Finance Valuation Methods: Relative, Intrinsic, and Special Cases

What is the fundamental core of everything you do in finance and investing?

Valuation

What are the two fundamental ways to value a company?

Relative valuation and Intrinsic valuation

What does relative valuation compare a company to?

What similar companies are worth

What does intrinsic valuation estimate?

The net present value of its future cash flows, or its Assets net of Liabilities

What are the two main relative valuation methodologies?

Comparable Public Companies (Public Comps) and Precedent Transactions

What is the basic idea of a Discounted Cash Flow (DCF) analysis?

A firm's value is the sum of its discounted future cash flows and its discounted terminal value

What is a Net Asset Value (or Liquidation) model?

Valuing a firm's Assets and subtracting the modified Total Liability Value

Which industries most commonly use a Net Asset Value model?

Balance Sheet-centric industries such as insurance

Why will you almost always use Public Comps and Precedent Transactions in any industry?

Because they are universally applicable

In which types of industries is a DCF analysis generally NOT relevant?

Commercial Banks, Insurance Firms, (Some) Oil & Gas Companies, Real Estate Investment Trusts (REITs)

Why might a DCF not be relevant for a commercial bank?

"Free Cash Flow" is not a meaningful metric

For what type of company does a DCF work best?

Stable, mature companies with predictable growth rates and profit margins

Why do Precedent Transactions generally produce higher numbers than Public Comps?

A buyer must pay a premium to acquire 100% of another company

Does valuation give you a precise, perfectly accurate number?

No, it is used to estimate a valuation range

What are the three main criteria for picking Comparable Public Companies?

Geography, Industry, and Financial metrics like Revenue or EBITDA

What is the additional fourth criterion used for selecting Precedent Transactions?

Time (e

g

, Transactions Since X year)

What is a Liquidation Valuation?

Valuing a company's Assets, assuming they are sold to repay its Liabilities, with the remainder going to Equity Investors

What is an M&A Premiums Analysis?

Selecting Precedent Transactions and calculating the premium the buyer paid for the seller's share price in each case

What is a Future Share Price Analysis?

Projecting a company's future share price based on the P/E multiple of comparable companies, then discounting it back to present value

What is a Sum of the Parts valuation?

Splitting a company into different segments, picking different sets of comparables for each, valuing them separately, and adding them up

What is a Leveraged Buyout (LBO) Analysis used for in the context of general valuation?

To determine the minimum amount a PE firm could pay to achieve a target return, setting a "floor" on valuation

Metrics & MultiplesHow do you calculate the P/E multiple?

Price Per Share / Earnings Per Share, or Equity Value / Net Income

What is EBIT mathematically equivalent to on the income statement?

The company's Operating Income

How do you calculate EBITDA?

EBIT + Depreciation + Amortization

What is one standard method to calculate Unlevered Free Cash Flow?

EBIT * (1 - Tax Rate) + Non-Cash Charges - Change in Operating Assets and Liabilities - CapEx

What is one standard method to calculate Levered Free Cash Flow?

Net Income + Non-Cash Charges - Change in Operating Assets and Liabilities - CapEx - Mandatory Debt Repayments

What does Enterprise Value / EBIT rough approximation measure?

How valuable a company is relative to its income from business operations

What does Enterprise Value / EBITDA rough approximation measure?

How valuable a company is relative to its operational cash flow

What does the P/E multiple measure?

How valuable a company is in proportion to its after-tax earnings

Which two profitability multiples are by far the most common in finance?

EV/EBITDA and EV/EBIT

Why is P/E considered the "least accurate" or worst multiple?

It includes non-cash charges and is impacted by tax rates and capital structures

Why are Free Cash Flow multiples not used as frequently as EBIT/EBITDA?

They take more time to calculate and may not be standardized across companies

What is "Book Value" just another word for?

Shareholders' Equity

Why have Price to Book Value (P/BV) multiples become less relevant over time for most industries?

Companies have become more service and intellectual property-oriented over time

What specific multiple is often used for Retail, Restaurant, and Airlines?

