Stock Valuation Methodologies

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Valuation methodologies overview

Advantages and disadvantages

Comparable company trading analysis

Description

• Compare the current trading level of a Company to its peers

• Specifically determine how the market has valued the earnings, cash flow, net asset value, assets or other characteristics of similar companies. Compare these ratios to the Company’s performance and/or use them to impute an aggregate market value of the Company

Advantages

• Market efficiency means that trading values in theory should reflect industry trends, business risk, market growth, etc.

• Values obtained can be a reliable indicator of the value of the Company for a minority investment (i.e., a non-control investment)

• Useful technique for assessing vulnerability: when fundamental vs. market value gap is large, vulnerability may be high

Disadvantages

• Always comparing apples to oranges. Truly comparable companies are rare and differences are hard to account for

• Thinly traded, small capitalization or poorly followed stocks may not reflect fundamental value

• Many people feel that the stock market is “emotional” and that it sometimes fluctuates irrationally (i.e., the market can be wrong)

• Current high level of M&A activity in certain sectors has introduced distortions in relative pricing benchmarks

Comments

• The unaffected trading level does not include a control premium or synergy value associated with strategic acquisitions

• Explaining value gaps between the Company and its comparables can involve extensive use of judgment

Comparable transactions and premium analysis

Description

• Determine the value offered in past acquisitions of similar companies

• Specifically, determine the pricing of past deals as compared to the...

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...ndustry group, but may be categorized generally as follows:

 Equity value multiples: cash flows to equity holders only (e.g., net income, book value, operating cash flow)

 Common ratios: P/E, P/BV, P/OCF (after tax)

 Firm value multiples: cash flows to all investors (e.g., revenues, EBIT, EBITDA)

 Common ratios: FV/revenues, FV/EBIT, FV/EBITDA

• J.P. Morgan typically uses median values; mean values often skewed from outlying data and therefore more likely to be misleading

• Keep back-up file to trading comparable presentation page in Lotus/Excel spreadsheet for easy updates/corrections

 Show file location or Lotus/Excel output: = cell (“filename”)

 Linking prices in Excel: = IDD (“ticker,” “close,” 0)

• Provide summary recent financial data and key operating ratios as backup

• Check all data with source material (10K, 10Q) to explain trading anomalies

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