Numerical Examples of Relative Valuation
These examples illustrate how to use common multiples in relative valuation.
Example 1: Price-to-Earnings (P/E) Ratio
- Target Company: TechCo, a software company.
- Comparable Companies: Three similar software companies: SoftCorp, Innovate, and DataSolv.
| Company | Market Cap (Millions) | Net Income (Millions) | P/E Ratio |
|---|---|---|---|
| SoftCorp | $500 | $50 | 10.0 |
| Innovate | $750 | $75 | 10.0 |
| DataSolv | $1000 | $100 | 10.0 |
| Average | 10.0 |
TechCo has a net income of $60 million. Using the average P/E ratio of the comparable companies, we can estimate TechCo's value:
- Estimated Market Cap of TechCo = Average P/E Ratio * TechCo's Net Income = 10.0 * $60 million = $600 million
Example 2: Enterprise Value-to-EBITDA (EV/EBITDA)
- Target Company: EnergyPro, an oil and gas company.
- Comparable Companies: Two similar oil and gas companies: PetroCorp and GasCo.
| Company | Enterprise Value (Millions) | EBITDA (Millions) | EV/EBITDA |
|---|---|---|---|
| PetroCorp | $2000 | $400 | 5.0 |
| GasCo | $3000 | $600 | 5.0 |
| Average | 5.0 |
EnergyPro has EBITDA of $500 million. Using the average EV/EBITDA multiple of the comparable companies, we can estimate EnergyPro's enterprise value:
- Estimated Enterprise Value of EnergyPro = Average EV/EBITDA Multiple * EnergyPro's EBITDA = 5.0 * $500 million = $2500 million
If EnergyPro has debt of $800 million and cash of $200 million, we can calculate the equity value:
- Equity Value = Enterprise Value - Debt + Cash = $2500 million - $800 million + $200 million = $1900 million
Example 3: Price-to-Sales (P/S) Ratio
- Target Company: RetailNow, an online retailer.
- Comparable Companies: Two similar online retailers: ShopFast and eGoods.
| Company | Market Cap (Millions) | Revenue (Millions) | P/S Ratio |
|---|---|---|---|
| ShopFast | $250 | $500 | 0.5 |
| eGoods | $400 | $800 | 0.5 |
| Average | 0.5 |
RetailNow has revenue of $600 million. Using the average P/S ratio of the comparable companies, we can estimate RetailNow's market capitalization:
- Estimated Market Cap of RetailNow = Average P/S Ratio * RetailNow's Revenue = 0.5 * $600 million = $300 million
Example 4: Using Regression Analysis (Simplified)
Let's say you're valuing a REIT (Real Estate Investment Trust) and believe that its Funds From Operations (FFO) growth rate is a key driver of its P/FFO multiple. You collect data on several comparable REITs and run a simple regression:
P/FFO = a + b * (FFO Growth Rate)
Where:
- P/FFO is the Price to Funds From Operations ratio
- FFO Growth Rate is the expected future growth rate of Funds From Operations
- a and b are the regression coefficients.
After running the regression, you find:
- a = 8
- b = 10
Your target REIT has an expected FFO growth rate of 6%. Therefore:
- Estimated P/FFO = 8 + 10 * 0.06 = 8 + 0.6 = 8.6
If your target REIT's FFO is $5 per share, its estimated share price would be:
Important Considerations:
- Comparable Selection: The accuracy of relative valuation depends heavily on the selection of comparable companies or transactions.
- Adjustments: It may be necessary to adjust the multiples of comparable assets to account for differences in size, growth, risk, or other factors.
- Outliers: Be aware of outliers in the data and consider excluding them from the analysis.
- Context: Always consider the context in which the multiples are being used. Industry-specific factors and market conditions can affect multiples.
These examples provide a basic overview of how to use relative valuation techniques. In practice, relative valuation can be more complex and may involve more sophisticated analysis.