RELATIVE VALUATION

-Parvesh Aghi
Fundamental Principles of Relative Valuation

2
Relative Valuation

Quantum of the cash flows 3

Two components to relative valuation

** risk, growth potential, and

* by converting prices into
cash flows
multiples of earnings,
book values, or sales

4
Price to Sales ratio or Market Cap/ sales

Company A Company B

Market Cap Rs 100 crores Rs 100 crores

Sales Rs 50 crores Rs 100 crores

Price to sales ratio 2 1

Conclusion : Company is clearly expensive

But if Company A sales are growing at 50% per annum and expected to grow
for next 5 years at the same rate and company B sales are not at all growing
…..which is better ?

5
USE OF RELATIVE VALUATION

6
Reasons for Popularity

7
Potential Pitfalls

8
STANDARDIZED VALUES AND MULTIPLES

» To compare the values of similar firms in the market ,

we need to standardise the values in some ways by
scaling them to a common variable.
1.To the earnings the firms generate ( EPS/EBIT
EBIDTA
2.To the book value
3.To the revenues that firms generate
4.To the Firm’s operational performance measures
that are specific to firms / sectors ( production
capacity/ subscribers / natural reserves)

9
Multiples

10
Earnings Multiples

PE ratio :
when buying a
* value of the
stock
operating
assets of the
EV/ EBIDTA:
firm.
when buying a
business
In a multiple, we should be consistent on numerator and denominator part. If numerator is
equity value then denominator should be measure of equity not firm and visa versa.
.
11
Multiples should be consistent

» Both the value (the numerator) and the

standardizing variable ( the denominator) should
be to the same claimholders in the firm.
» For example :
» Numerator = Market value of a equity/ firm /
enterprise
» Denominator = could be EPS /EBIT or EBITA or
EBIDTA

12
Book Value Multiples

13
Revenue Multiples

*Market value of equity / revenues.

14
Sector-Specific Multiples

15
» You would have seen that all multiples are not
used at a time to value a company. Which
multiple is more relevant to value a particular
company depends on various factors including
industry in which the company is operating, stage
of industry, focus of investors/traders etc.

16
Examples
» Let’s understand this with couple of real examples:
» One of the recent and most talked about deal happened in the recent
past was Facebook acquired Whatsapp. Everybody was surprised
with the $19 billion valuation paid for Whatsapp. What was the basis
of that valuation? Revenue, EBIT, EBITDA or Net Income?.

» The answer might surprise you. Basically none of them as currently

Whatsapp does not have any revenue stream (app is free for
subscriber and company is not advertising on its app). So what made
Facebook paid $19 billion fortune. Actually Facebook paid $19 billion
for 450 million existing user base of Whatsapp. And this is what the
key valuation metrics which market and investors are focusing on in
social networking companies (Facebook, Twitter, Linkedin etc.).

17
» Based on user number, Facebook paid around
$42 per user for Whatsapp compared to $130 per
user valuation what Facebook is having. This is
how this industry is currently being valued by
investors and traders.

18
 RIGHT MULTIPLES
Multiple Positive Limitation Conclusion

Can be used for the industry where profitability

1. Not effected by accounting policy differences Does not capture profitability part of is negative. Or where profitability margins are
EV/Sales in comaparable companies comaprable companies in a standard range.
2. Can be used for the industry where profitability
is negative. E,g, e commerce and electric
  vehicles
3. EV based multiples are not effected by
  differnces in capital structure
       
Can be used for almost every industry except,
1. Less effected by accounting policy differences Can not be used for the industry havingloss making industry, banking and financial
EV/EBITDA than other profit margins negative ebitda companies
2. Captures picture of profitability of comparable This multiple is more useful specially in case
companies, which is not the case with ev/sales of capital intensive industry, compared to
  multiple ev/ebit margin
3. EV based multiples are not effected by Huge D&A exp can distort earnings in capital
  differnces in capital structure intensive industry if we use EBIT
4. Not effected by non operating items of income
  and expenses.
       
