companies, for example), why do you use Enterprise Value rather than Equity Value?
You use Enterprise Value because those Proved Reserves or Subscribers are "available" to all the investors (both debt and equity) in a company. This is almost always the case unless the metric already includes interest income and expense (FFO and AFFO abo
Rank the 3 main valuation methodologies from highest to lowest expected value.
Trick question - there is no ranking that always holds up.In general, Precedent Transactions will be higher than Comparable Public Companies due to the Control Premium built into acquisitions (i.e. the buyer must pay a premium over a company's current sha
Would an LBO or DCF produce a higher valuation?
Technically it could go either way, but in most cases the LBO will give you a lower valuation. Here's the easiest way to think about it: with an LBO, youdo not get any value from the cash flows of a company in between Year 1 and the final year - you only
When would a Liquidation Valuation produce the highest value?
This is highly unusual, but it could happen if a company had substantial hard assets but the market was severely undervaluing it for a specific reason (such as an earnings miss or cyclicality).As a result, the Comparable Companies and Precedent Transactio
Why are Public Comps and Precedent Transactions sometimes viewed as being "more reliable" than a DCF?
It's because they're based on actual market data, as opposed to assumptions far into the future.Note, however, that you still do make future assumptions even with these (for example, the "Forward Year 1" and "Forward Year 2" multiples in the graphs above
What are the flaws with Public Company Comparables?
No company is 100% comparable to another company. �The stock market is "emotional" - your multiples might be dramatically higher or lower on certain dates depending on the market's movements.�Share prices for small companies with thinly-traded stocks may
You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies - can you think of a situation where this is notthe case?
Sometimes this happens when there is a substantial mismatch between the M&Amarket and the public markets. For example, no public companies have been acquired recently but lots of small private companies have been acquired at low valuations.For the most pa
What are some flaws with Precedent Transactions?
Past transactions are rarely 100% comparable - the transaction structure, size of the company, and market sentiment all make a huge impact.�Data on precedent transactions is generally more difficult to find than it is for public company comparables, espec
How would you present these Valuation methodologies to a company or its investors? And what do you use it for?
Usually you use a "Football Field" chart where you show the valuation range implied by each methodology. You always show a range rather than one specific number.Once again, see the graph we've been using throughout this section of the guide for an example
Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?
The company has just reported earnings well-above expectations and its stock price has risen in response. �It has some type of competitive advantage not reflected in its financials, such as a key patent or other intellectual property.�It has just won a fa
How do you take into account a company's competitive advantage in a valuation?
1.Highlight the 75th percentile or higher for the multiples rather than median. 2.Add in a premium to some of the multiples.3.Use more aggressive projections for the company.
Do you ALWAYS use the median multiple of a set of public company comparables or precedent transactions?
Nope. In fact, you almost always show a range. And you may make the median the center of that range, but you don't have to - you could focus on the 75thpercentile, 25th percentile, or anything else if the company is outperforming or underperforming for so
Two companies have the exact same financial profiles (revenue, growth, and profits) and are purchased by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction - how could this happen?�
�One process was more competitive and had a lot more companies bidding on the target.�One company had recent bad news or a depressed stock price so it was acquired at a discount.
�They were in industries with different median multiples.�The two companies
If you were buying a vending machine business, would you pay a higher EBITDA multiple for a business that owned the machines and where they depreciated normally, or one in which the machines were leased? The Depreciation expense and the lease expense are
You would pay a higher multiple for the one with leased machines if all else is equal. The Purchase Enterprise Value would be the same for both acquisitions, but Depreciation is excluded from EBITDA - so EBITDA is higher, and the EV / EBITDA multiple is l
How would you value a company that has no profit and no revenue?
There are two options:1.You could use Comparable Companies and Precedent Transactions and look at more "creative" multiples such as EV / Unique Visitors and EV / Pageviews (for Internet start-ups, for example) rather than EV / Revenue or EV / EBITDA.2.You
The S&P 500 Index (or equivalent index in other country) has a median P / E multiple of 20x. A manufacturing company you're analyzing has earnings of $1 million. How much is the company worth?
It depends on how it's performing relative to the index, and relative to companies in its own industry. If it has higher growth and/or higher margins, you may assign a higher multiple to it - maybe 25x or even 30x, and therefore assume that its Equity Val
A company's current stock price is $20.00 per share, and its P / E multiple is 20x, so its EPS is $1.00. It has 10 million shares outstanding. Now it does a 2-for-1 stock split - how do its P / E multiple and valuation change?
They don't. Think about what happens: the company now has 20 million shares outstanding... but its Equity Value has stayed the same, so its share price falls to $10.00. Its EPS falls to $0.50, but its share price has also fallen to $10.00, so the P / E mu
Let's say that you're comparing a company with a strong brand name, such as Coca-Cola, to a generic manufacturing or transportation company.Both companies have similar growth profiles and margins. Which one will have the higher EV / EBITDA multiple?
In all likelihood, Coca-Cola will have the higher multiple due to its strong brand name.Remember that valuation is not a science - it's an art, and the market often behaves in irrational ways. Values are not based strictly on financial criteria, and other