Comparable Valuation Table of Contents

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Table of Contents
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Concept, Pros & Cons Process of Valuation

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Enterprise Multiples Benchmarking

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LTM & Calendarization

Adjustments to Financials

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Fair Value Range

Common Pitfalls

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Calculating Diluted Shares

Concept of Enterprise Value Equity Multiples

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Snapshots
Interview Questions Recommended Reading

Comparable Valuation Introduction

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

Concept
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 higher P/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 of the above conditions

Pros
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Cons
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Captures Market Sentiment Works best in the short run (between quarterly results) Quick & easier to apply & explain than fundamental approaches like DCF More relevant when inflow/outflow of funds changes or is expected to change significantly Very popular among Investment Banks, Brokerage houses & Mutual Funds. Implying that this is one of the ways in which the majority decide fair value (for the short run)

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In the real world it is very difficult to find comparable companies Myopic - Focus on quarterly results rather than the long term Fair Value based on peer comparison may imply that exuberance will always result in biased valuations irrespective of Intrinsic value Many Analysts use Comps in the down cycle while using DCF in the upturn. Indicating that Comps are likely to under value stocks when fundamentals are in the up cycle and vice-versa 1

Comparable Valuation The Process

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

Step 1
Identifying the Comparable Universe The Industry or Sector may not be comparable as a result of different products & markets implying different fundamental performance and hence different valuation. It is for this reason that one must look at the Sub-Sector. E.g. Industry > Metals Sector >Alloys Sub Sector > Non Ferrous Alloys

Step 2
Spreading Comps Making calculations > Margins & Ratios > Last Twelve months > Fully Diluted shares > Enterprise Value > 3yr CAGR sales & PAT Equity Multiples > P/E, PEG, P/B, P/FCFE Enterprise Multiples > EV/Sales, EV/EBITDA, EV/EBIT, EV/FCFF Sector Specific Multiples > EV/EBITDAR, EV/Ton, EV/Subscriber, EV/Plane, EV/Employee, EV/branch

Step 3
Benchmarking Companies with Similar Sales, Market cap, Margins and other Performance Metrics must be indentified to determine closest comparable companies and thus benchmark them against the company in question

Step 4
Determining Fair Value Benchmarking would help arrive at a range of multiples. Average & Median Multiples of such companies would help determine the fair value of the company in question while Highest & Lowest Multiples will serve to determine a range

Comparable Valuation LTM & Calendarization

Calculating Last Twelve months (LTM)
A.k.a. Trailing Twelve Months (TTM) sometimes also referred to as Latest Twelve Months. LTM Data1 is simply calculated for the purpose of using the latest available data as the Data from annual fiscal results could be one or more quarter older. The calculation is very simple and involves extracting latest available Annual results along with latest & corresponding previous years 9 months results Annual Sales as on 31-Mar-09 >> Rs.1,200Crs Last 9 months ended 31-Dec-09 >> Rs.1,000Crs Previous 9 months ended 31-Dec-08 >> Rs.800Crs
LTM = 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!

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Calendarization
Company results are always reported as per Fiscal year (FY) ended as decided by the management. In India, it is usually 31-Mar. A Calendar year CY (Jan-Dec) is way of re-basing companies that have different fiscal years. The process is called Calendarization. The issue starts with Financial Projections itself which are made on FY basis so as to make it comparable to what the company will report in future. The only way to make it comparable to other companies that have different Fiscal Years is to calendarize (restate in Jan-Dec terms) add quarterly results and subtract corresponding quarters, like LTM. However, in case of Annual Forecasts one may need to proportionally alter it.
E.g. If Company A has a FY of 31-Mar. Sales for FY 2009 are Rs.1,200Crs while that of FY 2010E are Rs.1400Crs CY2010E Sales = (3/12*1200) + (9/12*1500) = Rs.1350Crs (Sales from Jan-Dec 2010)

Comparable Valuation Making Adjustments

Why Make adjustments ?
Company reported formats are not consistent across companies and hence may create distortions when making comparisons. Secondly, items which cannot be forecasted with reasonable accuracy must be excluded. Such items are non-operational and usually non-recurring in nature. When calculating multiples it is essential to capture operational/sustainable performance only. This is because value cannot be consistently created through non-operational means. Companies that have higher non-operational gains/losses will have a greater risk resulting in a higher and unstable beta. This will increase the Cost of Equity thereby increasing the speed of the treadmill and making Value Creation through beating market expectations more difficult!
Note: These adjustments pertain to fundamentals alone. In the real world analysts often make adjustments to the multiples as well. Such arbitrary assumptions are specific to every analyst resulting from their expertise & experience!