1. Captures picture of profitability of comparable Can be used for almost every industry except,
companies, which is not the case with ev/sales Can not be used for the industry havingloss making industry, banking and financial
EV/EBIT multiple negative ebitda companies
2. EV based multiples are not effected by We should avoid using this multiple for capital
  differnces in capital structure intensive industry
3. Not effected by non operating items of income Huge D&A exp can distort earnings in capital
  and expenses. intensive industry if we use EBIT
       
1. Captures picture of profitability of comparable Effected by capital structure
companies, which is not the case with ev/sales differences Can be applied in the industry having
P/E Multiple multiple negligible leverage.
Effected by non operating items of
  income and expenses
Most effected by accounting policy
  differences
       
Can be used for industry not having sales, but does not capture financial performance Eg, Whatsapp, and other app based
EV/operating matrix subscribers etc of comparable companies companies
 

19
 MULTIPLES USED

104

Sector Multiple Used Rationale

Cyclical Manufacturing PE, Relative PE Often with normalized
earnings
Growth firms PEG ratio Big differences in growth
rates
Young growth firms w/ Revenue Multiples What choice do you have?
losses
Infrastructure EV/EBITDA Early losses, big DA
REIT P/CFE (where CFE = Net Big depreciation charges
income + Depreciation) on real estate

Financial Services Price/ Book equity Marked to market?

Retailing Revenue multiples Margins equalize sooner
or later
Thus, a firm which has historically traded at half the market PE (Relative PE =
Relative PE = PE of Firm / PE of Market . 0.5) is considered over valued if it is trading at a relative PE of 0.7.
What to control for

21
FOUR BASIC STEPS TO USING MULTIPLES

22
FOUR BASIC STEPS TO USING MULTIPLES

23
1.Multiple is defined consistently and measured uniformly

24
Consistency

25
Consistency

26
Consistency

27
Uniformity

28
2.Distributional characteristics of a multiple

29
Distributional characteristics of a multiple

» It is difficult to look at a number and pass

judgment on whether it is too high or low without
the knowledge of cross distribution of a multiple.
» The table below summarizes the average and
standard deviation for three widely used multiples
US companies Current PE Price-to book Equity EV/EBITDA
Average 48.12 7.14 26.52
Median 23.12 2.53 8.64
Standard dev 235.64 65.44 250.54
Minimum .10 .00 0.00
Maximum 10,081 4,447 11,322

30
31
Right Skewed distribution

32
Distributional characteristics of a multiple

33
Time variation in multiples
» Multiples can change over time
US Stocks Average Median % of firms
with PE ratios
Jan 00 52.16 24.55 65.33
Jan 01 44.99 14.74 63.00
Jan 02 43.44 15.50 57.06
Jan 03 33.36 16.68 49.99
Jan 04 41.40 20.76 58.18
Jan 05 48.12 23.21 56.43

» 2000 was the peak of market bubble.

» Multiples during recession will decrease

34
35
36
37
3.Analyse the multiple
» In discounted cash flow valuation the value of a
firm is a function of three variables , namely

38
Analyse the multiple

39
Analyse the multiple

40
Analyse the multiple

41
Math

42
Analyse the multiple

43
Math

44
MULTIPLES – Key driver

45
4.Application Tests

46
Application Tests

47
What is a comparable firm ?

A telecom firm can be compared to a software firm , if two are

Identical in terms of cashflows , growth & risk

48
Controlling for differences across firms

49
Subjective Adjustments

50
Subjective Adjustments

» EPD

51
Subjective Adjustments

52
Modified Multiples

53
Modified Multiples
» The P/E ratios and expected growth rates in EPS over the next five years, based on
consensus estimates from analysts, for the firms that are categorized as beverage
firms are summarized in the following table:

54
Modified Multiples

55
Sector Regressions

56
Market Regressions

57
Market Regressions

58
Market Regressions

59
Market Regressions

60
Predicted PE vs Actual PE - Regression

61
Market Regressions

62
Market Regressions

63
Market Regressions

64
MULTIPLES – Key driver

65
Steps in performing comparable company analysis

66
» Limitations of Statistical Techniques
»             Statistical techniques are not a panacea
for research or for qualitative analysis. They are
tools that every analyst should have access to, but
they should remain tools. In particular, when
applying regression techniques to multiples, we
need to be aware of both the distributional
properties of multiples that we talked about earlier
in the chapter and the relationship among and
with the independent variables used in the
regression.

