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In this unit of Security Analysis and Portfolio Management, we are going to discuss about
one of the important aspects in security analysis and portfolio management that is Valuation
of Equity Shares. Although valuation of different finance instruments can be there but, in this
case, we are going to emphasize valuation of equity shares of a particular company.
So, in this, we are going to discuss the basic approaches or valuation, different methods
of valuation. So, coming to the basic approaches, there are two fundamental approaches, that
is, one is a direct approach, another is indirect approach. As per direct approach is concerned,
we by applying a particular mechanic mechanism, we will find the value of the equity shares
directly whereas, in indirect approach what we do? There, we value the company as a whole
and from there we drive the value of the equity shares. So, that is the fundamental difference
in direct approach and indirect approach. Coming to the importance of the valuation
of shares, any investor like to buy or sell the share depending on the intrinsic worth
of the particular share access and so the investor should like to know, what the value
intrinsic value is, so that, accordingly in the market he can take a buy or sale decisions.
So, if as per him the value of a particular share is rupees 50 and the market if he is
selling for rupees 55, in that case the investor will not like to buy that from the market,
either if the investor is holding the share, he will like to sell.
So, in whatever the case may be irrespective the market price, the investor is likely to
value the share on his or her own based on certain suitable measure, that he feels that
he is right for the particular share. And the valuation of equity shares for those matters
will quite subjective, why? Compare to an instrument like a valuation of bond at temperature
in which case, we have got the periodic interest to come, then there is a requirement of principle
is certain, unlike that in case equity shares, what happens? Whatever the investor is going
to get from the shares is not certain, so dividends can be there and another thing is
the change in market price can be there. And change in market price is subject to market
fluctuation. So, how much is going to be there while selling the share in future, nobody
can determine it accurately. So, in that case what happens is, different people they depend
on different method of valuation. So, there are lot of subjectivity is involved as far
as valuation equity share is concerned. One cannot find a single value that is appropriate
or that is acceptable to different types of investor in the market, even if the company
is one and same.
So, further what we discuss in this module, the classic measures of valuation and in that
we have what asset based measures, then we have about valuation multiples, then we have
about discounted cash flow measure. As per the asset based valuation measures are concerned,
here the valuation is supposed to be driven by the value of the assets of the particular
company; asset is something which is held by the company to generate future revenue
as well as future from that future cash flow. So, that is the so if the assets are good
for the companies, the company is supposed to be valued well by the investor, that is
asset based valuation, we will have different methods there. Then second category is valuation
multiple, in valuation multiple the other way relative valuation. Here what happens,
we will like to find the value of particular company share compared to the peer group.
So, when I say peer group, that peer group should be in the same sector, almost of same
size in terms of turnover or total assets of the company, otherwise there is no point
in comparing those target company with the comparable will company.
So, comparable company should be essential compared compare will in the way that they
should be in same, at least from the same sector. So, if you are going to value a steel
company, so we should have the valuation parameters of steel sector companies and then we can
find out the value target company. And this relative valuation is quite popular in a in
the case of those companies, which are closely held by different promoters it is not listed.
So, there is no quote of market price available. So, instead of having the market price of
this company, what we do? We have the market price of comparable company from the market
and certain parameters are used and then based on the valuation parameter, there for the
peer group or the comparable companies, the target company value is found out. Typically
in case of merges, acquisitions and sale of majority stake by the promoters, in those
cases the relative valuation is quite popular, there are couple of valuation multiple measures,
which we will discuss subsequently. Then, last third one in the category is discounted
cash flow based measures. So, coming to the two measures like the earlier
two measures, which is the asset based valuation and the valuation multiple. They can depend
upon certain accounting parameters whereas, accounting parameters can be manipulated.
So, in that case, there are certain experts who argue that instead of going those measures,
which are based on accounting parameters so much, they can go for something cash flow
base measure because, investor is investing in terms of cash today and he like to get
back in terms of cash also. So, that is called the discounted cash flow based measures.
So, what happens in this particular measure? The investors will be forecasting the cash
flow for a particular investment horizon and they that cash flow which is going to happen
in future that will be discounted at a particular rate of return and the value of the particular
company, value of the equity for that matter can be found out. So, these are three classic
measures of valuation, we also have two different methods again. These are actually there are
certain changes to the earlier measures like for instance, this is a venture capital private
equity approach. In that case what happens, private equity
or venture capital is something who will like to invest privately with a company, which
has the lot of growth percepts. And this company is not supposed to be listed in the market
also and what as the lot of growth potential and the when the market price or the value
of the company appreciates a lot and the venture capital list or private equity can exit.
