Corporate Valuation

Syllabus topics

i. Dividend Discount Model, Constant growth / zero growth/ H Model

ii. Relative Valuation -Using Equity and Enterprise Multiples
iii. Asset based approaches
iv. EP Model, Book Value approach, Earnings Capitalization approach
v. Valuing private businesses, intangibles, financial companies

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Relative Valuation
Equity and Enterprise Multiples
Relative Valuation
▪ Relative Valuation is a Pricing Game
▪ In relative valuation, the value of an asset is compared to the values assessed
by the market for similar or comparable assets.
▪ You need:
▫ Comparable assets and their market prices
▫ A multiple (ratio)
▫ To compare the multiples of similar assets controlling for any
differences between the firms to judge whether the asset is under or
over priced

4
Relative Valuation Multiples (Ratios)

Equity Multiples

1. PE = Price / Earnings = MPS EPS = Market Capitalization Net Income

2.PB = Price / Book = MPS BVPS

= Market Capitalization (Book value of equity share capital + R&S)

3. Price / Dividend MPS DPS = Market Capitalization Dividend paid

4. Price / FCFE

5. PEG =PE / Growth 5

Relative Valuation Multiples (Ratios)
Enterprise Value
Multiples

1. EV/ Sales = (Market Capitalization + Market value of Debt – Cash) Sales

2.EV/ EBITDA = (Market Capitalization+ Market value of Debt – Cash)

Earnings before Interest, Tax, Depreciation & Amortization

3. EV/ Invested Capital = (Market Capitalization + Market value of Debt – Cash)

Book Value of Equity + Book Value of Debt – Cash

6
Relative valuation -Rationale
▪ Relative valuation mostly reflects market perceptions and moods

▪ When multiples are used as screens, relative valuation requires less

information than DCF valuation

▪ Relative Valuation is useful when:

▫ the objective is to sell a security at that price today (as in the case of an IPO)
▫ investing on “momentum” based strategies

▪ Since portfolio managers are judged based upon how they perform on a
relative basis (to the market and other money managers), relative valuation
is more tailored to their needs

7
Why Analyst mostly use relative valuation?
1. It is easier to sell with relative valuation as we need to just find a group
of companies that are overvalued and compare with them
(Pick the right group to compare and you can prove any thing you want).

2. With relative valuation, there will always be a significant proportion of

securities that are under valued and over valued.
3. It is much easier to put the blame on the market. With relative valuation,
you have a line of defense.
4. In DCF, if you are wrong, you are wrong alone. It may happen that when
everyone is buying, you are selling, and when everyone is selling, you are
buying. But in relative valuation, you are never alone. The ones who are
alone, if they make a mistake, get fired .
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Which valuation approach to use?
▪ We should acknowledge that there is a market that has information. We
cannot ignore it. It is better to aid intrinsic valuation with relative
valuation to understand the mood of the market
▪ Comparing both intrinsic and relative value, you can check whether you
have done some grave mistakes in intrinsic valuation

Use both…………….Intrinsic and Relative valuation

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Decomposing the Multiple
1. Define the multiple (know how to compute it to use for comparison)
The same multiple can be defined in different ways by different users. When comparing and using
multiples calculated by others, it is critical to understand how the multiples have been estimated.
2. Describe the multiple (know the nature of the multiple)
Know the cross-sectional distribution of a multiple to help you look at a number and pass
judgment on whether it is too high or low. Use histograms to see the distribution of the data
3. Analyze the multiple (know the fundamental drivers)
Understand the fundamentals that drive each multiple, and the nature of the relationship
between the multiple and each variable.
4. Apply the multiple (know how to use multiples to value a business)
Define the comparable universe and control for differences
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I. Definitional Test
I. Definitional Test
A. Principle of Consistency
▫ Both the numerator and the denominator of a multiple should
address to the same claimholders in the firm.
▫ If the numerator figure is addressing to the equity holders, the
denominator should also be an equity figure.
▫ The definition of consistency does not mean you have the same
formula used for all the firms in comparable