67
»       The fact that multiples are not normally distributed can pose problems when using standard regression
techniques. These problems are accentuated with small samples, where the asymmetry in the distribution can be
magnified by the existences of a few large outliers.
» �      In a multiple regression, the independent variables are themselves supposed to be independent of each
other. Consider, however, the independent variables that we have used to explain valuation multiples – cash flow
potential or payout ratio, expected growth and risk. Across a sector and over the market, it is quite clear that high
growth companies will tend to be risky and have low payout. This correlation across independent variables creates
�multicollinearity� which can undercut the explanatory power of the regression.
» �      Earlier in the chapter, we noted how much the distributions for multiples changed over time, making
comparisons of PE ratios or EV/EBITDA multiples across time problematic. By the same token, a multiple
regression where we explain differences in a multiple across companies at a point in time will itself lose predictive
power as it ages. A regression of PE ratios against growth rates in early 2005 may therefore not be very useful in
valuing stocks in early 2006.
» �      As a final note of caution, the R-squared on relative valuation regressions will almost never be higher than
70% and it is common to see them drop to 30 or 35%. Rather than ask the question of how high an R-squared has
to be to be meaningful, we would focus on the predictive power of the regression. When the R-squared decreases,
the ranges on the forecasts from the regression will increase. As an example, the beverage sector regression (from
illustration 7.3) yields a forecasted PE of 32.97 but the R-squared of 51% generates a range of 27.11 to 38.83 for
the forecast with 95% accuracy; if the R-squared had been higher the range would have been tighter.
»  
»  

68
Limitations of Statistical Techniques
            Statistical techniques are not a panacea for research or for qualitative analysis. They are tools that every analyst should have
access to, but they should remain tools. In particular, when applying regression techniques to multiples, we need to be aware of both
the distributional properties of multiples that we talked about earlier in the chapter and the relationship among and with the
independent variables used in the regression.
�      The fact that multiples are not normally distributed can pose problems when using standard regression techniques. These problems
are accentuated with small samples, where the asymmetry in the distribution can be magnified by the existences of a few large outliers.
�      In a multiple regression, the independent variables are themselves supposed to be independent of each other. Consider, however,
the independent variables that we have used to explain valuation multiples – cash flow potential or payout ratio, expected growth and
risk. Across a sector and over the market, it is quite clear that high growth companies will tend to be risky and have low payout. This
correlation across independent variables creates �multicollinearity� which can undercut the explanatory power of the regression.
�      Earlier in the chapter, we noted how much the distributions for multiples changed over time, making comparisons of PE ratios or
EV/EBITDA multiples across time problematic. By the same token, a multiple regression where we explain differences in a multiple
across companies at a point in time will itself lose predictive power as it ages. A regression of PE ratios against growth rates in early
2005 may therefore not be very useful in valuing stocks in early 2006.
�      As a final note of caution, the R-squared on relative valuation regressions will almost never be higher than 70% and it is common
to see them drop to 30 or 35%. Rather than ask the question of how high an R-squared has to be to be meaningful, we would focus on
the predictive power of the regression. When the R-squared decreases, the ranges on the forecasts from the regression will increase. As
an example, the beverage sector regression (from illustration 7.3) yields a forecasted PE of 32.97 but the R-squared of 51% generates a
range of 27.11 to 38.83 for the forecast with 95% accuracy; if the R-squared had been higher the range would have been tighter.
 

69
» BACK UP SLIDES

70
Find the right comparable companies

71
» The analyst will run a screen based on criteria
that include:
» Industry classification
» Geography
» Size (revenue, assets, employees)
» Growth rate
» Margins and profitability

72
Gather financial information

73
Gather financial information

74
Setup the comps table
» In Excel, you now need to create a table that lists all the relevant
information about the companies you’re going to analyze.
» The main information in comparable company analysis includes:
» Company name
» Share price
» Market capitalization
» Net debt
» Enterprise value
» Revenue
» EBITDA
» EPS
» Analyst estimates

75
Calculate the comparable ratios
» With a combination of historical financials and analyst estimates
populated in the comps table, it’s time to start calculating the
various ratios that will be used to value the company in question.
» The main ratios included in a comparable company analysis are:
» EV/Revenue
» EV/Gross Profit
» EV/EBITDA
» P/E
» P/NA
» P/B

76
Use the multiples from the comparable companies to value the company
in question

» Analysts will typically take the average or median of the

comparable companies’ multiples and then apply them to
the revenue, gross profit, EBITDA, net income, or
whatever metrics they included in the comps table.
» In order to come up with a meaningful average, they often
remove or exclude outliers and continually massage the
numbers until they seem relevant and realistic.
» For example, if the average P/E ratio of the group of
comparable companies is 12.5 times, then the analyst will
multiply the earnings of the company they are trying to
value by 12.5 times to arrive at their equity value.