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Items to be adjusted
Although one may have to make more adjustments than the ones mentioned, below are a few general guidelines

> Extraordinary Gains/Losses/write ups/write downs Such items are non-recurring in nature and typically related to Foreign Exchange, one time write ups/downs, losses due to strikes/lock-outs etc. Such losses must be added back and a reverse treatment of such gains must be made > Accounting anomalies1 Inventory adjustments LIFO to FIFO Deferred taxes The most popular accounting shenanigan used by companies to smoothen income Leases A capital cost and hence should be excluded from EBIT to reflect true Operational or Asset Efficiency Capitalizing vs Expensing This can have a significant impact on earnings and hence distort related multiples.
1Discussed in

Classroom

Comparable Valuation Calculating Diluted Shares

Fully Diluted Shares The Concept
Many companies provide ESOPs to employees as a non-cash incentive. Such options when executed threaten to dilute Earnings as More no. of shares chase Earnings. As an analyst you are required to calculate the maximum damage to existing shareholders through such conversions. The Treasury Stock Method assumes that proceeds from all InThe-Money (ITM) options shall be used to buyback shares in a bid 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

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Example
CMP INR 345

No. of Weighted ITM Proceeds Options Avg. Strike Options from Treasury (in Lacs) Price (in lacs) Conversion Stock 4,325 INR 238 4,325 1,029,350 2,984 6,236 INR 267 6,236 1,665,012 4,826 8,793 INR 290 8,793 2,549,970 7,391 2,465 INR 356 0 0 0 8,576 INR 390 0 0 0 No. of Shares 19,354 15,201 O/S Shares Add ITM Options Less Treasury Stock Fully Diluted Shares 1,987,653 19,354 15,201 1,991,806

Comparable Valuation Enterprise Value

Enterprise Value The Concept
A.k.a. Total Enterprise Value (TEV) or Firm Value (FV) Suppose you were to buy a Company which had Debt worth Rs.1,000Crs, Cash of Rs.500Crs & Market Value of equity as Rs.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 pay down debt and is hence subtracted! Enterprise Value represents the Value of the company (and not just the Equity!). It is a metric used to determine the value payable for buying the entire 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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Visual Explanation
Minority Interest
Other Non Equity Claims ST& LT Debt Less Excess C&CE

Market Value of Equity

Enterprise Value

Comparable Valuation Equity Multiples

Equity Multiples The Concept
The guiding principle for calculating a multiple is that the Numerator and Denominator must be consistent i.e. if the Numerator represents Value paid by Equity the denominator must reflect a fundamental/financial item available to Equity. Equity Multiples measure value available to Equity Shareholders alone. The Numerator of course, is Current Market Price or Market Capitalization. For the Denominator, starting from the top of the Income 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.

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Common Equity Multiples

> P/E or PER (Variant | CPE = P/CEPS) Calculated as CMP/Diluted EPS. It is a poor multiple as EPS can be easily masked through Income smoothing1 measures while Sales, EBITDA & EBIT are still tougher to manipulate! Secondly, P/E does not reflect the effect of leverage. > M/B or P/B or (Variant P/ABV = P/Adjusted BV) Calculate as Diluted Market Capitalization/Book value. Where Book Value = Share Capital + Reserves. P/B is more stable as compared to P/E and hence is a preferred metric for the BFSI sector > PEG or PE/EG (Price to Earnings/Earnings Growth) Calculated as PE/Expected Earnings Growth (3 year CAGR). As a substitute one may also use historical earnings growth. > P/FCFE Calculated as Diluted Market Capitalization/Free Cash Flows to Equity . Price paid for sustainable cash flows.
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Other things being equal a Lower Multiple indicates a cheaper stock!

