How to value a business by analogy, a guide to using comparative market ratios. How to Valuate a Business by Analogy: A Guide to the Why book How to Valuate a Business by Analogy: A Guide to Using Comparative Market Ratios

The book by well-known finance specialist Elena Chirkova is devoted to one of the least developed aspects of corporate finance - the applicability and correct use of the comparative method in valuation. The author not only helps a financial analyst to understand the theoretical principles of comparative valuation and the nuances of using certain comparative ratios, but also reveals the specifics of working with companies operating in emerging markets, primarily in Russia. The book is written on extensive practical material and contains examples from the author's personal experience. It is the first special textbook entirely devoted to comparative assessment and has no analogues both in Russia and in the world. 4th edition, revised and enlarged.

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by the LitRes company.

1. Introduction to the theory of multipliers

Imagine that you want to sell your two-room apartment in Moscow in a 9-story panel house built in the 1970s. You do not trust realtors and want to evaluate it yourself first. And so you open a database of apartments for sale in your city and find that two more apartments are being sold in the immediate vicinity of your house - a “odnushka” in a 9-story brick “Stalinist” building across the street and a “three-ruble note” in a “khrushchev” in your backyard. For the first one they ask for $2500 per sq. m. m, for the second - $ 1900. You call ads, ask an agent, look at apartments and as a result you will find out the following. The area of Stalin's "odnushka" - 36 square meters. m - quite decent for a one-room apartment, there is a combined bathroom with a window, as is now fashionable, a large 20-meter room, a pantry, mezzanines, but the kitchen is small - only 7 sq. m. The apartment is recently renovated, "native" parquet in excellent condition. The entrance is also renovated and equipped with an intercom. A significant disadvantage is that all windows overlook a noisy avenue, although brand new double-glazed windows muffle this noise. In addition, the floors in the house are wooden, there was no overhaul of the house. The floor is the last one. "Treshka" in the "Khrushchev" - small size, only 62 square meters. m: a tiny kitchen, no auxiliary premises, the entrance is open and very dirty, there are scribbles on the walls and it smells of homeless people, there is no elevator, and the apartment is on the fourth floor, but the house is in the courtyard (all windows face the courtyard), very green and cozy. But from the bus stop further than the "Stalinka" - there it is right in front of the windows.

Based on this information, you are trying to evaluate your “kopeck piece”, which is something between a “one-room apartment” and a “three-room apartment” - a more or less normal layout, it was recently renovated, but all the windows face the avenue, and the entrance is dirty, like in the "badass". Mentally, you make a list of factors that affect the price of an apartment: the prestige of the area, proximity to transport, the material of the house (panel, brick, monolith, etc.), its number of storeys, the condition of the house (ceilings, communications, overhaul age), the condition of the entrance , neighbors (presence of communal apartments), the presence of an elevator, a garbage chute, the availability of amenities (for example, main gas or gas water heater), the floor on which the apartment is located, windows - to the courtyard or street, layout, condition of the apartment, etc., not to mention about the legal purity of documents. Having made a rough estimate, you decide to list the apartment for $2,300 per sq. m and gradually lower the price. Realistic situation, isn't it?

What we have just done is the valuation of an object (in this case, real estate) by analogy. Imagine how many factors you need to consider even to evaluate an apartment. Approximately by analogy, a business is also evaluated, only the task becomes more complex. It is more difficult to find analogues (they are not so obvious), the range of factors that affect the value is wider, it is more difficult to formulate how our analogues (each of them) differ from the company being valued and what adjustments will need to be applied. This is what this book is about. But first, a few introductory paragraphs.

1.1. Terminology used

Anyone whose activities are related to the financial market must have heard or said himself: “this stock is quoted at P / E ten”, “this security is overvalued by P / S”. The foreign abbreviations P/S and P/E denote market ratios that are used to value companies and their securities.

In the English-language financial literature, I have counted at least six terms for valuation based on market ratios:

Grade by multipliers(from the English multiplier - a multiplier), since to obtain a result, any indicator of the company is multiplied by a certain coefficient;

Grade using the "reference" company method(guideline company), since the company being valued is compared with the reference company, the price of which is known in advance;

Grade Similarly(by analogy), since an analogy is drawn between the company being valued and the reference one;

comparative(comparable) valuation, since one security is valued by comparison with others;

relative(relative) valuation, since one security is valued relative to others (on a relative scale);

market(market) valuation, as it relies on market information about the peer company.

In this regard, I remember such a case. A few years ago, I was asked to give a lecture on multiples to an economics student, and it was presented as a presentation on the use of market comparisons in valuation. Indeed, one can say so - the possible options for the name of this method are not exhausted by the above list.

The term "assessment by analogy" was more common in the 1970s and 1980s than it is today; the term "reference company" is used more often by professional valuers than by investment bankers, while the other four terms are, in my opinion, equally widespread. But they mean the same thing: the same method or approach to evaluation, the same calculation algorithm, so the choice of the term reflects the professional affiliation of the author of the text rather than hinting at any nuances of the method.

Multipliers are widely used for "instantaneous" evaluation of companies (securities). At the same time, in the course of such an assessment, the object of assessment is compared with a certain analogue, the multipliers of which can be taken as a standard.

1.2. The concept of "animator"

The use of multipliers is due to the difficulty of establishing a direct ratio of prices for shares of different companies.