77
Interpreting the results

» Once the numbers are complete and the comps

table is finalized, it’s time to start interpreting the
results.  One way to use the information is to look
for companies that are overvalued or
undervalued.  Comps can help you uncover the
opportunities, but the results need to be
interpreted carefully as they don’t include any
qualitative factors whatsoever.

78
» To properly evaluate the numbers in the comps
table you have to understand why numbers are
what they are.  Why does Company A trade at a
discounted EV/EBITDA multiple to Company B?
» Is it because it’s undervalued and a good buying
opportunity?
» Or, is it because it has a much lower growth rate
and requires more capex spending?

79
» Even though Company A trades at a lower
multiple, it might actually be “more expensive”
than Company B!
» The is where the art of being a great financial
analyst comes into play.
» 

80
  Valuation
  EV/Sales EV/EBITDA EV/EBIT P/E
Company Name x x x x
Infosys Ltd 3.7x 13.4x 14.6x 21.4x
Wipro 2.5x 10.5x 12.1x 16.7x
Tata
Consultancy 5.4x 18.2x 19.1x 25.7x
services
HCL
2.3x 9.4x 10.9x 14.2x
Technologies
Tech Mahindra 1.8x 8.9x 10.7x 14.6x

Average 3.2x 12.1x 13.5x 18.5x

Median 2.5x 10.5x 12.1x 16.7x

81
  Market Data   Financial Data

  Price Market Cap EV   Sales EBITDA EBIT Earnings

Company
(Rs/share) (Rs crores) (Rscrores)   (Rs crores) (Rs crores) (Rs crores) (Rs crores)
Name

Infosys Ltd 775 3,30,416 3,07,848 82,675 23,052 21,041 15,410

Wipro 249 1,50,461 1,48,948 59,574 14,232 12,284 9,022

Tata
Consultancy 2165 8,11,828 7,97,818 1,46,463 43,817 41,761 31,562
services

HCL
1063 1,43,998 1,39,982 60,427 14,869 12,796 10,120
Technologies

Tech
659 63,583 61,281 34,742 6,871 5,742 4,354
Mahindra

82
  Market Data   Financial Data   Valuation

Market EV/EBITD
  Price EV   Sales EBITDA EBIT Earnings   EV/Sales EV/EBIT P/E
Cap A  
Company
($/share) ($M) ($M)   ($M) ($M) ($M) ($M)   x x x x
Name  
The Coca-
Cola 38.14 1,68,041 1,85,122 46,854 13,104 11,127 7,381 4.0x 14.1x 16.6x 22.8x
Company
Pepsico,
81.37 1,23,883 1,43,824 66,415 12,344 9,878 5,618 2.2x 11.7x 14.6x 22.1x
Inc.
Dr Pepper
Snapple
52.31 10,326 12,764 5,997 1,319 1,103 620 2.1x 9.7x 11.6x 16.7x
Group,
Inc.
Monster
Beverage
69.62 11,618 11,004 2,246 606 584 357 4.9x 18.1x 18.9x 32.5x
Corporatio
n
National
Beverage 20.81 964 968 645 78 66 41 1.5x 12.5x 14.6x 23.5x
Corp.

Average                   2.9x 13.2x 15.3x 23.5x

Median                   2.2x 12.5x 14.6x 22.8x

83
84
85
86
87
 Multiple Positive Limitation Conclusion

Can be used for the industry where

1. Not effected by accounting policy Does not capture profitability part of profitability is negative. Or where profitability
EV/Sales differences in comaparable companies comaprable companies margins are in a standard range.
2. Can be used for the industry where
profitability is negative. E,g, e commerce and
  electric vehicles
3. EV based multiples are not effected by
  differnces in capital structure
       
Can be used for almost every industry
1. Less effected by accounting policy Can not be used for the industry except, loss making industry, banking and
EV/EBITDA differences than other profit margins having negative ebitda financial companies
2. Captures picture of profitability of This multiple is more useful specially in case
comparable companies, which is not the case of capital intensive industry, compared to
  with ev/sales multiple ev/ebit margin
3. EV based multiples are not effected by Huge D&A exp can distort earnings in
  differnces in capital structure capital intensive industry if we use EBIT
4. Not effected by non operating items of
  income and expenses.
       