Comparable Valuation Enterprise Multiples

Enterprise Multiples The Concept
Enterprise Multiples measure value available to the whole Enterprise The Numerator is the Enterprise Value as calculated before while the Denominator can only include Sales, Gross Profit, EBITDA and EBIT. If one went further down and included items like PBT or PAT it would go against the principle of consistency as discussed in the previous slide! Items like Interest or preference dividend are not payable by the entire firm but are cost of providing capital that are to be borne by 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!

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Common Enterprise Multiples

> EV/Sales The metric is used for companies that have yet to break even or have faced an unexpected loss in operational earnings > EV/EBITDA The most commonly used multiple by bankers, the metric captures operational efficiency of the firm > EV/EBIT Although bankers say that EBIT creates noise in forming a fair picture as depreciation may be affected by accounting methods. We still believe that in Capital intensive sectors like Cement the metric makes more sense than EV/EBITDA as EV/EBIT captures asset efficiency as well! > Sector Specific Multiples EV/Ton, EV/EBITDAR, EV/Subscriber, EV/Sqft., EV/Store, EV/Employee, EV/Plane, EV/branch etc. 8

Other things being equal a Lower Multiple indicates a cheaper company!

Comparable Valuation Benchmarking

Benchmarking
Benchmarking is the process of comparing companies in the peer set with the target company. It involves comparing financial & market performance along with other relevant numbers. Benchmarking is part Art part Science. The Science lies in correct calculations while forming a story about the companys current and expected performance is Art! A bankers job is to sell a company more than what it is worth and there lies the 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

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What to look out for ?

> Sales, EBITDA & PAT growth Higher numbers indicate superior scaling up capabilities, competitive advantages and management quality or leveraging parent companys contacts to secure orders > Margins Higher Margins indicate competitive advantage/s in terms of brand value, geographical advantage > ROE, ROCE, Debt Ratio & ATO Reflect profitability & Efficiency of the Firm & its Equity. A higher ROE with a low ROCE indicates a good use of leverage > Promoter Holding A higher number indicates promoter confidence and in turn leads to greater investor confidence resulting in a higher multiple. A very low number on the other hand may have a higher multiple too as a result in speculation of a takeover!
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All performance measures must be calculated as LTM along with Last 3 year & forward 3 year Average

Comparable Valuation Determining Fair Value & Forward Multiples

Determining an Implied Fair Value Range
Calculating Implied Share Price (LTM or Forward)
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.

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Is the range over stretched ?

> The benchmarking process leaves only the most closely comparable companies. Now, the analyst usually takes an average of multiples and uses it to determine the Fair Value of the Target. The process of setting a range is usually taken as Low & High multiples of the closest comparable group. But what if one of the companies has a fairly higher multiple than the others? > In such a case one may take an average of the group and add & subtract an arbitrary number to derive a range of value. Or simple exclude the company that has a starkly different multiple!
For e.g. IF Min and Max of the closest comparable group is 7.5x & 12.5x the Fair range for the Target company is the same 7.5x-12.5x. However, if the analyst perceives this to be very wide she may choose to calculate an average i.e. 10x (=(7.5+12.5)/2). Now to derive a range he/she may add & subtract 0.5x from it i.e. Range = 9.5x10 10.5x !

Calculating Forward Multiples

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.

Comparable Valuation Pitfalls in Application

Common Pitfalls in Application
One can very easily go wrong with Multiples because of their deceptively 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 be forecasted 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

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Why Enterprise Multiples are superior ?

