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AswathDamodaran1RelativeValuation:BasicsAswathDamodaranAswathDamodaran2Whatisrelativevaluation?nInrelativevaluation,thevalueofanassetiscomparedtothevaluesassessedbythemarketforsimilarorcomparableassets.nTodorelativevaluationthen,•weneedtoidentifycomparableassetsandobtainmarketvaluesfortheseassets•convertthesemarketvaluesintostandardizedvalues,sincetheabsolutepricescannotbecomparedThisprocessofstandardizingcreatespricemultiples.•comparethestandardizedvalueormultiplefortheassetbeinganalyzedtothestandardizedvaluesforcomparableasset,controllingforanydifferencesbetweenthefirmsthatmightaffectthemultiple,tojudgewhethertheassetisunderorovervaluedAswathDamodaran3StandardizingValuenPricescanbestandardizedusingacommonvariablesuchasearnings,cashflows,bookvalueorrevenues.•EarningsMultiples–Price/EarningsRatio(PE)andvariants(PEGandRelativePE)–Value/EBIT–Value/EBITDA–Value/CashFlow•BookValueMultiples–Price/BookValue(ofEquity)(PBV)–Value/BookValueofAssets–Value/ReplacementCost(Tobin’sQ)•Revenues–Price/SalesperShare(PS)–Value/Sales•IndustrySpecificVariable(Price/kwh,Pricepertonofsteel....)AswathDamodaran4TheFourStepstoUnderstandingMultiplesnDefinethemultiple•Inuse,thesamemultiplecanbedefinedindifferentwaysbydifferentusers.Whencomparingandusingmultiples,estimatedbysomeoneelse,itiscriticalthatweunderstandhowthemultipleshavebeenestimatednDescribethemultiple•Toomanypeoplewhouseamultiplehavenoideawhatitscrosssectionaldistributionis.Ifyoudonotknowwhatthecrosssectionaldistributionofamultipleis,itisdifficulttolookatanumberandpassjudgmentonwhetheritistoohighorlow.nAnalyzethemultiple•Itiscriticalthatweunderstandthefundamentalsthatdriveeachmultiple,andthenatureoftherelationshipbetweenthemultipleandeachvariable.nApplythemultiple•Definingthecomparableuniverseandcontrollingfordifferencesisfarmoredifficultinpracticethanitisintheory.AswathDamodaran5DefinitionalTestsnIsthemultipleconsistentlydefined?•Proposition1:Boththevalue(thenumerator)andthestandardizingvariable(thedenominator)shouldbetothesameclaimholdersinthefirm.Inotherwords,thevalueofequityshouldbedividedbyequityearningsorequitybookvalue,andfirmvalueshouldbedividedbyfirmearningsorbookvalue.nIsthemultipleuniformallyestimated?•Thevariablesusedindefiningthemultipleshouldbeestimateduniformlyacrossassetsinthe“comparablefirm”list.•Ifearnings-basedmultiplesareused,theaccountingrulestomeasureearningsshouldbeappliedconsistentlyacrossassets.Thesameruleapplieswithbook-valuebasedmultiples.AswathDamodaran6DescriptiveTestsnWhatistheaverageandstandarddeviationforthismultiple,acrosstheuniverse(market)?nWhatisthemedianforthismultiple?•Themedianforthismultipleisoftenamorereliablecomparisonpoint.nHowlargearetheoutlierstothedistribution,andhowdowedealwiththeoutliers?•Throwingouttheoutliersmayseemlikeanobvioussolution,butiftheoutliersalllieononesideofthedistribution(theyusuallyarelargepositivenumbers),thiscanleadtoabiasedestimate.nAretherecaseswherethemultiplecannotbeestimated?Willignoringthesecasesleadtoabiasedestimateofthemultiple?nHowhasthismultiplechangedovertime?AswathDamodaran7AnalyticalTestsnWhatarethefundamentalsthatdetermineanddrivethesemultiples?•Proposition2:Embeddedineverymultipleareallofthevariablesthatdriveeverydiscountedcashflowvaluation-growth,riskandcashflowpatterns.•Infact,usingasimplediscountedcashflowmodelandbasicalgebrashouldyieldthefundamentalsthatdriveamultiplenHowdochangesinthesefundamentalschangethemultiple?•Therelationshipbetweenafundamental(likegrowth)andamultiple(suchasPE)isseldomlinear.Forexample,iffirmAhastwicethegrowthrateoffirmB,itwillgenerallynottradeattwiceitsPEratio•Proposition3:Itisimpossibletoproperlycomparefirmsonamultiple,ifwedonotknowthenatureoftherelationshipbetweenfundamentalsandthemultiple.AswathDamodaran8ApplicationTestsnGiventhefirmthatwearevaluing,whatisa“comparable”firm?•Whiletraditionalanalysisisbuiltonthepremisethatfirmsinthesamesectorarecomparablefirms,valuationtheorywouldsuggestthatacomparablefirmisonewhichissimilartotheonebeinganalyzedintermsoffundamentals.•Proposition4:Thereisnoreasonwhyafirmcannotbecomparedwithanotherfirminaverydifferentbusiness,ifthetwofirmshavethesamerisk,growthandcashflowcharacteristics.nGiventhecomparablefirms,howdoweadjustfordifferencesacrossfirmsonthefundamentals?•Proposition5:Itisimpossibletofindanexactlyidenticalfirmtotheoneyouarevaluing.