Example 1 . Assume that companies A and B are identical in absolutely everything, except for the number of shares. Let's say each company has $100 in revenue and $10 in net profit. Theoretically, the market capitalization, or the market value of 100% of the shares, of companies A and B should be the same, since it does not depend on how many shares the company's capital is divided into. Let the market capitalization of both companies be $100. At the same time, company A has 10 shares in circulation, and company B has 20 shares. Neither company has any debts. In this case, one share of company A is worth $10, and one share of company B is worth $5. Thus, the share prices of these companies differ by a factor of two, and the only reason for this is the different number of shares.

Example 2 Now suppose that Company A is similar to Company B, but exactly twice as large, so that it has $200 in revenue and $20 in net income. Meanwhile, the number of shares in companies A and B is the same - 10 each. If company B's capitalization is $100 and one share is worth $10, then company A's capitalization should be twice as large and be $200, and the cost of one share of this company should be $20.

Example 3 Finally, suppose Company A is twice the size of Company B (as in the previous example), but it has half the number of shares (10 and 20 respectively). Then one share of company A should be worth $20, and one share of company B should be worth $5.

From the above examples it is clear that there are two fundamental factors on which, other things being equal, the price of one share depends: the total number of shares and the size of the company. Thus, in order to answer the question of how overvalued or undervalued the shares of company A are compared to the shares of company B, it is necessary to take into account both the size of the company and the number of shares issued by it. You must admit that it is rather difficult to simultaneously control these two factors in calculations, even in such simplified examples as ours, not to mention more complex situations when the number of shares is in the millions (and this number is unlikely to be round). In addition, a third factor always arises: the company being valued and its benchmark are not absolutely similar: for example (very simplified), their revenue differs by one and a half times, and net profit is only 30%.

To simplify the cost analysis, the method of multipliers (comparative coefficients) was invented, which allows you to gracefully abstract from the impact on the share price of the two factors mentioned above - the size of the company and the number of shares into which its share capital is divided. In other words, this method allows calculations to be made as if the compared companies were the same size and had the same number of shares. Comparison of share prices is made in relation not to the company's revenue or net income, but to revenue or earnings per share. If we divide the price of a share by revenue or earnings per share, then we just get the P/S ratios, where P is the price (price) and S is the volume of sales in monetary terms (sales), which, as a rule, , identical to revenue, and P / E - the ratio of share price to net profit per share (earnings per share - EPS).

Multipliers allow you to think about the value of shares not as securities quotes, but as quotes of the company's financial or in-kind indicators (revenue or net profit). They show how much, for example, one dollar of company A's revenue is quoted higher than one dollar of company B's revenue, thus being relative, or comparative company valuation indicators.

Now back to our examples. The idea of multipliers is based on the economic law of one price, which states that two identical assets must have the same market prices. In this ideal model:

If companies differ from each other only in the number of shares (example 1), then their P / S and P / E values \u200b\u200bare the same;

If companies are similar, as maps of the same area are similar at different scales, or as geometric figures can be similar, and they have the same number of shares (example 2), then their multipliers also coincide;

Moreover, even when companies are similar, they have miscellaneous the number of shares (example 3), their P/S and P/E are still the same (see calculations in Table 1).

Thus, as a result of the transition to calculations per share, the procedure for cost analysis was significantly simplified and a fairly effective way was found to compare companies of different sizes with different numbers of shares. This simplification is based on two additional assumptions:

The valuation of a company by the market does not depend on the number of its shares;

The market values shares of large and small companies equally if these companies are similar.

The first assumption looks quite plausible and does not threaten the financial analyst with any complications. It is known, for example, that a stock split does not lead to a change in the company's market capitalization. In the case of the second assumption, the situation is not so unambiguous. (More on this in Section 11.5.)

1.3. Application of the multiplier-based valuation method

The main area of application of multipliers is the valuation of companies (shares). Multiplier-based valuation is very popular among financial analysts.

First, it is used by financial asset managers, financial analysts and traders to evaluate quoted securities (that is, those that already have a market price) in order to determine whether it is appropriate to purchase them at the current market price. In other words, multiples help answer the question: “Is a particular security overvalued or undervalued compared to other securities of companies in the same industry, country, etc.?”

Secondly, this method is used to value closed or unlisted companies, i.e. those whose shares do not have market quotations. Such an assessment is necessary: when carrying out mergers and acquisitions of closed companies; at the initial public offering of shares; when the share of one of the shareholders is redeemed by other shareholders; when transferring company shares as collateral; for restructuring, etc. - in short, wherever the appraisal is applicable.

It is clear that in the first case it is assumed that the market may be irrational, i.e., to evaluate financial assets not at their fair value, and in the second case it is vice versa: the valuation is based on the market prices of similar companies, and thus it is understood that these market prices fair.

Strictly speaking, valuation by multiples is not the main method of valuing stocks (companies). It is traditionally believed that the most accurate, although more time-consuming method of business valuation is cash flow discounting. However, in practice, discounting is not always applicable, and in many cases it becomes necessary to supplement it with an estimate by multipliers. It applies in particular to the following situations:

When required "instant"(read - simplified) evaluation;

with insufficient data to evaluate on discounted cash flows;

if it is not possible to provide accurate forecasting for a long period;

when it is necessary to give an assessment of objectivity(when assessed by multiples, this is ensured through the use of market information);

if you want to check the estimate using other methods, i.e. when auxiliary check methods are needed.

Let's consider these cases in more detail.

Instant assessment. A financial analyst may simply not have time to do the calculations. Often the situation requires the adoption of almost instant financial decisions, especially when trading securities, when a trader is forced to decide in a matter of seconds whether to buy or sell them. Multiplier-based valuation is by far the simplest and fastest of all known methods, which, in fact, explains its widespread use in recent times.