> Sales, EBITDA & EBIT are more stable Although Window Dressing is a common practice it is more pronounced in EPS rather than items available for the Enterprise! > Capital Neutral & Reflect Operational Efficiency EV multiples reflect operational performance and hence can be used to compare firms with different Capital Structures. > Reflect Selling price of the Firm Equity value can be very misleading for a banker as M&As are not about buying stocks but about buying companies. Equity Analysts primarily focus on the next Qtr EPS number. Whereas for bankers (Deal makers) and Credit Analysts quality of earnings & long term sustainable profitability is more important! > What if a company is loss making? If a company is loss making all Equity multiples will prove useless! Thats when one may use the EV/Sales or EV/EBITDA multiple to judge fair value. 11

Comparable Valuation Snapshot - LTM & EV

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LTM ended 8th-Apr-10 Other Total Operating Operational Sales Income Revenues EBITDA D&A 8,421 19,653 6,926 3,694 2,114 7,001 3,493 2,865 1,742 1,414 173 109 34 25 66 16 11 8,594 19,653 7,035 3,728 2,139 7,066 3,509 2,876 1,742 1,414 2,571 5,895 1,928 963 602 2,169 1,515 1,305 481 335 342 962 282 225 128 379 347 182 68 73 all figures in Rs. Crores ExtraReported Other ordinary Adj.s EBIT PAT Income Items to PAT Adj. PAT 2,229 4,933 1,646 738 474 1,790 1,169 1,123 412 262 1,546 2,809 1,226 410 179 1,174 983 398 242 228 106 255 150 3 (26) 58 60 8 3 12 (45) 106 255 150 3 (26) 58 15 8 3 12 1,440 2,554 1,076 407 205 1,116 968 390 239 216

EV calculation all figures in Rs. Crores ConPref vertible Enterprise Capital Debt C&CE Value 984 113 881 85 55 104 472 39 125 327 17,104 27,307 20,483 6,202 4,552 16,486 8,707 5,881 1,881 1,330

Company Name ACC Grasim Gujarat Ambuja India Cements Dalmia Cement Ultratech Cement Shree Cement Madras Cement JK Cements JK Lakshmi Cements

Market Cap 17,270 23,161 20,713 4,025 2,040 13,726 7,684 2,966 1,342 919

Net Debt

STD

Minority LTD Interest 450 3,395 166 1,988 2,338 2,142 1,496 2,463 564 703 -

(166) 368 4,146 2,177 2,512 2,760 1,024 2,915 540 411 864 274 229 723 490 101 35 (229) 486

Note: The data above is an illustration only!

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15 Day Financial Modeling & Equity Valuation Comparable Valuation Comparable Valuation | Output Sheet Snapshot - Output Sheet
3 yr CAGR Capacity (in Crore tons per annum)
2.263 4.880 2.200 1.295 0.900 2.190 0.683 1.100 0.750 0.475 -

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Promoter Stake

LTM Margins

LTM Enterprise Multiples

LTM Equity Multiples

Company

CMP

52 week Low
365.00 872.00 56.00 45.00 67.20 678.00 320.00 55.25 31.25 31.00 -

52 week Diluted Shares High (in crores)

903.60 2,938.00 357.00 298.00 219.85 1,346.00 1,790.00 128.70 141.35 149.20 18.771 8.171 153.030 28.981 8.094 12.432 3.484 23.797 6.993 12.137 -

Sales PAT

31-Mar-09 EBITDA

EBIT

Adj. EV/Sales EV/EBITDA EV/EBIT EV/Ton PAT

17% 13% 15% 11% 10% 16% 28% 14% 14% 15% 2.0x 1.4x 2.9x 1.7x 2.1x 2.3x 2.5x 2.0x 1.1x 0.9x 6.7x 4.6x 10.6x 6.4x 7.6x 7.6x 5.7x 4.5x 3.9x 4.0x 7.7x 5.5x 12.4x 8.4x 9.6x 9.2x 7.5x 5.2x 4.6x 5.1x $168 $124 $207 $106 $112 $167 $284 $119 $56 $62

P/E Adj. P/E

PE/G

ACC Gra s i m Guja ra t Ambuja Indi a Cements Da l mi a Cement Ul tra tech Cement Shree Cement Ma dra s Cement JK Cements