EV/EBITDAR, where the R stands for Rent

Why is EV/EBITDAR used for retail and airlines?

For comparability purposes because some companies own buildings and others rent them

What unique multiple is commonly used for Oil & Gas companies to normalize accounting differences?

EV/EBITDAX, where the X stands for Exploration expense

What metrics are commonly used for Real Estate Investment Trusts (REITs)?

P/FFO (Funds from Operations) per Share and P/AFFO (Adjusted Funds from Operations) per Share

What multiples might you use for Internet companies that do not yet have revenue?

EV / Unique Visitors or EV / Registered Users

After calculating multiples for a set of comps, what statistical figures do you typically find?

Minimum, maximum, median, 25th percentile, and 75th percentile

Meaning, Trade-offs & CorrelationsWhat is the most common incorrect interpretation of a valuation's output?

That it tells you exactly how much a company is worth

What type of graph is normally used to present the full range of valuation values?

A "Football Field" graph

What is a key advantage of using Public Comps?

They are based on real data as opposed to future assumptions

What is a key disadvantage of using Public Comps?

There may not be true comparables, and it is less accurate for thinly traded stocks

What is a key advantage of using Precedent Transactions?

They are based on what real companies have actually paid for other companies

What is a key disadvantage of using Precedent Transactions?

Data can be spotty and there may not be truly comparable transactions

What is a key advantage of a DCF?

It is less subject to market fluctuations and theoretically sound since it is based on ability to generate cash flow

What is a key disadvantage of a DCF?

It is highly subject to far-in-the-future assumptions and less useful for fast-growing, unpredictable companies

What is the major disadvantage of Liquidation Valuation?

It tends to produce extremely low values that are not useful for most healthy companies

Why can't you use acquisitions of private companies in an M&A Premiums Analysis?

Premiums only apply to public companies with stock prices

What is an advantage of a Sum of the Parts valuation?

It more accurately values diversified, conglomerate-type companies

Generally, which produces a higher valuation: Precedent Transactions or Public Comps?

Precedent Transactions tend to be higher due to the control premium

Which methodology produces the lowest numbers 99% of the time?

Liquidation Valuation

How does revenue growth typically correlate with valuation multiples?

A company with higher revenue growth generally has higher revenue multiples than peers not growing as quickly

What is a PEG multiple?

P/E Divided by EPS Growth

Do companies with identical multiple figures always have similar true valuations?

No, basic math can impact multiples, especially when companies have very different margins

Real World ScenariosWhat are the three primary purposes of a valuation in the real world?

To give a client an idea of value, to justify an acquisition offer, or to approximate value for internal purposes

Why might a company be legitimately valued at a premium to its peers?

Due to market position, competitive advantages not in the financials, or recent positive announcements

How does owning versus leasing a building impact a company's EBITDA?

Owning results in depreciation and interest which are excluded from EBITDA; leasing creates rental expense which reduces EBITDA

If a Biotech company doesn't have revenue yet, what is an acceptable alternative to relative valuation?

Creating a far-in-the-future, multi-stage DCF based on drug market size

What are the 3 major valuation methodologies you walk through in an interview?

Public Company Comparables, Precedent Transactions, and the Discounted Cash Flow Analysis

Which two methodologies are examples of relative valuation?

Public Comps and Precedent Transactions

Which methodology is an example of intrinsic valuation?

Discounted Cash Flow Analysis

How do you calculate multiples for Precedent Transactions?

They must be based on the purchase price of the company at the time of the deal announcement

Should you ever look at a seller's Equity Value prior to a deal being announced for transaction multiples?

No, you only care about what the offer price was at the initial deal announcement

How would you fundamentally value an apple tree?

By looking at what comparable apple trees are worth and the present value of the apple tree's cash flows

When is a DCF strictly not so useful?

When cash flows are unpredictable or when Debt and Operating Assets fundamentally drive the business like in Banks

What are four examples of more "exotic" valuation methodologies?