Lack of data. A financial analyst may not have enough data to build complex financial models. Such situations arise all the time, for example:

When buying and selling shares by a portfolio shareholder who does not have sufficient information about the company;

When conducting a valuation for the purposes of a hostile takeover, which does not involve full disclosure of information on the part of the acquired company;

When evaluating a young company (startup), which does not yet have its own history of operations.

In the absence of time and sufficient information, valuation based on multiples is practically the only way out, although not ideal.

Impossibility of accurate forecasting. Multipliers are often used as part of the discounted cash flow method. As a rule, in this case they are used in assessing the residual, or final, value of the business ( terminal value-TV). In the book [ Copeland, Koller and Murrin 2008] the term continuing value is used, translated into Russian as “extended value”. This use of market ratios is due to the fact that the cash flow model is never built on an infinitely long period. A specific forecast horizon is chosen, say 10 years, and the value of the business is calculated as the sum of the discounted cash flows for that period plus the present value of the residual value of the business at the end of the selected period. The residual value, in turn, is calculated through a multiplier, for example, as the profit of the "end" year, multiplied by a certain coefficient. The use of multipliers to calculate the residual value of a business is discussed in Sec. 9.2, which will discuss the choice of the forecasting horizon, as well as the specifics of using multipliers for these purposes.

Objectivity. In Western countries, especially in the US, multiples valuation is widely used by the judiciary. From a legal point of view, it is sometimes quite difficult to prove how fair (objective) a valuation is based on the future net cash flows of the company being valued, since we are talking about forecasts that can be very subjective. In this sense, market valuation is considered more fair and is therefore taken into account in court cases. This practice is gradually starting to take root in Russia.

In Japan, for example, before 1989 there was a law in force, according to which banks are the underwriters of the initial issues of shares ( initial public offering - IPO) were required to calculate placement prices using multiples of three comparable companies, while multiples of P/E, P/BV (an abbreviation of the expression price to book value ratio is the ratio of the market value of assets to their book value) and P/DIV ( price/dividends– “price/dividends”). This was done in order to prevent underwriters from underestimating the placement price of initial issues (as is known, the undervaluation of shares during initial placement averages 16–17% of the market price on the first day of trading), but practice has shown that this measure does not lead to the disappearance of undervaluation IPO, since the underwriting bank usually chose from possible comparable companies those that had lower multiples [ Ibbotson, Ritter 1995].

Validation of estimates by other methods. Multiplier-based estimating is a good additional test for results obtained with other methods. If the analyst has an internal feeling that the valuation based on multiples is close to fair, then its significant divergence from the discounted cash flow valuation will most likely indicate errors in the financial model (however, the discrepancy between the discounted cash flow valuation and the valuation by multiples may also indicate the wrong choice of analogues). If there were no errors in the calculations, then the valuation results obtained by these two methods should coincide or at least be in a rather narrow range (of course, such a statement implies that we are not talking about serious market anomalies).

1.4. Limitations of the multiplier valuation method

Due to the apparent simplicity and speed of the calculations, the comparative method of evaluation has become widespread, but we must not forget that "free cheese is only in a mousetrap": you have to pay for speed and simplicity, and first of all - the accuracy of the estimate. English-speaking financiers use the expression quick and dirty evaluation(quick and dirty evaluation). This is what is called the assessment based on multipliers. There are two types of error in making such an estimate.

Firstly, the error arises due to the fact that when assessing by multipliers, it is sometimes extremely difficult to select a group of peer companies that are as similar as possible to the company being valued. Just as no two people are the same, no two companies are the same. If we do not know the company being valued well enough to build a net cash flow model for it, then we also cannot accurately select analogues for it, not to mention the fact that sometimes close analogues objectively do not exist. Working with multipliers, we really get a comparative, or relative, assessment in the full sense of the word - an assessment compared with that group of analogues (or relative to it), which is selected by the appraiser. However, whether such an estimate is an approximation to a fair price is an open question.

Secondly, if the error of the first kind is a human error in the selection of analogue companies, which may be forced due to lack of information, then the error of the second kind arises regardless of the will and qualifications of the analyst. The multiplier valuation is a market valuation and is based on relevant market indicators calculated either on the basis of stock prices of public companies or on the prices of transactions for the acquisition of similar companies. The company being valued is compared on the basis of these indicators with a group of peer companies. Assuming that the market is rational and always values companies fairly (based on the present value of future cash flows), the difference in multiples between the two companies can only reflect the degree of their difference. If we assume that the market can be wrong, then different multipliers can also reflect market errors - overestimation or underestimation of the shares of one company relative to another. For the correct use of multiples, we must be sure that our group of peers is valued correctly, i.e. the market on average fairly “valued” the securities of the industry represented by the group of peers on a specific date. However, without a fundamental analysis of the situation on the financial market as a whole, there can be no such confidence.

Thus, the multiplier valuation method is fraught with certain threats arising from the fact that when using market information it is extremely difficult to correctly take into account market sentiment. The market as a whole can be “overheated” or, conversely, subject to investor panic, and in addition, it can overestimate or underestimate companies in a particular industry that is currently “in fashion” or “out of fashion”, etc. In such cases, the values of multipliers for a group of peer companies turn out to be distorted in comparison with the values calculated on the basis of their fair prices. Consequently, the advantages of multipliers are a continuation of their shortcomings. As has been repeatedly said, an assessment based on multipliers is called relative, or comparative, i.e. we evaluate the value of a particular security only in relation to to the group of peer companies (or in comparison) that we have chosen, and our method is vulnerable if, say, the market as a whole is “overheated” or a particular industry is overvalued, as happened recently, for example, with Internet shares. companies.