920.05 2,834.50 135.35 138.90 252.00 1,104.05 2,205.55 124.65 191.85

8% 18% 18% 9% 45% 25% 35% 20% 28%

-4% 24% 3% -3% 18% 63% 66% 63% 48%

46.21% 25.50% 46.00% 27.37% 56.60% 54.78% 65.56% 42.00% 69.78% 44.48%

30% 30% 27% 26% 28% 31% 43% 45% 28% 24%

26% 25% 23% 20% 22% 25% 33% 39% 24% 19%

11.2x 8.2x 16.9x 9.8x 11.4x 11.7x 7.8x 7.5x 5.5x 4.0x

12.0x -323.0x 9.1x 19.2x 10.0x 12.3x 7.9x 7.6x 5.6x 4.3x 37.7x 617.3x 54.8x 19.6x 3.7x 11.5x 8.9x 8.9x

9.9x -294.4x

59% 216%

JK La ks hmi Cements 75.75

Medi a n Avera ge Ma x Mi n

22% 27% 8%

36% 49% -4%

46.11% 47.83% 69.78% 25.50%

29% 31% 45% 24%

24% 26% 39% 19%

15% 15% 28% 10%

2.0x 1.9x 2.9x 0.9x

6.1x 6.2x 10.6x 3.9x

7.6x 7.5x 12.4x 4.6x

$122 $141 $284 $56

9.0x 9.4x 16.9x 4.0x

9.5x 9.8x 19.2x

10.2x 14.5x 617.3x

59% 216%

4.3x -323.0x

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

Is Comparable valuation better than DCF ?

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In most cases DCF & Comps are complimentary i.e. one provides a sanity check to the other! However, in times of conflict it is better to rely on DCF. This is because Comps do not attempt to arrive at Intrinsic value, implying that the market could easily stretch valuations based on Comps. This is because one cannot substantiate whether Infosys is correctly trading at an Earnings multiple of 35x unless one can test it through at least one or more methods that Value a company based on its Fundamentals. DCF ties Stock Value to fundamentals whereas Comps are driven by Sentiments & Consensus Estimates! This also implies that when more money chases few stocks they are driven primarily by demand-supply gap rather than fundamentals ! In such times the broader market relies on Comps rather than DCF. DCF Value is driven by Fundamental performance which does not change drastically between two quarters. However, Multiples change every second indicating a very short life. Hence, Comps are better suited between quarters while DCF should be relied upon for a longer horizon say >1 year

Which approach has more longetivity ?

How does one forecast Share Price with Comps ?

Typically Average of LTM multiples of closest comparable companies are multiplied by the Consensus Estimate of the appropriate fundamental metric (the denominator). E.g. Average of LTM adjusted P/E of closest comparable companies is 10x and Consensus estimate of adjusted EPS for next year is Rs.12 implying a forward price of Rs.120 (=10 x 12)
Although there are several formulas available to Forecast Multiples. The analyst typically divides Current 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 Forward P/E is 4x (=Rs.100/25). 14

How does one determine a forward multiple?

Comparable Valuation Interview Questions Contd

What are Consensus Estimates ?

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

Why do we use Consensus Estimates ?

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

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 does not influence current traded multiples/prices. Calendar Year (CY) data is used to re-base companies with different FY endings. E.g. Companies with Mar, Sep, Dec ended results can only be compared if they have a common base i.e. Jan-Dec

Why Calendarize ?

Why are adjustments made to fundamentals ?

Non-Recurring items like Other Income, Extraordinary gains/losses and other one time items cannot be forecasted with reasonable accuracy and should be excluded since they distort Value. Such gains should be subtracted and losses be added back to reflect sustainable income.

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Comparable Valuation Interview Questions Contd

Why and How are Diluted Shares Calculated ?

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

What factors/metrics are used to arrive at the closest comparable companies ? How does one determine a Fair Value range

To start with, when possible one should look at the Sub-Sector and not Sector or Industry. Within that, one should look at companies with very similar products/product mix. Secondly, Sales should be given more weight than Market Cap else valuation will result in circular reasoning. Thereon, one may use Geographic presence, Degree of Revenue Concentration, Capacity, Margins, ROCE & ROE, Leverage ratios etc. to arrive at the tightest range of companies.
Once the process of benchmarking has been carried out one may use the Min & Max of the tightest range to determine a Fair Value range

Can P/E or EV Multiples be negative ? If Yes ,What should be done ?