Liquidation Valuation, LBO Analysis, Sum of the Parts, and M&A Premiums Analysis

When is a Liquidation Valuation specifically useful?

In bankruptcy scenarios to advise if it's better to sell off Assets separately or sell 100% of the company

When would you strictly use a Sum of the Parts valuation?

When a company has completely different, unrelated divisions like a conglomerate

Why might an LBO Analysis be used when both strategics and financial sponsors are competing to buy a company?

To determine the potential price if a PE firm were to acquire the company

In a Football Field chart, what specific percentile markers do you calculate to define the boxes?

Minimum, 25th percentile, median, 75th percentile, and maximum

What is the fundamental idea or purpose of EBITDA?

To move closer to a company's cash flow since Depreciation and Amortization are non-cash expenses

What is the largest glaring problem with using EBITDA as a proxy for cash flow?

It completely excludes Capital Expenditures (CapEx)

Do you pair Unlevered Free Cash Flow with Equity Value or Enterprise Value?

Enterprise Value

Do you pair Levered Free Cash Flow with Equity Value or Enterprise Value?

Equity Value

Why is calculating Equity Value / EBITDA comparing apples to oranges?

EBITDA is available to all investors, while Equity Value only reflects what is available to common shareholders

Why does Warren Buffett famously dislike EBITDA?

Because it hides the Capital Expenditures companies make and disguises how much cash they require

Does EBIT explicitly include Capital Expenditures?

No, but it includes Depreciation, which follows CapEx closely

Besides CapEx and interest, what is another major cash item that EBITDA ignores?

Working capital requirements like Accounts Receivable and Inventory

What is the main difference in usage between P/E and EV/EBITDA?

P/E depends on the company's capital structure, whereas EV/EBITDA is capital structure-neutral

In what specific industry condition are you more likely to use EV/EBIT over EV/EBITDA?

In industries where D&A is large and Capital Expenditures and fixed assets are important

Could EV/EBITDA ever mathematically be higher than EV/EBIT for the exact same company?

No, because EBITDA must be greater than or equal to EBIT

What industry-specific multiple might be used for technology/Internet companies?

EV / Unique Visitors or EV / Pageviews

Why do you pair Enterprise Value with industry metrics like Subscribers or Proved Reserves?

Because those metrics are "available" to all the investors (both debt and equity) in the company

Is there a strict rule ranking the 3 main valuation methodologies from highest to lowest?

No, it is a trick question and there is no ranking that always holds up

Would an LBO or DCF model generally produce a higher valuation?

A DCF, because an LBO only derives value from the final year whereas a DCF includes period cash flows

In what unusual scenario would a Liquidation Valuation produce the highest value?

If a company had substantial hard assets but the market severely undervalued its earnings

Why are Public Comps and Precedent Transactions sometimes viewed as being more reliable than a DCF?

Because they are based on actual market data, as opposed to assumptions far into the future

What is a major flaw with Public Company Comparables regarding market psychology?

The stock market is emotional, so multiples might be dramatically higher or lower on certain dates

Give a situation where Precedent Transactions would NOT produce a higher value than Public Comps

When there is a substantial mismatch between the M&A market and the public markets

What are two major flaws with Precedent Transactions?

Past transactions are rarely 100% comparable, and data is generally more difficult to find

What qualitative factor could cause a company to be valued at a premium despite identical margins?

A strong brand name, such as Coca-Cola

How mechanically do you take into account a company's competitive advantage in a valuation model?

Highlight the 75th percentile of multiples, add a premium, or use more aggressive projections

Do you ALWAYS strictly use the median multiple of a set of public comps?

No, you almost always show a range and may focus on other percentiles

Why might two identical companies sell for vastly different EBITDA multiples in precedent transactions?

One process was more competitive, one had recent bad news, or different accounting standards

If buying a vending machine business, would you pay a higher EV/EBITDA multiple if the machines were owned or leased?

You would pay a higher multiple for the one with leased machines if all else is equal