B. Principle of Uniformity
▫ The variables used in calculating the multiple should be defined and
estimated uniformly across assets in the “comparable firm” list.
▫ If earnings-based multiples are used, the accounting rules to
measure earnings should be applied consistently across assets.
The same rule applies with book-value based multiples.
12
Creation of a Valuation Multiple

13
Source: Damodaran on Valuation by Aswath Damodaran, Wiley Finance
A. Consistency Test
▪ P/E (consistent)  Price / EBITDA (inconsistent)
= MV of equity ÷ EBITDA of firm
= Market price per share
÷ Earnings per share (if a company raises debt to buyback shares,
the market value would shrink, but EBITDA
would remain the same as it is calculated
▪ EV / EBITDA (consistent) before interest, so all the stocks with lots of
debt will look cheaper. If you are comparing
= (MV of debt + MV of equity – Cash) firms with different debt ratios, the firms
÷ EBITDA of the firm with more debt will look cheaper on a Price to
EBITDA basis)

▪ EV / Sales (consistent)  Price / Sales (inconsistent)

= (MV of debt + MV of equity – Cash) = MV of equity ÷ Sales of firm
÷ Sales of the firm
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B. Uniformity Test

There are several ways in which P/E ratio can be computed:

▪ Price: is usually the current price
is sometimes the average price for the year
▪ EPS: EPS in most recent financial year (Current P/E)
EPS in trailing 12 months (Trailing P/E)
Forecasted earnings per share in future year (Forward P/E,2024)

First question to ask on looking at a multiple is what is the definition of that multiple

15
II. Descriptive Test
Multiples have skewed distribution
Price to Earnings ratio of Indian firms in June 2023
400

350

300

250
No. of firms

200

150

100

50

0
<4 4-8 8-12 12-16 20-24 24-28 28-32 32-36 36-40 40-50 50-75 75-100 >100
No. of firms 162 190 306 295 232 179 171 148 124 233 335 178 342
PE ratio

17
Multiples have skewed distribution
Price to Book ratios of Indian companies in June 2023
3000

2500

2000
No. of firms

1500

1000

500

0
<4 4-10 10-20 20-40 40-80 >80
No. of firms 2800 737 215 64 19 11
PE ratio

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Multiples of the Indian Equity Market - June 2023
No. of firms lost
in the sample PE ratio Price to Book ratio EV to EBITDA ratio

Total number of listed

companies
4201 4201 4201

Firms with a multiple 3166 3846 4063

Outliers push
the average to
almost twice Average 50.11 4.17 129.98
the median

Median 26.72 1.93 14.76

Minimum 0.00 0.01 0.26

Maximum 1948.95 271.32 2793

You lose even more firms as you go to forward P/E, because you need analyst estimates of expected earnings per 19
share to compute this. Any firms not followed by analysts will not have a forward P/E
II. Descriptive Test
▫ Multiples have asymmetric distribution. They range from zero to infinity

▫ Throwing out the outliers may seem like an obvious solution while calculating the
average of a multiple, but if the outliers all lie on one side of the distribution (they
usually are large positive numbers), it can lead to a biased estimate.

▫ Statistics help to make sense of large and contradictory data and so for an
asymmetric distribution, use Median instead of Mean to calculate the average of a
multiple

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Impact of Survival Bias on the Average of a Multiple
▪ Survival Bias - When the sample does not calculate valuation multiples for
firms with negative earnings, you are throwing away the most distressed,
the youngest, the riskiest and high growth companies from the sample. This
introduces bias into the process of calculating average of multiples across
industry/ sector.

▪ We need to know the average, standard deviation, median, and outliers to

get a sense of the data

▪ Are there cases where the multiple cannot be estimated? Will ignoring
these cases lead to a biased estimate of the multiple?
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Trailing PE ratios across the Globe

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Source: Damodaran on Valuation by Aswath Damodaran, Wiley Finance
Price to Book ratios across the Globe

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Source: Damodaran on Valuation by Aswath Damodaran, Wiley Finance
Global sample
▪ Earlier, the risk in a developing market was higher than developed market.
But now due to globalization, difference between developed and developing
countries risk premiums has reduced. So, the comparables can be from all
over the globe. The Analyst can take global data for Relative Valuation
▪ Data service providers like Bloomberg, Capital IQ provide information for
relative valuation.
▪ While calculating multiples, currency does not matter
▪ Using multiples, a global investor can find whether a country is cheap or
expensive.