Here it is appropriate to make a brief but extremely important remark about the market efficiency hypothesis. Under this hypothesis, the quoted asset's market price is an unbiased estimate of its fair value. With a weak degree (weak form) of market efficiency, it is required that the price of an asset instantly take into account information that affects its price (but it is not determined which one exactly), with a medium degree (semistrong form), it is stipulated that we are talking about all publicly available information, with a strong degree (strong form) - about absolutely all information, including insider information. Quite often, the market efficiency hypothesis is interpreted in this way: "market prices for securities are fair (fair) at every moment of time." But such an interpretation is incorrect even for the hypothesis of a strong degree of market efficiency. In an efficient market, asset prices can be higher or lower than their fair values, it is only necessary that the deviations of real prices from fair ones be random. Thus, with equal probability, each security can be both undervalued and overvalued even in an efficient market. In addition, at present, most corporate finance specialists agree that the hypothesis of the efficiency of financial markets is incorrect. And this concerns efficiency not only of a strong degree (which was recognized for a long time and even by the author of this hypothesis, the American economist Eugene Fama), but also of an average degree. In support of this opinion, a huge statistical material has already been accumulated.

It turns out something like a contradiction. On the one hand, the multiplier valuation method itself carries an error, since the market prices of peer companies may be unfair. On the other hand, the comparative method is used to evaluate a quoted company, i.e., already valued by the market, precisely in order to check whether our company is undervalued or overvalued by the market at a given point in time compared to a group of peer companies. And it is the multiplier valuation method that makes it possible to assess the fairness of the company's market price.

Warren Buffett, who owns the words in the epigraph of the book, preceded the conclusion contained in them with such a story. When he was 24, he worked for Rockwood & Co., a New York chocolate company. Since 1941, when cocoa beans were sold at 50 cents a pound, the company has used the LIFO (last in, first out) inventory method. In 1954, a poor cocoa bean harvest drove prices up to 60 cents a pound, and before prices fell, the company decided to quickly sell most of its inventory. If they were simply implemented, then the income tax at the rates in force at that time would be 50%. Meanwhile, in 1954, a new tax code was passed in the United States that allowed companies to waive this tax if their stocks were distributed to shareholders as part of a business reorganization plan. Under these conditions, the management of Rockwood & Co. decided to close the sale of cocoa butter as an independent business and stated that the reserves of 13 million pounds of cocoa beans are attributable to it. The company offered its shareholders to buy their shares in exchange for cocoa beans and was ready to give 80 pounds of cocoa beans per share. Before the buyback announcement, one share of the company was worth $15, and after the buyback, its price rose to $100, despite the fact that the company suffered large operating losses during this period. $15 is far less than the market value of the cocoa beans on the balance sheet per share. On the other hand, if the quotes reach $100, then this means that the investor buying the shares gets the right to sell $48 worth of cocoa beans (80 × $0.6) and own an ownership interest in Rockwood & Co., which he values at $52 ( $100 - $48), while the company's reserves will be reduced as a result of the restructuring. In other words, an investor is willing to pay $52 for shares of a company with less inventory than the company had on its balance sheet when its shares were worth only $15. This example indicates that the stock was either undervalued prior to the buyback announcement or overvalued after it.

The inaccuracy of the estimate based on multiples does not mean that it should be discarded. Inaccurate estimates are quite acceptable if the analyst understands the limitations that the simplified cost analysis method imposes on the result and its reliability. It is much worse if quick assessments are not fully understood and filled with real content. The use of multiples for valuation sometimes comes down to a routine calculation procedure that requires familiarity with the basics of finance and knowledge of the four basic operations of mathematics, and such an approach seems accessible to everyone. Meanwhile, the competent and creative use of multipliers can significantly improve the accuracy of the assessment, i.e., if possible, mitigate the shortcomings of the method, as well as understand the causes and extent of inaccuracies, which is extremely important for making financial decisions. Thus, in the assessment it is important interpretation result, and only a thorough understanding of the applied method allows these interpretations to be made.

With a reasonable approach to multiplier valuation and competent use of all its advantages, an analyst can turn a "dirty" valuation into a virtuoso and meaningful one, however, in this case it will turn out to be not so "fast".

1.5. The place of comparative evaluation in the classification of evaluation methods

Security question 1

Next, we will talk about how the valuation of the company itself, its investment projects and securities correlate. However, I invite the reader to test his knowledge and, before he looks into the depths of the book, answer this question on his own. So how do you think they compare?

Traditionally, there are three methods for assessing a company (business):

1) by discounted cash flows (the so-called income method or income approach);

2) by assets (cost method or approach);

3) by multipliers (comparative assessment or comparative approach).

In order to determine the place of comparative evaluation among all possible methods, we would like to build a classification in a slightly different way. To this end, it is necessary to introduce three oppositions.

A valuation based primarily on information about the company itself, compared to a valuation by analogy with other companies (comparative valuation).

A company's valuation of its projects, in other words, its future cash flows, compared to the company's valuation of its current tangible and intangible assets.

Valuation based on the past versus valuation based on the present and future.

The value of a company (or business) can be represented in different ways, for example, as the sum of assets and as the sum of liabilities of a given business (the sum of assets is equal to the sum of liabilities).

