Valuation & DCF Analysis Review
Questions and Correct Answers
What's the point of valuation? Why do you value a company? ✅You value a company
to determine its implied value according to your views of it. If you are advising a client
company, you might value it so you can tell management the price that it might receive
if the company sells
But public companies already have market caps and share prices, why bother valuing
them? ✅Because a company's market cap and share price reflect its current value
according to the market, but the market might be wrong!
What are the ways to value a company? ✅"Fundamentally, there are only 2 ways to
value a company: relative valuation - comparing it to what similar companies are worth -
and intrinsic valuation - estimating the net present value of its future cash flows. With
relative valuation, you mostly look at other public companies and recent M&A deals to
estimate what your company might be
worth.
"
What are the 3 main valuation methods? ✅A DCF, public comparables, and precedent
transaction analysis.
What is Public Comps? ✅Public comparables analysis is a relative valuation approach
used to evaluate how the market is valuing a peer group of companies that are similar
to the target company.
What is Precedent Transactions? ✅Precedent transaction analysis is another relative
valuation technique that is used to derive an implied value of a target company in an
M&A context. This approach is based on the premise that the implied value of a target
company can be estimated using historical transactions of comparable companies
under similar circumstances (i.e. geography, size, timing, takeover environment, etc.)
Can you walk me through how you use Public Comps and Precedent Transactions?
✅First, you select the companies and transactions based on criteria such as industry,
size, and geography (and time for transactions). Then, you determine the appropriate
metrics and multiples and calculate them for all the companies and transactions. Next
you might apply those multiples to the financial metrics for the company you're
analyzing to estimate the potential range for its valuation.
,How do you select Comparable Companies or Precedent Transactions? ✅Geography,
Industry, and Size (like revenue or EBITDA), and Time - usually the last 1-2 years. A list
of 5-10 companies is a good list
Why is it important to select Public Comps and Precedent Transactions that are similar?
✅Because the comparable companies and transactions should have similar Discount
Rates and Free Cash Flow figures. If the companies in your set all have similar
Discount Rates and Free Cash Flows, it's easier to conclude that one company trades
at higher multiples because its expected growth rate is higher.
Are there any screens you should AVOID when selecting Comparable Companies and
Precedent Transactions? ✅You should avoid screening by both financial metrics and
Equity Value or Enterprise Value. For example, you should NOT use this screen:
"Companies with revenue below $1 billion and Enterprise Values above $2 billion." If
you use that screen, you're artificially constraining the multiples because EV / Revenue
must be above 2x for every company in the set.
Public Comps and Precedent Transactions seem similar. What are the main
differences? ✅For Precedent Transactions you focus on historical metrics and
multiples only - as of the announcement date. Also, the multiples produced for
precedent transactions tend to be higher than the multiples from Public Comps because
of the control premium. But the multiples also tend to span wider ranges because deals
can be done for many different reasons.
Can you walk me through the process of finding market and financial information for the
Public Comps? ✅You start by finding each company's most recent annual and interim
filings. And you want to calculate the diluted share count and Current Equity Value and
Current EV based on the information there and its most recent Balance Sheet. Then,
you calculate its Last Twelve Months (LTM) financial metrics by taking the most recent
results. For the projected figures, you look in equity research or find consensus figures
on Bloomberg. And then you calculate all the multiples by dividing Current Equity Value
or Current Enterprise Value by the appropriate metric. For example, you might want
revenue, ebitda, and net income metrics with the corresponding multiples, and use a
LTM and forward 1 and forward 2 years.
Can you walk me through the process of finding market and financial information for the
Precedent Transactions? ✅You find the acquired company's filings from just before the
deal was announced, and you calculate the LTM financial metrics using those for
example LTM revenue and EBITDA . To calculate the company's Transaction Equity
Value and Transaction Enterprise Value, you use the purchase price the acquirer paid,
and you move from Equity Value to Enterprise Value in the same way you usually do,
using the company's most recent Balance Sheet as of the announcement date.
How do you decide which metrics and multiples to use in these methodologies? ✅You
usually look at a sales-based metric and its corresponding multiple and 1-2 profitability-
, based metrics and multiples. For example, you might use Revenue, EBITDA, and Net
Income, and the corresponding multiples: EV / Revenue, EV / EBITDA, and P / E. You
do this because you want to value a company in relation to how much it sells and to
how much it keeps of those sales.
Why do you look at BOTH historical and projected metrics and multiples in these
methodologies? ✅Historical metrics are useful because they're based on what actually
happened, but they can also be deceptive if there were non-recurring items or if the
company made acquisitions or divestitures. Projected metrics are useful because they
assume the company will operate in a "steady state," without acquisitions, divestitures,
or non-recurring items, but they're also less reliable because they're based on
predictions of the future.
When you calculate forward multiples for the comparable companies, should you use
each company's Current Equity Value or Current Enterprise Value, or should you project
them to get the Year 1 or Year 2 values? ✅No, you always use the Current Equity
Value or Current Enterprise Value. NEVER "project" either one.
What should you do if some companies in your set of Public Comps have fiscal years
that end on June 30th and others have fiscal years that end on December 31st? ✅You
have to "calendarize" by adjusting the companies' fiscal years so that they match up.
Normally, you calendarize to match the fiscal year of the company you're valuing.
How do you interpret the Public Comps? What does it mean if the median multiples are
above or below the ones of the company you're valuing? ✅The interpretation depends
on how the growth rates and margins of your company compare to those of the
comparable companies. Public Comps are most meaningful when the growth rates and
margins are similar, but the multiples are different. This could mean that the company
you're valuing is mispriced and that there's an opportunity to invest and make money.
For example, all the companies are growing their revenues at 10-15% and their
EBITDAs at 15-20%, and they all have EBITDA margins of 10-15%. Your company also
has multiples in these ranges. However, your company trades at EV / EBITDA multiples
of 6x to 8x, while the comparable companies all trade at multiples of 10x to 12x. That
could indicate that your company is undervalued since its multiples are lower, but its
growth rates, margins, industry, and size are all comparable.
Is it valid to include both announced and closed deals in your set of Precedent
Transactions? ✅Yes, because Precedent Transactions reflect overall market activity.
Even if a deal hasn't closed yet, the simple announcement of the deal reflects what one
company believes another is worth.
Why do Precedent Transactions often result in more "random" data than Public Comps?
✅The problem is that the circumstances surrounding each deal might be very different.
For example, one company might have sold itself because it was distressed and about
to enter bankruptcy. But another company might have sold itself because the acquirer
desperately needed it and was willing to pay a high price.