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EV to EBITDA ratios across the Globe
It is important to know how a multiple has changed over time to defy the rule of thumb

2010 2023

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Source: Damodaran on Valuation by Aswath Damodaran, Wiley Finance
III. Analytical Test
III. Analytical Test
1. What are the fundamentals that drive a multiple?
Every multiple has a companion variable - its key determinant, its driver

2. How do changes in these fundamentals change the multiple?

The relationship between a fundamental and a multiple is almost never linear.
It is impossible to properly compare firms on a multiple, if we do not know how
fundamentals and the multiple move.

Not only is it important that you find the drivers for each multiple, but you need to understand how
changes in these drivers change the multiple. For example, we all accept the intuition that a company
with a 20% growth rate should have a higher PE than an otherwise similar company with a 10% growth
rate, but how much higher? Twice as high (which would make the relationship linear), 2.5 times as high, 1.5
times as high…
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Dividend Discount Model (DDM) and its variations
▪ DDM Single-period, P0

▪ DDM with zero growth, P0

▪ DDM Constant /stable growth, P0

∗( )

▪ DDM 2- stage model

∗ ∗ ∗[ ] ∗ ∗ ∗( )
P0
∗
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1. PE ratio
▪ To understand the fundamentals of a multiple, start with the basic dividend
discount model which is the most basic discounted cash flow method.
▫ With the dividend discount model,
∗( )∗
P0

▫ Dividing both sides by the current earnings per share,

∗ ∗ 𝐏𝐚𝐲𝐨𝐮𝐭 𝐑𝐚𝐭𝐢𝐨∗(𝟏 𝐠𝐧)
∗( ) 𝐫 𝐠𝒏

▫ If this had been a FCFE Model, P0

( )∗( )
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1. PE ratio
▪ With the two-stage dividend discount model, dividing both sides by the
earnings per share:
1+g n
P0 Payout Ratio ∗ 1 + g ∗ [1 − ] Payout Ratio ∗ 1 + g n ∗ (1 + gn)
1+r n
= +
EPS0 r −g rn − gn ∗ 1 + r n

▪ For a firm that does not pay what it can afford to in dividends, substitute
FCFE/Earnings for the payout ratio.

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Calculating intrinsic PE – A simple example
Assume that you have been asked to estimate the PE ratio for a firm which has the following characteristics:

Variables High Growth Phase Stable Growth Phase

Expected Growth Rate 20% 4%
Payout Ratio 20% 80%
ROE 25% 20%
Beta 1.00 1.00
Number of years 5 years Forever
Treasury bond rate is 4.5%, equity risk premium 9.5%.
1+g n
P0 Payout Ratio ∗ 1 + g ∗ [1 − ] Payout Ratio ∗ 1 + g n ∗ (1 + gn)
1+r n
= +
EPS0 r −g rn − gn ∗ 1 + r n

Cost of equity (r) using CAPM= 4.5%+ (1 x 9.5%) = 14%

1.205
0.20 ∗ 1.20 ∗ (1 − ) 0.80 ∗ 1.205 ∗ 1.04
1.145 31
PE = + = 11.92
0.14 − 0.20 0.14 − 0.04 ∗ 1.145
Stock selection using PE ratio screen

You should invest in a stock with:

1. PE = LOW
2. Expected growth rate = HIGH
3. Risk (beta) = LOW
4. ROE = HIGH

Companion Variable : Expected Growth rate

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Relation between PE and its Companion Variables
▪ Quarterly earning announcements of companies provide information about
the expected growth rate of the company. Earning growth surprises have
much bigger impact on PE ratios when interest rates are low than when they
are high
▪ As interest rates rise, holding all else constant, PE ratios drop, but they drop
more for high growth stocks than for low growth stocks.
▪ If a firm is able to reduce its risk, the stock sees a pay-off with higher PE
▪ If a firm can increase its growth, it should see a pay-off with higher PE
▪ The best combination for screening stocks with PE is stocks with low risk
and high growth
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Relation between PE and its Companion Variables

▪ The worst combination is stocks with high risk and low growth
▪ For a given growth rate, the higher the ROE, the higher is the PE
▪ When ROE < cost of equity, increasing growth lowers PE

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PE ratio and political risk

The country with

the lowest PE
ratio is Russia.
Is it cheap?