A negative P/E indicates that EPS is negative (loss making company). EV can be negative when the cash component is relatively higher than Debt + Market Cap. Negative EVs usually occurs in times of Exuberance i.e. when markets crash and Market Value goes below fair value. A negative EV can be seen in the BFSI sector as they are cash rich and during bearish phases they may trade well below their fair value. In both the above situations one may use P/B as it is more stable. However, for startups or companies that have accumulated losses even P/B will be negative! 16 In such extreme situations one is left with no choice but to use P/Sales!

Comparable Valuation Interview Questions Contd

Can Share Price be calculated through EV multiples

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Yes. One simply calculate EV and then subtract Net Debt to arrive at Equity value and finally divide it by 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.3,000 while Value per share = Rs.3,000/300 = Rs.30 Consolidated Statements represent Sales, EBITDA , EBIT etc. contributed by Minorities as well. If one does not include Minority interest, the Value of the Enterprise will be understated and the firm will appear cheaper than it actually is! Excess Cash (not Operating Cash!) is subtracted as it may be used to pay down debt. In any case, the Cash available is a source and not an application of funds! Ideally, one must use all Cash Equivalents while not including minimum required cash (i.e. Operating Cash) While calculating a multiple the numerator must be consistent with the denominator. EV represents the value created by (or belonging to) the entire firm, hence, the denominator must be an item available for all i.e. Sales, EBITDA, EBIT & FCFF. However, After EBIT all other items like Interest, Preference dividends, Minority interest etc. are payments made to particular claimholders and are hence 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! 17

Why is Minority Interest included in EV ?

Why is Excess Cash Subtracted from EV ?

Why not use EV/PAT or P/EBITDA?

Comparable Valuation Interview Questions Contd

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What are the most popular Multiples ?

The most popular multiples are P/E, P/B, EV/EBITDA, and P/CEPS [Cash EPS = (PAT + Dep.)/Diluted Shares] in that order. In the service sector EV/EBITDAR is the norm. Where R indicates rental/lease expense and is a significant expenditure in the sector. It is added back as it is a charge payable to a particular claimholder to fund assets and hence treated as debt. Irrespective of whether a company leases/rents/buys assets its EV will remain same! (Remember: EV is Capital Neutral!) Efficiency in each sector is driven by specific metrics. For e.g. in the Hotel industry EV/EBITDA will not reflect the additional EV created as a result of 500 rooms added. In such cases a sector specific multiple proves superior. EV/room indicates how well has the company used each room to increase Enterprise Value. Secondly, it acts as an indicator of premium/discount over liquidation cost. E.g. if a room costs Rs.5Lacs to build and a company has 10,000 such rooms its liquidation value is Rs.500Crs (although it is just a ball park number!)
Sector Healthcare Hospitality Retail Telecom IT & ITES BFSI Recommended Multiple EV/Bed EV/Room EV/Sq.ft & P/Sales EV/Subscriber EV/Employee P/B
1Although the

Why are Sector Specific Multiples used ?

List of Sector Specific Multiples

Sector Airlines

Recommended Multiple EV/Plane or EV/Passenger EV/Screen EV/Subscriber P/B, EV/NAV, EV/IC EV/BOE2 & EV/EBITDAX3

Cement/Steel etc. EV/Ton

1

Multiplex Print Media Infrastructure Oil & Gas

multiple defies the principle of consistency it is popular for sectors where breakevens are distant 2BOE = Barrel of Equivalent (One Barrel = 159litres) 3EBITDAX, where X = Exploration expenses

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Comparable Valuation Recommended Reading

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Recommended Reading Books 1. Mckinsey Valuation 4th Edition Tim Koller, Marc Goedhart & David Wessels 2. Investment banking Joshua Pearl & Joshua Rosenbaum 3. Stock Valuation: A guide to Wall Streets most popular models Scott Hoover
Recommended Articles 1. The right Roles of Multiple in valuation Mckinsey Quarterly 2. 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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