On the liability side, this value can be represented as the value of the company's shares plus the value of its long-term liabilities, as well as hybrid or derivative securities, that is, those that have features of both stocks and bonds. (For simplicity, in our further discussion, we will generally abstract away from hybrid instruments.) The value of shares indicates the share of the company's assets “as if owned” by its shareholders, while the value of liabilities indicates the share of creditors in the company's assets.

On the other hand, the value of a company can be represented as the sum of its assets, and this can be done in at least two ways (a simplified division is presented in the table below).

Firstly, assets can be divided or grouped, so to speak, “by project”. For example, they can be divided into assets used for current activities, new investment opportunities (projects in the portfolio) of the company, and those assets that are not (and will not be) involved in either current activities or new projects. At the same time, the current activity can itself be considered as an investment project with zero initial investment. When dealing with assets, it is important to ensure that none of them is forgotten and at the same time that there is no double counting, such a mistake is quite easy to make. If we are talking about projects, then we evaluate them by discounted cash flows, that is, by the income that they will bring in the future. This is future-based valuation.

Secondly, assets can be grouped as balance sheet items, where they are divided into fixed and current, tangible and intangible, etc. When considering assets as fixed and current assets, all three assessment options are possible - based on the past, present and future:

future-based assessment- this is an assessment by discounting the cash flow, which, however, is not generated by the company in general and not by its business unit, but by a specific object. For example, one might assume that a company will lease out its building or lands owned by it, and discount the associated cash flows;

assessment based on the past(or the so-called cost method) is the historical amount of investments or the purchase price of an object minus its depreciation. For example, equipment with a lifespan of 10 years was bought 5 years ago for $100, so it now costs $50 (excluding repricing due to inflation);

evaluation based on this represents the current market price at which a given asset can be sold or bought, or its replacement cost, i.e. the price at which the same asset can be built (after depreciation). The market price is usually calculated based on the value of similar properties that have been sold and the price of which is known. For example, you can determine the price of a building based on its area and price per 1 sq. m, calculated on the basis of sales prices of similar buildings. This assessment is comparative. In this example, we used the comparative method to value only one of the company's assets. Other types of assets may be valued differently.

Simplified in the first case, our balance sheet looks like this:

... and in the second case like this:

However, the path of analogy, or comparison, could have been taken from the very beginning. Then, in order to evaluate the company's shares, it was not necessary to undertake an assessment of its assets either in the form of the sum of projects or in the form of the sum of factors of production. Shares could be valued directly: by comparison with the securities of other companies.

What is the difference between our classification and the commonly used one? When the company's assets are presented not as the sum of projects, but as the sum of tangible and intangible objects, i.e. assets in the accounting sense, then practically the same valuation methods are applicable to each specific asset as for the company as a whole (valuation by discounted cash flow and comparative valuation), therefore, strictly speaking, asset valuation is not an independent valuation method. Rather, it is a way of dividing a company into elements for the subsequent evaluation of each of them. I say this to bring you to the idea that comparative valuation is a method that allows you to evaluate not only the company as a whole, but also its individual assets.

1.6. Disadvantages of working with databases containing information on multipliers

Before moving on to the question of building multipliers correctly, I would like to say a few words about why you have to do it yourself every time. Currently, paid sources of financial information are available, which provide analogues for a particular company and even calculate their multipliers. It would seem that now there is no need to know the rules for their calculation, if the computer has already “calculated” everything. However, with the exception of certain cases, we do not recommend working with "ready-made" multiples due to the fact that with this approach it is extremely difficult to get a meaningful assessment of the company you are interested in.

End of introductory segment.

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The above introductory fragment of the book How to value a business by analogy: A guide to the use of comparative market ratios (E. V. Chirkova, 2017) was provided by our book partner -

Elena Vladimirovna Chirkova

How to Valuate a Business by Analogy: A Guide to Using Comparative Market Ratios

How to Valuate a Business by Analogy: A Guide to Using Comparative Market Ratios
Elena Vladimirovna Chirkova

The book is written on extensive practical material and contains examples from the author's personal experience. It is the first special textbook entirely devoted to comparative assessment and has no analogues both in Russia and in the world.

4th edition, revised and enlarged.

Elena Chirkova

How to Valuate a Business by Analogy: A Guide to Using Comparative Market Ratios

Editor Vyacheslav Ionov

Editor-in-Chief S. Turco

Project Manager O. Ravdanis

Proofreader E. Chudinova

Computer layout A. Abramov

Cover design by A. Bondarenko

The cover design uses an image from shutterstock.com.

All rights reserved. The work is intended solely for private use. No part of the electronic copy of this book may be reproduced in any form or by any means, including posting on the Internet and in corporate networks, for public or collective use without the written permission of the copyright owner. For copyright infringement, the legislation provides for the payment of compensation to the copyright holder in the amount of up to 5 million rubles (Article 49 of the LOAP), as well as criminal liability in the form of imprisonment for up to 6 years (Article 146 of the Criminal Code of the Russian Federation).

- OK then! Marya Nikolaevna finally decided. - I now know your estate ... no worse than you. What price will you put per soul? (At that time, the prices of estates, as you know, were determined by the soul.)

"Yes... I suppose... you can't take less than five hundred rubles," Sanin said with difficulty.

I.S. Turgenev. spring waters

Sometimes there's more to stock valuation than a price-to-earnings ratio.