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Macroeconomic factors that impact Country PE
Factors that affect Country PE:
1. Economic risk
2. Interest rate
3. Real GDP growth rates

The regression of PE ratios on these variables provides the following regression

model:
PE = 16.16 - 7.94 Interest Rates + 154.40 Growth in GDP - 0.1116 Country Risk (June 2000)

R2= 73%

You can pull out the date on these variables from Bloomberg, World bank websites
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2. PEG ratio –its origin
Peter Lynch ran Fidelity Fund, had the task to buy growth companies. But non
looked cheap. So, he wanted a multiple which allowed him to buy good growth
companies though they were trading at a high PE ratio.

So even though PE is high, if the expected growth rate is high, PEG will be low, and
these stocks can be chosen for investment.

▪ PEG Ratio = PE ratio/ Expected Growth Rate in EPS

▫ For consistency, you should make sure that your earnings growth
reflects the EPS that you use in your PE ratio computation.
▫ The growth rates should preferably be over the same time period.
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Calculating Intrinsic PEG – A simple example
Estimate the PEG ratio for a firm with the following characteristics:
Variables High Growth Phase Stable Growth Phase
Expected Growth Rate 15% 8%
Payout Ratio 25% 50%
Beta 1.00 1.00
Number of years 5 years Forever

Riskfree rate = 4.5%, Required rate of return (using CAPM) = 4.5% + 1 x 9.5% = 14%
The PEG ratio for this firm can be estimated as follows:

∗ ∗[ ] ∗ ∗( )
PEG ( ) ∗
.
. ∗ . ∗( ) . ∗ . ∗ .
𝑃𝐸𝐺 = .
+ = 0.71 38
. ∗( . . ) . ∗ . . ∗ .
2. Relation between PEG and its Companion Variables
 Risk, payout and growth rate, which affect PE ratios, continue to affect PEG
ratios as well.

 The PEG multiple is designed to control for growth while finding a low PE stock.
In that quest, you should be aware that you might find a stock with low PEG, high
growth but with higher risk too.

 For a given growth rate, PEG ratio increases with increase in ROE. However, high
growth firms with very low ROE can trade at very low PEG ratios

 As risk-free rate rise, PEG ratio decrease.

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2. Relation between PEG and its Companion Variables

 As growth increases, not necessarily PEG decreases. We need to look at the

companies in the sector to understand how PEG ratios behave given the risk and
growth in the sector.

 High risk companies will always look cheap from PEG perspective, if you do not
control for risk.
e.g. Technology companies will look cheap as compared to utility sector
companies

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Stock selection using PEG ratio

You should invest in a stock with:

1. PEG = LOW
2. ROE = HIGH
3. Risk (beta) = LOW
4. Either high growth or low growth !!!!!
Companion Variable : Return on Equity

Remember:
High-risk companies look cheap on PEG ratio basis
Low ROE companies look cheap on PEG ratio basis
Companies that have average growth rate have low PEG ratio 41
3. Price to Book ratio
The Intrinsic Price to Book ratio is derived from Dividend Discount Model as:
0 n 0 n
or EV multiple as
0

The relationship between PB and its companion variables:

 For companies with competitive advantage, ROE > ke, PB ratio > 1
 For companies with ROE < ke, PB < 1
 For companies with ROE = ke, PB ratio =1
 The greater the difference between ROE and ke, the higher is the PB ratio
 Growth creates value only when ROE> ke or ROC > ko
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Stock selection using Price to Book ratio

You should invest in a stock with:

1. PB = LOW
2. ROE = HIGH
3. Risk (beta) = LOW

Companion Variable : Return on Equity

43
4. EV to EBITDA
EV/EBITDA has become a widely used multiple.
Reasons:
▪ Less sampling bias as fewer companies have negative EBITDA.
▪ Depreciation is dependent on accounting standards choice making
companies less comparable and exposing to bias. EBITDA is calculated
before treating for depreciation and therefore it is not influenced by the
choice of accounting standard.