1. Captures picture of profitability of Can be used for almost every industry
comparable companies, which is not the case Can not be used for the industry except, loss making industry, banking and
EV/EBIT with ev/sales multiple having negative ebitda financial companies
2. EV based multiples are not effected by We should avoid using this multiple for
  differnces in capital structure capital intensive industry
3. Not effected by non operating items of Huge D&A exp can distort earnings in
  income and expenses. capital intensive industry if we use EBIT
       
1. Captures picture of profitability of Effected by capital structure
comparable companies, which is not the case differences Can be applied in the industry having
P/E Multiple with ev/sales multiple intangible leverage.
Effected by non operating items of
  income and expenses
Most effected by accounting policy
  differences
       
does not capture financial
Can be used for industry not having sales, but performance of comparable Eg, Whatsapp, and other app based
EV/operating matrix subscribers etc companies companies
 

88
CASE STUDY

89
About Snyder’s-Lance

90
About Snyder’s-Lance

91
Campbell Soup Company

92
Highlights

93
» CAMDEN, N.J. and CHARLOTTE, N.C., Dec. 18,
2017 - Campbell Soup Company (NYSE: CPB) and
Snyder’s-Lance (NASDAQ: LNCE) today announced
that the companies have entered into an agreement
for Campbell to acquire Snyder’s-Lance for $50.00 per
share in an all-cash transaction.
» The purchase price represents a premium of
approximately 27 percent to Snyder’s-Lance’s closing
stock price on Dec. 13, 2017, the last trading day prior
to media reports regarding a potential transaction. The
acquisition, which has been approved by the

94
» Boards of Directors of both companies, will enable
Campbell to expand its portfolio of leading snacking
brands.
» Snyder’s-Lance is a leading snacking company that
manufactures and markets snack food throughout the
United States. The company’s portfolio includes well-
known brands such as Snyder’s of Hanover, Lance,
Kettle Brand, KETTLE chips, Cape Cod, Snack Factory
Pretzel Crisps, Pop Secret, Emerald and Late July.
Snyder’s-Lance has leading market positions in its core
categories including pretzels, sandwich crackers, kettle
chips, deli snacks and organic and natural tortilla chips.1

95
Acquisition and Snyder’s-Lance Highlights:

» Combines the strengths of both organizations to

drive sales growth and expand Campbell’s
footprint in the $89 billion U.S. snacking market,
which had a three-year compound annual growth
rate (CAGR) of nearly 3 percent2  Snyder’s-
Lance reported $2.2 billion in net sales for the
trailing 12 months ended Sept. 30, 2017  From
calendar 2012-2016, Snyder’s-Lance net sales
grew at an 11.5 percent CAGR; organic net sales
outpaced category growth with a 4 percent CAGR
»

96
» The acquisition of Snyder’s-Lance will accelerate
Campbell’s access to faster-growing distribution
channels including the convenience and natural
channels

97
 COMPARABLE DEAL ANALYSIS
SNYDER Equity Enterprise ENTERPRISE VALUE EQUITY
Value Value

LTM LTM LTM LTM PE

sales EBIDTA EBIT

5,224 6,320 2.8x 22.2x 33.9x 74.9x

(All Numbers are in USD millions except per share data)

98
DETAILS

99
ENTERPRISE VALUE

100
KEY FINANCIALS

101
EQUITY CONSIDERATION

102
TREASURY STOCK METHOD

103
104
 Comparison of Multiples IPO Valuation

Choice of the Multiple Depends on Industry, Profitability, Accounting Regimes

Multiple Advantage Disadvantage
 Meaningful for loss-making companies
 Does not take differences in profitability
EV / Sales  Very limited impact of
into account
accounting differences

 No distortions based on different  Does not take differences in capital

EV / EBITDA depreciation policies expenditures into account

 Possible distortions based on different

EV / EBIT  Valuation based on quality of operation
accounting policies

 Does not take differences in profitability

EV / Capital  Based on invested capital, which
into account
Employed determines potential earnings power  Distortions through accounting differences

 Focuses on earnings to shareholders  Accounting differences may distort true

P/E Ratio measures of earnings

 Does not take differences in capital

Price / CFPS  “Cash is king”
expenditures into account

 Based on equity, which determines  Does not take differences in profitability

Price / Book earnings power into account

26
» Limiting the use of banknotes has also been
recommended by health experts, as one of the
effective measures everyone can take. They are
potentially one of the most contaminated objects
with high circulation.

106