Warren Buffett
Letter to Berkshire Hathaway Shareholders, 1988

introduction

Dear readers! I am pleased to present to you the fourth edition of my book. I started developing the topic of valuation using comparative market coefficients (or multipliers) from a methodological position back in 2000, when, while working in the investment banking division of an investment company, I realized that theoretical knowledge that can be gleaned from classic financial textbooks is clearly not enough . Each time we had to think of something, to guess about something, to rest against the impossibility of giving a reasonable interpretation of the results obtained, etc. For example, we all the time faced a huge (twice or more) gap in the company's valuation when using different multipliers , and the question constantly arose which of the estimates is closer to the truth. It was then that I began to systematize the evaluation work carried out by me and my colleagues and the results obtained in the course of it and “finish” for myself the theory of comparative coefficients, very sparingly presented in finance textbooks.

Since then, little has changed. None of the currently available open sources provides the necessary amount of knowledge for the practical mastery of the entire range of assessment methods, taking into account the nuances of applying each of them. Much knowledge is only "in the heads" of practitioners and is transmitted literally from mouth to mouth. And this circumstance creates a serious problem in raising the qualifications of financial analysts.

The realization that there is no systematic manual for such an important practical aspect of financial analytical work, combined with my personal experience, prompted me to write this book. It is based on the knowledge gained by me over several years of consulting and investment banking practice; most of the examples in the book are actual calculations made by the team I worked with while running projects, or calculations I encountered while on the "other side" of the deal...

I see my goal in providing financial analysts with theoretical knowledge and on their basis to gain practical skills necessary in order to:

Determine the appropriateness of using multiplier valuation in each specific case and understand when it is preferable to use which valuation method;

Choose the multipliers that are most suitable for evaluating a particular company;

Competently calculate the values of multipliers;

To be able to interpret the results obtained in the assessment by multipliers, i.e. to understand all the distortions and errors associated with the use of this assessment method.

Thus, we will talk about the limits of applicability of the method. All the steps described below are aimed at obtaining a more accurate assessment of both companies and their securities, the importance of which is invaluable when making an investment decision.

You have probably already noticed the second epigraph, which seems to contradict the content of the book. It would seem that if the author is going to talk about the use of comparative market coefficients (multipliers) in the assessment, then why include in the epigraph the phrase according to which the assessment should go beyond the scope of their calculation? In fact, there is no contradiction, because the purpose of this methodological manual is precisely to teach you the creative and meaningful use of multiples to value companies and show that the simplest comparisons do not always lead to the desired result.

In choosing the style of presentation for my book, I focused on readers with an initial financial background. To understand the text, you will need knowledge of such terms as "discount rate", "discounting", "discounted cash flow", "weighted average cost of capital", "fixed income security", "Gordon's dividend model", "asset pricing model". » (capital asset pricing model - СAPM). In addition, basic financial reporting skills are required. Special training in the field of valuation is not required. I expect that those who are familiar with the basics of corporate finance will understand almost every word in this book.

And now briefly about the difference between the new edition of the book and the previous one. It contains two major additions.

First. A new chapter has appeared in the book - "Using multiples to assess the overvaluation and undervaluation of the stock market as a whole." In previous editions of the book, and in this one too, I talk a lot about the fact that multiples valuation is a relative valuation, it allows you to calculate the value of an asset based on the value of similar assets, but says nothing about whether the value of similar assets is fair, can you rely on it. This is a serious problem when estimating by multiples. It is partly solvable. Very often, the revaluation of the shares of a particular group of companies, for example, an industry one, is associated with overheating of the market as a whole. And the revaluation of the market as a whole may well be tested with the help of multiples, in particular, historical averages. This will be discussed in the next chapter.

Second. I came across the fact that, even after studying the theory, analysts do not always know where to get data for calculating multipliers - to peep possible analogue companies, analyze whether they are suitable, find transactions with similar assets, find their financial indicators, and in some cases and ready-made multipliers. Therefore, I have prepared for you a list of the main sources of information, which includes more than 20 resources both on international companies and transactions, and on Russian ones. A significant part of them is paid, but large companies subscribe to a lot or are ready to subscribe if necessary.

I also updated the statistics, made a list of sources on the topic, and made other changes that I felt were necessary.

1. Introduction to the theory of multipliers

1.1. Terminology used

In the English-language financial literature, I have counted at least six terms for valuation based on market ratios:

Evaluation by multipliers (from the English multiplier - multiplier), since to obtain a result, any indicator of the company is multiplied by a certain coefficient;

Evaluation by the "reference" company method (guideline company), since the company being valued is compared with the reference company, the price of which is known in advance;

Evaluation by analogy (by analogy), since an analogy is drawn between the company being valued and the reference one;

How to evaluate a business by analogy. Chirkova E.V.

Methodological manual on the use of comparative market coefficients in the valuation of business and securities.

M.: 2005. - 190 p.

The book by Elena Chirkova, a well-known financial consultant, co-head of M&A and fundraising at Deloitte's Financial Services Department, is devoted to one of the least developed aspects of corporate finance - the applicability and correct use of the comparative method in valuation. The author not only helps a financial analyst to understand the theoretical principles of comparative valuation and the nuances of using certain comparative ratios, but also reveals the specifics of working with companies operating in emerging markets, primarily in Russia.

The book is intended for financial analysts, investment appraisers, teachers and students.