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4. EV to EBITDA
The value of the operating assets of a firm can be written as:
EV0= thus, EV=
∆

Dividing both sides of the equation by EBITDA,

( ) / ∆ /

The determinants of EV/EBITDA are:

• The cost of capital
• Expected growth rate
• Tax rate
• Reinvestment rate (or ROC)
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Calculating Intrinsic EV/EBITDA – A simple example

Consider a firm with the following characteristics:

• Tax Rate = 27.5%
• Capital Expenditures/EBITDA = 30%
• Depreciation/EBITDA = 20%
• Cost of Capital = 12%
• The firm has no working capital requirements
• The firm is in stable growth and is expected to grow 5% a year forever.
In this case, the Value/EBITDA multiple for this firm can be estimated as follows:

( . ) . ∗ . .
. . . . . . . .

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4. Relationship between PEG and its Companion Variables

 EV/EBITDA decreases with increase in tax rate and cost of capital

 EV/EBITDA decreases with increase in reinvestment rate

 At a particular cost of capital, EV/EBITDA increases with increase in ROC

47
Stock selection using EV/EBITDA

You should invest in a stock with:

1. EV/EBITDA = LOW
2. Re-investment rate = LOW
3. ROC = HIGH
4. Tax rate = LOW
5. Cost of capital = LOW
6. Growth rate = HIGH

Companion Variables : Re-investment rate , Return on Capital

48
5. Revenue Multiples
▪ Since revenues cannot be negative, you lose less companies while computing
this multiple
▫ EV / Sales = Enterprise Value / Revenues
▫ Price / Sales = Market Capitalization / Revenues Price to Sales is internally inconsistent
▪ As Free Cash Flow to the Firm = EBIT (1 - tax rate) (1 - Reinvestment Rate), value of the Firm
can be written as a function of the after-tax operating margin

1+g n
Value 1 − RIR growth 1 + g ∗ [1 − ] 1 − RIRstable 1 + g n ∗ 1 + gn
1 + WACC n
= After − tax Oper. Margin ∗ { + }
Sales WACC − g WACC − gn 1 + WACC n

g = Growth rate in after-tax operating income for the first n years

gn = Growth rate in after-tax operating income after n years forever (Stable growth rate)
RIR Growth, Stable = Reinvestment rate in high growth and stable growth periods
WACC = Weighted average cost of capital
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Stock selection using EV/Sales

You should invest in a stock with:

1. EV/Sales = LOW
2. Operating margin = HIGH
3. Cost of capital = LOW
4. ROC = HIGH
5. Growth in Profits = HIGH

Companion Variable of EV/Sales : Operating income margin

Companion variable of Price/ Sales : Net profit margin
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Drivers of Valuation Multiples – A Summary
Price to Earnings Price to Book Price to Sales Price to Dividend Yield

• Growth NI1 • ROE • Net margin • Growth NI1

• Payout, ROE • Growth NI1 • ROE • Cost of equity
• Cost of equity • Payout • Cost of equity
• Cost of equity • Growth NI1
• Payout

EV to FCFF EV to EBIT EV to EBITDA EV to Sales EV to Invested Capital

• Cost of capital • ROC • ROC • After-tax Operating • ROC

• GrowthOI1 • Reinvestment rate • Reinvestment rate Margin • Reinvestment rate
• Risk • Risk • Reinvestment rate • Risk
• GrowthOI1 • GrowthOI1 • Risk • GrowthOI1
• Taxes • GrowthOI1

Note: Cost of equity, cost of capital measures risk

Expected Growth in Net Income= Growth NI1 51
Expected Growth in Operating Income= Growth OI1
A Gist

▪ While comparing companies with multiples, multiples should be defined in

the same way
▪ We should know the cross-sectional distribution of a multiple to help us
pass a judgement whether it is too high or low
▪ Even in relative valuation, we need to make assumptions about the firm’s
future to estimate the multiples
▪ We should know the fundamentals that drive each multiple and the
relationship of each variable with the multiple
▪ We need to define comparable universe and control for differences
though it is the most difficult task in relative valuation. There are no
perfect comparables. 52
IV. Application Test
Sampling Choice

▪ Using relative valuation, you are assuming that the firms in a sector have the
same amount of risk, growth and cash flows!.... But is it actually so?

