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Basic Principles of Financial Valuation Discounting

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Chandan Das
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32 views9 pages

Basic Principles of Financial Valuation Discounting

Uploaded by

Chandan Das
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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BASIC PRINCIPLES OF

FINANCIAL VALUATION
DISCOUNTING
Valuation by Comparables
James P. Weston
Professor of Finance
The Jones School, Rice University
VALUATION BY COMPARABLES

Practitioners often refer to “comps”

Comparable transactions or prices

Quick, easy, and dangerous!


ASSUMPTIONS FOR “COMPS”

1.  You can identify close comparables

2.  You have a value–relevant ratio

3.  The market values comps similarly


COMPARABLES IN USE

(​Price/𝐴𝑡𝑡𝑟𝑖𝑏𝑢𝑡𝑒 )∗ 𝑌𝑜𝑢𝑟 𝐴𝑡𝑡𝑟𝑖𝑏𝑢𝑡𝑒=𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑦𝑜𝑢𝑟 𝑎𝑠𝑠𝑒𝑡

Examples of attributes:
„  P/E ratios
„  Earnings Yield
„  Dividend Yield
„  Return on Assets
„  EBITDA multiples
P/E RATIOS

Price–to–earnings ratio is popular

How much a dollar of current earnings costs?

“Trades at X times earnings”


P/E RATIOS: EXAMPLE
Value Lowes Corporation by comps

Home Depot Lowes


E (earnings) $6.80 $2.46
P/E 25 --
Comp value -- $61.60

Comp value of Lowes = P/E Home Depot * E Lowes

= 25 * $2.46 = $61.60

Lowes actual price in


= $74 (about 20% different)
the market
OTHER COMMON COMPS

Return on Assets or Equity (ROA/ROE)

Return on invested capital (ROI)

Dividend yield

PEG ratio (P/E ratio over Growth in E)


MEASURING COMPS

Comps rely on historical averages

Trailing 12m, most recent Q, past 3 years…?

Negative earnings, negative prices?


COMPS VS. DCF

„  Both can provide useful information

„  Executed correctly, both are valid

„  Comps often used (and abused) in practice

„  Both require forecasts

„  DCF is more appealing in theory and more


accurate, but requires much more work

„  Comps can be a good quick-and-dirty


valuation, but be careful!

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