How to Understand

Relative Valuation Model

What Is Relative Valuation Model?
• Also called multiples model
or market approach

• Use relevant fundamental benchmark to

value a business

• The equation
• Value = (fundamental indicator) x multiple
 Relative Valuation Model
Example: SMP Inc.
• ABC Corporation is considering acquiring a local family
business, SMP Inc., and trying to determine the purchase offer.

• The valuation team selects three of SMP’s close competitors as

comparables. All comps are publicly traded.

• The price-to-earnings multiples of comps are 20, 17, and 9.

The team decides to use the median of multiples as benchmark.

• The valuation team estimates that next year SMP will achieve
net income of $4 million and EPS of $0.8.

Estimate the implied price of SMP.

 Relative Valuation Model
Example: SMP Inc.
 Valuation Metric
MULTIPLE =
Fundamental Indicator

• Price multiples

• Enterprise value multiples

END
What Are Price Multiples?
 Price-Earnings Multiple (P/E)
Price per share
P/E =
Earnings per share(EPS)

• Earning power is a prime driver of value

• Widely recognized and used

• How reliable / useful is the earnings number?

 Price-Book Multiple (P/B)
Price per share
P/B =
Book Value of Common Equity per share

• P/B relates to the future earnings power.

• Book value is more stable than EPS.

• P/B can be misleading when there are
significant differences among the level or
age of assets and accounting practices.
 Link Between P/E and P/B
P P EPS
P/B = = × = (P/E) × ROE
BVE per share EPS BVE per share

• P/E indicates the valuation relative to a firm’s

profitability.

• Value of the firm with high ROE should be

higher than that of the firm with low ROE.
 Price-Sales Multiple (P/S)
Price per share
P/S =
Sales per share

• Sales are positive and less subjective to

distortion / manipulation.

• However, P/S ignores differences in cost

structures across companies.
Price-Cash Flow Multiple (P/CF)
Price per share
P/CF =
CF per share

• Which CF?

• P/CF addresses the issue of differences in

accounting practices and the quality of
earnings.

• CF are more frequently negative and more

volatile. END
What Are
Enterprise Value Multiples?
 EV/ EBITDA Multiple
Enterprise Value (EV)
EV/EBITDA=
Earnings before interest, tax, depreciation and amortization ( EBITDA )  

Sales revenue

+
- Cost of goods sold

+ + = Gross profit
- Operating expenses excl. D/A

= = EBITDA
-
EV Depreciation
- Amortization

= EBIT
 EV/ EBITDA Multiple
• Reflects the values of all claims on the firm’s
assets

• Useful for comparing firms of different leverage

and capital utilization

• Useful for valuing deals with substantial debt

financing

• EV/EBITDA does not factor in the firm’s capital

expenditure requirements
 Other EV Multiple
• EV / EBIT

• EV / sales

• EV / CF

END
What Are the Other Types of
Valuation Metrics?
 Industry Specific Multiples
Examples:
• Price / revenue per room

• Price / net asset value

• EV / subscriber

• EV / reserves
 Industry Specific Multiples
• Is there a fundamental indicator commonly
referenced in the industry?

• What is the common value driver of the

industry?

END
How to
Choose the Right Comps
 Choose Comps Carefully
• Analyze the company; identify value driver
• Selection criteria for comparable companies

Business profile Financial profile

 Choose Comps Carefully
Business profile
• Industry / sector / direct competitor
• Products / services
• Customers and end markets
• Distribution channels
• Geography
 Choose Comps Carefully
Financial profile
• Size
• Profitability
• Growth profile
• Return on investment
• Credit profile

How about precedent transactions?

 Choose Comps Carefully
Data to use:
• Financial reporting / filings
• Company earnings call / press release
• Equity research reports
• Industry research report
• Proxy statement for precedent transactions

END
How to
Choose the Right Multiples
 Which Multiples?
• Take a close look at the target company
• Price multiples vs. enterprise multiples
• Consider combining various multiples
• “Popular” multiples
• Utilize the industry-based multiples
 Which Multiples?
P/E P/B P/CF EV/EBITDA

Depends on
Y Y Y N
capital structure?