▪ Sample size
▫ If you define the criteria of comparison narrowly, you will get a small sample
that can be used for qualitative comparison of the firms
▫ If you define it broadly, you will get a larger sample wherein you can use a
statistical tool for controlling the differences to price the stock

▪ Statistical tools will help you to compare companies in spite of their differences.
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Controlling for Differences

1. If the comparable firms are just like your firm, you can directly compare the
multiples to price the stock
2. If there are obvious variations due to an important variable, you may explain
how the variable changes the price of the stock
3. For a few industries, you can modify the multiple to suit the industry
requirement e.g. for banks, the Tier 1 capital and the CASA ratio influence its
performance
4. If the sample is large, and the firms vary on multiple dimensions, you can use
statistical tools to control for the differences.

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I. Eyeballing Exercise – The Median test
Avg 3 yrs
Company Name PB ratio Growth in EPS % ROE% Beta Dividend Payout
Eicher Motors 7.46 43.63 24.22 0.80 35%
TVS Motor Co. 17.16 39.42 26.55 0.67 23%
Hero Motocorp 6.12 10.49 21.95 0.59 75%

Industry Median (2 wheelers) 7.46 39.42 24.22 0.67

Industry Median (Automobile) 7.00 42.01 18.79

Your quest is : To find a stock with a lower Price to Book ratio than the industry
median PB, higher ROE than the median ROE, and lower risk than the median risk of
the industry

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II. Story telling
Company Name PB ratio ROE % Beta
ITC 8.13 29.09 0.67
Godfrey Phillips 3.04 21.32 1.26
VST Industries 4.58 29.01 0.36
NTC Industries 1.05 7.37 0.60
Golden Tobacco 0.34
Median: 5 Co. 3.81 25.16 0.60

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III. Use of regression in Relative Valuation

▪ Regress PE ratio against payout/ROE, beta, and growth. The

coefficient on growth shows how much the market is ready to pay for
future growth.
▪ Run linearity test. If the regression fails the test, you can use log of the
variable and run the regression. E.g. Regress PEG ratio against payout,,
log natural of EPS growth rate, and beta.

