Continuing the theme of equity valuation techniques from the last post. We take a deep dive into using public comparable analysis. As mentioned briefly before, along with acquisition comparables, the purpose of this analysis is to compare a company to its peers to derive the relative value.
How do we determine what the peer group is? There are two types of criteria:
- Operational: customers, cyclicality, seasonality, distribution channels, industry, products/services, markets.
- Financial: growth prospects, margins, liquidity, size, leverage.
In order to provide prudent and accurate analysis, a list of public information must be collected for each company. These include: 10-K/annual report for the latest fiscal year, 10-Q/interim filing from latest quarter, news announcements since most recent filing, research and EPS estimates and the current share price.
The latest twelve months (LTM) is commonly used as the period under analysis. This is preferred as it is more recent than the last fiscal year. It also takes in account seasonality of certain businesses which would not be the case if only the last quarter was considered. Finally, it allows for comparability for companies with different year ends.
The multiples (financial ratio) of a company is compared with those in its peer group. These multiples are usually calculated at a point in time, off the current stock price and using all of the public information available. The multiples allow us to compare similar companies and similar transactions. The P/E ratio is an example of this.
- P/E = Current share price/Earnings per share (EPS)
- A higher ratio means an investor is willing to pay a higher price for the stock given the earnings because they are bullish about the future earnings/performance of the company.
- VW - 3.33 ( = 113.17/( 15799000000/465000000 ) )
- Ford - 2.26 ( = 12.04/( 20213000000/3801000000 ) )
- As of 6th January 2012
Multiples must be calculated with the correct underlying financial statistic. For example, for equity holders, they would only care about data which are applicable to shareholders. EBIT would not be very useful as it does not incorporate interest that needs to be paid to debtors.
- Equity based multiples include:
- P/E (price/EPS)
- market value/net income
- market value/book value
- Enterprise value multiples (applicable to all capital holders)
- enterprise value/sales
- enterprise value/EBITDA
- enterprise value/EBIT
These ratios are driven by three main factors:
- Size - dominance, market capitalisation, enterprise value
- Risk - operational efficiency, productivity (margins, return on investment capital, ROIC), financial risk (credit profile)
- Growth - cash flow, EBITDA, net income or EPS, sales
Forward multiples can also be used to value a company. A consensus of analyst estimates can be found on websites like Reuters, Bloomberg, Yahoo! Finance or Zacks.
Looking at the table or multiples above, I believe Volkswagen is fairly valued with an enterprise value/LTM EBITDA of 14.55x. They have shown strong growth in the last 5 years which is forecasted to continue. Although its multiple is less than that of Toyota's, it is also significantly less levered which also reduces its financial risk. Volkswagen trades in-line with Ford and to a less extent, Honda. Despite a higher multiple, it is also more levered and less profitable but I believe this is offset by the higher growth.
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