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Company valuation - Comparable trading multiple analysis

20 important questions on Company valuation - Comparable trading multiple analysis

What are the most commonly used valuation multiples?

Price/sales (P/S)
Price/earnings (P/E)
Price/book value (P/B)
Enterprise-value-to-EBITDA (EV/EBITDA)

Which valuation multiple is the most thourough and comprehensive?

EV/EBITDA

Why is the Price/Sales (P/S) multiple easy to apply but subject to potentially gigantic valuation errors?

The multiple is easy to use because a sales figure is available and hence by applying an average industry sales multiple, an estimated value can be easily derived.

However, the multiple assumes that financial structures, margins, taxes, etc. Are literally identical across the whole industry, which is obviously not the case.

(As a very rough rule of thumb) if a company has a net profit margin of around 10%, what is often a fair price as a Price/Sales?

1.0x

What is the problem with a P/E multiple if used as a valuation multiple versus a peer group multiple?

That the fundamental value of a business depends heavily on its financial structure, tax rate, and other liabilities, etc. While the P/E ratio only takes debt and leasing costs etc into account through their actual earnings contribution.

Also, this multiple takes accounting profits rather than actual cash flows into account.

What P/E multiples represent a fair value depending on a business' profitability, margin, financial structure, etc?

10-20x.

In order to fairly account for earnings growth, what do analyst often measure to the P/E multiple? Why?

The Price-Earnings-to-Growth ratio (PEG ratio).

If a share trades at a P/E ratio of 30x, but if its earnings grow at 30%, its PEG ratio is 1x, which is considered fair. Hence, a high P/E ratio is justified for companies with strong earnings growth.

When is Price/Book a reasonable indicator to derive a company's fair value? When it is not?

When the book value represents the net placement value of a company. Meaning that a company generates its business out of their fixed assets base, next to banks and other financial institutions.

It is not when a business' predominant asset is human capital, because then the company's book value is literally no indication of its fair value.

Companies that trade at a substantially discounted P/B ratio are seen by the market as highly risky. Why is that?

Because they are seen as structurally shrinking, subject to increased competition, adverse regulation, rising pressure, increased liabilities or they are seen as part of a losing industry.

What does a P/B ratio of 1.0x mean?

It means that the market agrees with the accountants in terms of determining the fair value of the company, i.e. That the book value also represents the market view on their fair value.

What is the difference between enterprise value and market value?

The enterprise value is the value of its business activities to all of its financiers, both equity as well as debt and other contributors.

The market value (enterprise value) is the value of a company to its shareholders.

What is EBITDA a good proxy for?

The operating cash flow of a business. It is the raw earnings figure of a business without taking into account costs of financing or write-offs or asset depreciation.

Why could EBIT give you the wrong idea while EBITDA cannot?

EBITDA is the earnings figure before taking into account, for example, the age of an asset base. If one would simply look for a high EBIT or net earnings, for example, and two businesses would be equal except that one had an old and written-off asset base, while the other had brand-new machines, one would be tempted to find the business with the older asset base more valuable, which would obviously be a wrong conclusion.

Why is EV/EBITDA such a good multiple?

Because EBITDA considers earnings that are not influenced by either financing, the age of asset base, taxes etc and as such represents good comparable 'pure' earnings.

EV takes into account the financial structure of a business as well as liabilities, minority interest, and provisions etc. That are not owned by the equity owners of the business.

What does an EV/EBITDA multiple of below 3.0x mean?

A business has substantial operational risks and/or the risk of shrinkage, for example, due to a patent running out, new competition, dramatic pricing pressure.

What does an EV/EBITDA multiple of above 10x mean?

Structural growth business (top-line growth >15%) with substantial cost savings potential through synergies or operational upgrades, a business with expansion potential that is worth acquiring at a strategic premium. A business with substantial pricing power ahead.

When net income is $288 and the company has 100 shares at a price of $45 per share. What is the price/earnings ratio?

EPS = net income / # of shares

$288 / 100 = 2.88

Price/earnings ratio = $45 / 2.88 = 15.63

When common stock is $100 and retained earnings is $775 and there are 100 shares at a price of $45 per share. What is the price/book value?

Book value of equity per share = common stock + retained earnings / # of shares

(100 + 775) / 100 = $8.75

Price/book value = 45 / 8.75 = 5.17

Price multiple valuation of many early-stage tech companies uses which multiple?

Price/sales ratio

A private pharmaceutical company that has $200 million in EBITDA and is financed with $300 million in debt. Using the comparable average of 5.30, the equity of this company would be valued at?

By multiplying its EBITDA by the average EV/EBITDA ratio

$200 * 5.30 = $1,160 million

Minus debt to get to the equity value

$1,160 - 300 = $760 million equity value

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A practical guide to interpreting financial statements and valuing companies

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Company valuation - Comparable trading multiple analysis

20 important questions on Company valuation - Comparable trading multiple analysis

What are the most commonly used valuation multiples?

Which valuation multiple is the most thourough and comprehensive?

Why is the Price/Sales (P/S) multiple easy to apply but subject to potentially gigantic valuation errors?

(As a very rough rule of thumb) if a company has a net profit margin of around 10%, what is often a fair price as a Price/Sales?

What is the problem with a P/E multiple if used as a valuation multiple versus a peer group multiple?

What P/E multiples represent a fair value depending on a business' profitability, margin, financial structure, etc?

In order to fairly account for earnings growth, what do analyst often measure to the P/E multiple? Why?

When is Price/Book a reasonable indicator to derive a company's fair value? When it is not?

Companies that trade at a substantially discounted P/B ratio are seen by the market as highly risky. Why is that?

What does a P/B ratio of 1.0x mean?

What is the difference between enterprise value and market value?

What is EBITDA a good proxy for?

Why could EBIT give you the wrong idea while EBITDA cannot?

Why is EV/EBITDA such a good multiple?

What does an EV/EBITDA multiple of below 3.0x mean?

What does an EV/EBITDA multiple of above 10x mean?

When net income is $288 and the company has 100 shares at a price of $45 per share. What is the price/earnings ratio?

When common stock is $100 and retained earnings is $775 and there are 100 shares at a price of $45 per share. What is the price/book value?

Price multiple valuation of many early-stage tech companies uses which multiple?

A private pharmaceutical company that has $200 million in EBITDA and is financed with $300 million in debt. Using the comparable average of 5.30, the equity of this company would be valued at?

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