58
 PE = 26.37 +0.875 DPR +0.05 gNI R2= 47%,
(2.45) (2.51) (2.32)

III. Statistical controls & Regression

Company name PE ratio Dividend Payout ratio N. Profit growth % Predicted PE
%

United Spirits 58.93 65.23 8.12 83.58

United Breweries 132.51 19.61 -37.30 41.15

Radico Khaitan 94.81 79.65 -18.91 94.73

Sula Vineyards 45.66 3.09 77.01 32.95

Tilaknagar Inds. 44.80 14.14 128.07 45.42

Globus Spirits 22.45 3.06 -34.74 26.80

Som Distilleries 38.13 10.99 140.36 43.34

G M Breweries 10.45 4.35 5.86 30.15

Assoc. Alcohols 20.17 0 -30.72 24.33

Jagajit Inds. 109.59 0 1412 103.42

Piccadily Agro 30.33 0 -23.63 24.73

IFB Agro Inds. 10.31 0 -15.25 25.18

Shri Gang Indus. 16.93 0 180 35.89

Aurangabad Dist. 10.00 2.73 90.24 33.36

Median 34.23 3.07 6.99 59

 PB = 0.16 +0.058 PAT margin +0.018 Sales growth, R2= 64%

III. Statistical controls & Regression (Indian Banks)

Price to PAT Sales Price to PAT Sales
Company Name Book margin% growth% Company Name Book margin% growth%
HDFC Bank 3.07 26.99 31
Bank of Maha 1.64 16.37 28.84
ICICI Bank 3.09 29.26 33.41
St Bk of India 1.42 16.47 26.1 Pun. & Sind Bank 1.6 16.41 18.07
Kotak Mah. Bank 3.11 35.39 31.53 RBL Bank 0.95 9.67 17.98
Axis Bank 2.24 20.81 31.73 Ujjivan Small 2.37 26.42 47.78
IndusInd Bank 2.23 20.32 23.82 Karur Vysya Bank 1.23 16.97 21.82
Bank of Baroda 0.94 15.92 35.63
Equitas Sma. Fin 1.78 13.78 24.98
Punjab Natl.Bank 0.67 3.86 22.62
IDBI Bank 1.41 18.11 26.52 City Union Bank 1.21 19.88 16.03
Union Bank (I) 0.82 10.49 25.02 J & K Bank 0.84 12.61 21.95
IOB 2.36 10.81 19.23 T N Merc. Bank 1.11 25.22 8.63
Canara Bank 0.76 12.85 28.74 Karnataka Bank 0.87 16.35 19.32
IDFC First Bank 2.28 10.93 37.04
CSB Bank 1.71 23.59 18.67
Indian Bank 1.02 12.39 21.41
Yes Bank 1.22 3.22 22.33 Utkarsh Small F. 0 16.15 35.49
AU Small Finance 4.32 17.41 38.43 South Ind.Bank 0.7 10.72 16.14
Bank of India 0.62 7.73 34.36 DCB Bank 0.77 11.1 24.12
UCO Bank 1.45 10.55 24.64
Fino Payments 6.19 68.61 125.88
Bandhan Bank 1.89 13.8 12.78
Federal Bank 1.28 18.02 31.42 Suryoday Small 1.3 6.56 25.09
Central Bank 1.04 6.59 19.15 Dhanlaxmi Bank 0.67 4.61 15.16 60
Predicted PB denoted most of the PSU banks as undervalued
IV. Modify the multiple to suit the industry

▪ Sometimes a multiple might not communicate the essence of the business

▪ EV/EBITDA of the transportation company that changes fleet is low due to
prediction that the firm will take loan to purchase the fleet and EBIT will
decrease in the near future not influencing EBITDA. The reinvestment rate
is able to capture this phenomenon and not the risk, growth, ROE/ ROCE. So
age of the fleet can be an additional companion variable while running the
regression on data of transportation companies

61
Equity multiples
Regressing multiples against its driver variables:
▪ Emerging Markets PE = 10.88 + 1.76 Beta + 43.90 gEPS + 6.90 Payout , R2=17.6%
▪ Global PE = 8.17 + 0.98 Beta + 50.80 gEPS + 18.20 Payout , R2=23.6%

▪ Emerging Markets PEG = 3.40 + 0.60 Payout – 0.55 ln(gEPS) - 0.268 Beta, R2=21.5%
▪ Global PEG = 4.99 + 1.00 Payout – 1.16 ln(gEPS) - 0.262 Beta, R2= 36.6%

▪ Emerging Markets PBV= 0.87 +3.10 gEPS + 0.23 Beta + 6.00 ROE + 1.00 Payout Ratio, R2= 28.0%
▪ Global PBV= 1.09 +3.60 gEPS - 0.16 Beta + 7.50 ROE + 0.80 Payout Ratio 28.1% R2=28.1%

62
Source: Damodaran on Valuation by Aswath Damodaran, Wiley Finance
Firm multiples
Regressing multiples against its driver variables:
▪ Emerging Markets EV/EBITDA= 30.93 + 4.90 g - 17.30 DFR - 40.40 Tax Rate, R2 = 11.9%
▪ Global EV/EBITDA= 25.62 + 9.20 g - 11.40 DFR - 32.70 Tax Rate, R2= 7.5%