Reflects capital expenditure

Y N Y N
requirements

Reflects differences in
Y N Y N
interest/tax

OK to value companies with

Y N Y Y
low tangible assets?

END
How to Calculate the Multiples
 Calculate Price Multiples
Example: Using the information contained in the following table, calculate P/E,
P/B, P/CF, and P/S multiples for Company X.
Company X Company Y
Price per share 15.85 10.75
1. Total assets (billions) 99.9 123.1
Assets growth -5.7% 2.0%
2. Net revenues (billion) 57.9 61.7
Revenues growth 2.7% -1.3%
3. Net cash flow from operating 16.4 15.4
activities (billions)
Cash flow growth 5.1% 12.4%

4. Book value of common 19.6 43.1

shareholders’ equity (billions)
Debt ratio: 80.4% 65.0%
[1 - 4] ÷ (1)
5. Net profit (billions) 7.8 1.5
Earnings growth -14.3% 150.0%
6. Shares outstanding (millions) 4,646 4,340
 Calculate EV/EBITDA Multiple
Example: Given the following accounting and financial information, calculate
the Company X’s EV/EBITDA multiple.

Company X
(numbers in millions)
Cash and equivalents = $5
Minority Interest = $2
Operating Income = $34
Price per share = $12
Interest Expense = $6
Number of fully diluted shares = $20
Depreciation & Amortization = $17
MV of debt = $10
BV of preferred stock = $40

END
How to Estimate the Value
 Benchmark Multiples “How To”
• Use the most closely matched comp
• Mean or median multiple of comps
• Mean or median multiple of the industry/sector
• Use a representative equity index
• Potential ceiling (high) or floor (low)
 Benchmark Multiples
The following table provides a sample
distribution of various multiples.

Selected COMPs EV/EBITDA P/E

High 9.0x 38.1x

Mean 6.7x 18.2x
Median 6.5x 15.3x
Low 3.8x 12.6x

Industry mean 7x 17x

Industry median 6.6x 16.1x
 Estimate Value

Value Metric = Fundamental Indicator of × Benchmark Multiple

Target Company of Comps

Implied Price = EPStarget × (P/E)comps

 Estimate Value

Value Metric = Fundamental Indicator of × Benchmark Multiple

Target Company of Comps

Implied = EBITDAtarget × (EV/EBITDA)comps

Firm Value
 Estimate Value
The following table provides an example of the
estimated valuation ranges based on various
relative valuation methods.
Valuation Valuation Range Max vs. Min
Multiples
method (price per share) valuation
Comparable P/E 24.20–29.00 19.8%
companies
EV/EBITDA
Precedent P/E 27.60–32.70 18.5%
transactions
EV/EBITDA
 Be Aware
The following may happen:
• No “right” companies to use for comparison
• No “right” metric to use
• No “right” way to combine comps’ data to
produce a benchmark multiple

• What if accounting and financial reporting are

different for comps and target?
END
What Is the Significance of
Estimation Period?
 Estimation Window
• Estimation period for price
• Generally current price
• Average price over a period

• Estimation period for fundamental indicators

• Most recent fiscal year
• Historical financials (LTM or TTM)
• Forward / leading financials (NTM or next FY)
 Forward Multiples
• Example:
Given the following data, calculate Company X’s
forward P/E, based on EPS for NTM.
Company X’s current stock price as of Q2 FY0 = $10

EPS Q1 Q2 Q3 Q4
FY 0 0.1A 0.2A 0.3E 0.4E
FY 1 0.5E 0.6E 0.7E 0.8E

END
What Are the
Potential Adjustments?
 Adjustments to Earnings
• Normalize earnings
• Adjust for transitory, non-recurring
components of earnings
• Adjust for cyclicality

• Calendarization

• Differences in accounting practices

 Other Adjustments
• Adjust for recent events in between the
reporting periods

• Basic vs. Fully diluted EPS

END