Format: djvu/zip

Size: 1.4 6 MB

/ Download file

CONTENT
Preface 7
Opening remarks 9
1 Introduction to the theory of multipliers 13
1.1. Terminology used 13
1.2. The concept of "multiplier" 14
1.3. Elaboration of valuation based on multiples in the financial literature and the idea behind writing this book 18
1.4. Book 22 Tasks
1.5. Disadvantages of working with databases containing information on multipliers 23
1.6. Application of the valuation method based on multiples 25
1.7. "Limitations" of the multiplier valuation method 29
1.8. The place of comparative evaluation in the classification of evaluation methods 34
1.9. Summary 37
2. What are multipliers, how did they arise and how are they used 39
2.1. "One Hundred Thousand Whys" - about animators 39
2.2. The logic of multipliers on the example of the indicator "price / net profit" 40
2.3. Summary 46
3 Multiplier numerator 47
3.1. The price of one share or 100% of the shares? 47
3.2. With or without options? 49
3.3. Market capitalization or business value? ... 52
3.4. Quotes or prices of large transactions? 57
3.5. Transaction prices for closed or public companies? 62
3.6. Asset prices 65
3.7. Summary 66
4 Denominator of the multiplier 68
4.1. What indicators can serve as denominators of the multiplier 68
4.2. Questions of correspondence between the numerator of the multiplier and its denominator 73
4.3. Summary 74
5 Profitable financial multipliers 75
5.1. Profit and loss statement indicators used to calculate multiples 75
5.2. Price/revenue multiplier 77
5.3. Ratio of share price to earnings before taxes, interest and amortization and operating margin 80
5.4. Multiplier "price/net profit" 84
5.5. Cash flow based indicators 87
5.6. Price/dividend multiplier 90
5.7. Summary 94
6 Financial indicators based on the value of assets 97
6.1. Types of indicators based on the value of assets 97
6.2. Relationship between balance multipliers and yield multipliers 100
6.3. Advantages, disadvantages and applicability of balance sheet indicators 103
6.4. Summary 106
7 Natural indicators 108
7.1. Applicability of natural indicators 108
7.2. The main types of natural indicators 111
7.3. Summary 114
8 “Future multiples” and growth multiples 115
8.1. Multiples based on current share prices and future financial performance 115
8.2. Multipliers using growth rates 119
8.3. Multiples based on future stock prices 121
8.4. Summary 129
9 Some special uses of multipliers 131
9.1. Using multipliers when attracting loan financing 131
9.2. Using multipliers when calculating the residual value of a business 137
9.3. Using multiples to express business value as a formula 144
9.4. Summary 146
10 Selection of analogues 148
10.1. Key factors influencing the choice of analogues 148
10.2. Country factor 149
10.3. Industry factor 152
10.4. Time factor 155
10.5. Other factors 161
10.6. Summary 164
11 Methods for calculating multipliers and their applicability 166
11.1. Palette of methods for calculating multipliers 166
11.2. Methods for calculating the average value of the multiplier 167
11.3. Regression Equation 169
11.4. Industry applicability of methods 174
11.5. Summary 176
12. Comparability of companies from developed and emerging markets: calculations and interpretations 177
12.1. Causes of Valuation Gap: Difference in Business Returns 178
12.2. Causes of the Valuation Gap: Differences in Expected Growth Rates 179
13 Instead of a conclusion 184
Answers to security questions 187
List of used abbreviations 192

How to evaluate a business by analogy. Chirkova E.V.

Methodological manual on the use of comparative market coefficients in the valuation of business and securities.

M.: 2005. - 190 p.

The book is intended for financial analysts, investment appraisers, teachers and students.

Format: djvu/zip

Size: 1.4 6 MB

/ Download file

Editor Vyacheslav Ionov

Chief Editor S. Turco

Project Manager O. Ravdanis

Corrector E. Chudinova

Computer layout A. Abramov

Cover design A. Bondarenko

The cover design uses an image from a stock photo bank. shutterstock.com

* * *

- OK then! Marya Nikolaevna finally decided. - I now know your estate ... no worse than you. What price will you put per soul? (At that time, the prices of estates, as you know, were determined by the soul.)

"Yes... I suppose... you can't take less than five hundred rubles," Sanin said with difficulty.

I.S. Turgenev. spring waters

Sometimes there's more to stock valuation than a price-to-earnings ratio.

Warren Buffett
Letter to Berkshire Hathaway Shareholders, 1988

introduction

I see my goal in providing financial analysts with theoretical knowledge and on their basis to gain practical skills necessary in order to:

Determine the appropriateness of using multiplier valuation in each specific case and understand when it is preferable to use which valuation method;

Choose the multipliers that are most suitable for evaluating a particular company;

Competently calculate the values of multipliers;

To be able to interpret the results obtained in the assessment by multipliers, i.e. to understand all the distortions and errors associated with the use of this assessment method.

And now briefly about the difference between the new edition of the book and the previous one. It contains two major additions.

I also updated the statistics, made a list of sources on the topic, and made other changes that I felt were necessary.

1. Introduction to the theory of multipliers

1.1. Terminology used

Anyone whose activities are related to the financial market must have heard or said himself: “this stock is quoted at P / E ten”, “this security is overvalued by P / S”. Foreign abbreviations P / S and P / E denote market ratios that are used to value companies and their securities.

In the English-language financial literature, I have counted at least six terms for valuation based on market ratios:

Grade by multipliers(from the English multiplier - a multiplier), since to obtain a result, any indicator of the company is multiplied by a certain coefficient;

Grade using the "reference" company method(guideline company), since the company being valued is compared with the reference company, the price of which is known in advance;

Grade Similarly(by analogy), since an analogy is drawn between the company being valued and the reference one;

comparative(comparable) valuation because one security is valued by comparison with others;

relative(relative) valuation, since one security is valued relative to others (on a relative scale);

market(market) valuation, as it relies on market information about the peer company.