▪ Emerging Markets EV/Sales = 3.22 + 1.60 g + 4.40 Oper Margin + 1.50 DFR - 2.80 Tax rate, R2=5.6%
▪ Global EV/Sales = 2.68 + 2.50 g + 8.10 Oper Margin + 2.10 DFR - 5.10 Tax rate R2= 17.8%

▪ Emerging Markets EV/IC= 2.80 + 1.20 g + 4.00 ROIC – 2.90 DFR, R2=58.4%
▪ Global EV/IC= 3.01 + 1.40 g + 6.40 ROIC – 3.20 DFR, R2=56.1%

If you have R2 of 6% for a multiple versus 80% for another, it is a no-brainer that you choose the R2 of 80% multiple to
value the companies in that sector. But if you have one multiple with R2 of 40% and another 52%, then you need to
use your intuition to choose the right multiple for valuation 63
Source: Damodaran on Valuation by Aswath Damodaran, Wiley Finance
Firm, Equity or Enterprise Multiple (which one to use?)

1. For valuing a financial company use equity multiple.

2. If leverage varies widely across the sector, use enterprise value multiple
3. With revenues in the denominator, you have to use enterprise multiple only
4. If many of the companies in the sector are money-losing, you need to use Revenues
as a scalar
5. If you valuing a money-losing company, use near-period forecasted figure in the
multiple
6. If the accounting number is too much influenced by accounting method choice, try
to avoid the measure

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Which multiple to use?
Multiple Most suited for….

P/E Firms with a proven track record of positive earnings and significant cash
expenses
PE/G Firms with stable EPS growth and risk characteristics

P/B Firms whose balance sheet reflect reasonably well market value of assets

EV/EBITDA Firms with substantial non-cash expenses like D&A, capital intensive firms

EV/FCFF Firms with stable growth and predictable capex

EV/Sales Young firms with negative earnings

When picking multiples, look into what managers in that sector focus on. You will get a
sense of which multiple to follow. E.g. Retail sector managers focus on store sales and
margins to evaluate their performance, they focus on net profit margins 65
Remember

1. If you are valuing a cyclical company, normalize the earnings variable used in the
multiple
2. If forecasted figures are not available for calculating forward numbers, use
trailing figures
3. To run a regression, you need a bigger sample, at least 10 companies
4. Control for the difference in the companies used as comparables
5. Find out whether the size of the company affects business economics

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Industry-specific multiples
Multiple Sector Comments
EV/Revenue Various Early stage companies
EV/Subscriber Various
Subscriber based businesses, such as Cable and Direct To Home (DTH)
EV/EBITDA Various Many Industrial and Consumer industries, but not Banks, Insurance, Oil & Gas
and Real Estate
EV/EBITA Various Commonly used in several Media industry sub-sectors, Gaming, Chemicals
and Bus & Rail Industries. Used when EBITDA multiples are less relevant due
to significant differences in asset financing (e.g. mix of leases, rentals,
ownership)
EV/EBITDAX Oil & Gas Excludes exploration expenses
EV/EBITDAR Retail, Airlines Used when there are significant rental and lease expenses incurred by
business operations
EV/Reserves Oil & Gas Used when looking at Oil & Gas fields and companies heavily involved in
upstream.
Gives an indication of how much the field is worth on a per barrel basis

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Industry-specific multiples
Multiple Sector Comments
EV/Production Oil & Gas And Airports For producing fields, gives value on a barrel per day production basis
For container ports, gives value per ton of cargo handled
For airports, gives value per passenger through airports

EV/Capacity Oil & Gas For refiners, gives a value metric in terms of barrel per day of refining
capacity
MarketCap/Book Banks/Technology/ Used for Semiconductor industry. Book value of equity is used since
Value (“P/BV”) Insurance there can be significant earnings fluctuation in this sector. Bank’s
shareholders equity is important because it is looked at as
a buffer/protection for depositors

EV/FFO Real Estate Principally used in the US. Often using normalized cash earnings,
excluding both exceptional items and goodwill amortization

P/E Various
PEG ratio High Tech, High Growth Big differences in growth across companies
(EV/EBITDA)/EBITD Used in Specialty Retail industry and when valuing emerging markets
A CAGR IPO candidates
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