1.2. The concept of "animator"

The use of multipliers is due to the difficulty of establishing a direct ratio of prices for shares of different companies.

Example 1 . Assume that companies A and B are identical in absolutely everything, except for the number of shares. Let's say each company has $100 in revenue and $10 in net profit. Theoretically, the market capitalization, or the market value of 100% of the shares, of companies A and B should be the same, since it does not depend on how many shares the company's capital is divided into. Let the market capitalization of both companies be $100. At the same time, company A has 10 shares in circulation, and company B has 20 shares. Neither company has any debts. In this case, one share of company A is worth $10, and one share of company B is worth $5. Thus, the share prices of these companies differ by a factor of two, and the only reason for this is the different number of shares.

Example 2 Now suppose that Company A is similar to Company B, but exactly twice as large, so that it has $200 in revenue and $20 in net income. Meanwhile, the number of shares in companies A and B is the same - 10 each. If company B's capitalization is $100 and one share is worth $10, then company A's capitalization should be twice as large and be $200, and the cost of one share of this company should be $20.

Example 3 Finally, suppose Company A is twice the size of Company B (as in the previous example), but it has half the number of shares (10 and 20 respectively). Then one share of company A should be worth $20, and one share of company B should be worth $5.

Now back to our examples. The idea of multipliers is based on the economic law of one price, which states that two identical assets must have the same market prices. In this ideal model:

If companies differ from each other only in the number of shares (example 1), then their P / S and P / E values \u200b\u200bare the same;

Moreover, even when companies are similar, they have miscellaneous the number of shares (example 3), their P/S and P/E are still the same (see calculations in Table 1).

The valuation of a company by the market does not depend on the number of its shares;

The market values shares of large and small companies equally if these companies are similar.

1.3. Application of the multiplier-based valuation method

The main area of application of multipliers is the valuation of companies (shares). Multiplier-based valuation is very popular among financial analysts.

When required "instant"(read - simplified) evaluation;

with insufficient data to evaluate on discounted cash flows;

if it is not possible to provide accurate forecasting for a long period;

when it is necessary to give an assessment of objectivity(when assessed by multiples, this is ensured through the use of market information);

if you want to check the estimate using other methods, i.e. when auxiliary check methods are needed.

Let's consider these cases in more detail.

Lack of data. A financial analyst may not have enough data to build complex financial models. Such situations arise all the time, for example:

When buying and selling shares by a portfolio shareholder who does not have sufficient information about the company;

When conducting a valuation for the purposes of a hostile takeover, which does not involve full disclosure of information on the part of the acquired company;

When evaluating a young company (startup), which does not yet have its own history of operations.

In the absence of time and sufficient information, valuation based on multiples is practically the only way out, although not ideal.

Impossibility of accurate forecasting. Multipliers are often used as part of the discounted cash flow method. As a rule, in this case they are used in assessing the residual, or final, value of the business ( terminal value-TV). In the book [ Copeland, Koller and Murrin 2008] used the term continuing value, translated into Russian as "extended value" . This use of market ratios is due to the fact that the cash flow model is never built on an infinitely long period. A specific forecast horizon is chosen, say 10 years, and the value of the business is calculated as the sum of the discounted cash flows for that period plus the present value of the residual value of the business at the end of the selected period. The residual value, in turn, is calculated through a multiplier, for example, as the profit of the "end" year, multiplied by a certain coefficient. The use of multipliers to calculate the residual value of a business is discussed in Sec. 9.2, which will discuss the choice of the forecasting horizon, as well as the specifics of using multipliers for these purposes.

In Japan, for example, before 1989 there was a law in force, according to which banks are the underwriters of the initial issues of shares ( initial public offering - IPO) were required to calculate placement prices using multiples of three comparable companies, while multiples of P/E, P/BV (an abbreviation of the expression price to book value ratio is the ratio of the market value of assets to their book value) and P/DIV ( price/dividends– “price/dividends”). This was done in order to prevent underwriters from underestimating the placement price of initial issues (as is known, the undervaluation of shares during initial placement averages 16–17% of the market price on the first day of trading), but practice has shown that this measure does not lead to the disappearance of undervaluation IPO, since the underwriting bank usually chose from possible comparable companies those that had lower multiples [ Ibbotson, Ritter 1995].

Here it is necessary to clarify that it is better to compare the prices of one share, and not the capitalization of various companies, since in the long term it is necessary to evaluate the results that a company shows per share in order not to “mix” the impact on the capitalization of mergers and acquisitions into operating results, issues and buybacks of shares, etc. This is logical from the point of view of the company's shareholders, who, during mergers and acquisitions and when issuing new shares, have the same number of shares in their hands as before, and only their share in the company changes ( unless they invest in it by buying shares of additional issue, or sell shares when they are bought out by the company). For more details, see sec. 3.1.

The term terminal value is also used, which is often translated either as "tracing paper" from English - "terminal value" or "final value". There is also the term postprognosis value - post-forecast value. I prefer the good Russian expression "residual value".

How to value a business by analogy, a guide to using comparative market ratios. How to Valuate a Business by Analogy: A Guide to the Why book How to Valuate a Business by Analogy: A Guide to Using Comparative Market Ratios

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* * *

How to evaluate a business by analogy. Chirkova E.V.

How to evaluate a business by analogy. Chirkova E.V.

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introduction

1. Introduction to the theory of multipliers

1.1. Terminology used

1.2. The concept of "animator"

1.3. Application of the multiplier-based valuation method

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