So, when they do the valuation of the company and venture capitalist and the private equity
players will be investing several companies out of that, so many may be successful, so
many may not be successful. So, there is a lot of a risk involved as far as venture capital
and private equity players are involved. So, what they do in this case? What is the different
the measure they apply, that if they are using a cash flow based measure. So, the discounting
factor is going to be quite high compare to retail investors, in case of private equity
players, it is going to be higher. So, they will discount at a very high rate
because they perceive that the risk is very high that is going to be the little different
approach as far as the private equity players and venture capitalists are concerned. Similarly,
the valuation in case of merges, acquisition also can be little different from the valuation
that a retail investor like to do for that matter. For instance, if by applying a proper
valuation measure, appropriate valuation measure like there are book value of assets or the
asset based measure earnings, based measure relative, valuation measure or cash flows
based measure, so of the valuation for share comes to let us say rupees 15.
And in that case, so will the investor like to buy the share, if the share is available
for rupees 15 or less whereas, in case of mergers and acquisition, what happens? The
large group of investor or a large or bigger company will like to take over this particular
target company, in that case, the takeover takes place; they will also have certain subsequent
they are going to have a control over the company assets. In that case, whereas a retail
investor from the buy or sale the share the company, they do not have any they do not
go to they are not going to have any controlling interest in the company.
So, what happens if the15 rupees were the value per share as per retail valuation? So,
the in case of merges acquisition, the investor who is going to acquire a controlling stake
in this particular company may attach some controlling control premium let us say it
is 20 percent. So, 15 rupees plus 20 percent of 15 rupees that comes to 3 rupees; so, mergers
or acquisition point of view, the acquiring company or acquiring investor like to pay
15 plus 3 rupees control that is 18 rupees instead of 15 rupees that is determined by
the general valuation measure, which is applicable for retail investor.
So, that is going to the difference as far as valuation in case of mergers and acquisitions
are concerned. Now, we move on to the different types of measures, in that coming to the asset
based valuation measure, which is where we is this asset based valuation also measure
is also known as book value of equity or a book value of share for that matter.
So, what happens in this case? We find the total value of the assets of the company as
per the balance sheet, whatever is there, how the financial statement will call balance
sheet for what it projects or what it depicts, the different types of assets of the company
whatever that is, because as per accounting book that is why it is called book value of
assets. So, the book values of assets are totaled
and only that asset which has got some tangibility or something some realized value assets. So,
that because then the assets can be there where certain assets like, fictitious assets
can be there, which cannot have any realized value.
So, expect those all the assets are clubbed and the total figure is found out, from there
the total book value assets, the book value of outsiders liability, that is the liability
for the let us say the company has got some de-ventures bonds or loans. So, their stake
is going to be detected from this and whatever value comes out of that, that is the value
of the equity share holders, that is total value book value of the equity and this book
value of equity is divided by number of shares of the number of equities or with the company
that gives the book value per share of the company.
So, this basic advantage of this particular method is that, the investor or the valuer
can rely on the financial statements, which are supposed to have been audited by the auditors
and they are suppose to reflect true and fair view of the company. So, that is something
if somebody can rely on the financier statements like balanced, then it is worth that one can
consider the value per share as per book value of assets. But, the major limitation this
particular approach is that companies value or company’s revenue, company’s cash flow,
companies profit, need not always be driven by the assets held by the company; there can
be some other factors, intangible factors which are not caption in the balanced that
can where drive the value of the company also. So, in that case, since those things are not
captured, in case of valuation of in case of balance sheet in the in balance sheet.
So, possible this book value of assets it could not useful for sustainable company.
For instance, if the customers buy the particular product of even little company because of
good brand, good image that has been created in the customers mind, and they are not essential
captured in the assets of the company. But still, the investor, the customers are going
to buy this particular product and possibly they can also, they will be willing to pay
premium over the other competitors of that particular product.
And they are real that realizes more revenue, more cash flow and the fact of that is driving
more revenue and more cash flow is not reflecting the balance sheet asset site, in that case,
this particular method like valuation asset, value based valuation method will not be suitable.
So, one has to look for certain other methods, which can take care of those particular factors,
that is the major limitation. One more limitation is that, the book value of assets is something
like historical in nature. So, the accounting book value whatever is
given in the assets are concerned, they may not to be reflect in true market value as
per today as such, as per the particular date when the valuation is taking place because
the inflation might have already taken place where the same assets can be acquired at a
higher where price by the company and which is not captured in the historical value of
the book value of assets. So, that is another limitation of this thing
and the book value of assets approach and third limitation is that, the book value of
assets is also subject to accounting adjustments accounting guidelines, which are lot of subjectivities
also involved. Different companies can follow different method or depreciation and because
the different method depreciation, the net fixed asset value can be actually different.
In that case, though the asset is one and same in the two companies, but the value reflected
in the balance sheet can be different because the company has adopted different method depreciation
subject to of course, approval of the relevant law or a relevant accounting guideline. In
that case, we cannot compare a one company’s value per share as per book value with another
company. So, before we do that, we have to make some
necessary adjustments, so that the value per share as per book value can be comparable.
So, these are certain limitation of the book value of assets, taking care of the limitation
as that the book value is historical nature, does not reflect the market value. We have
in other method actually adjusted book value, in this case what happens? The book values
of assets are adjusted according to market value of assets then, so when the valuation
is being done. So, instead of taking the balance sheet value
as reflected in the balance sheet, the assets value we took, we can take the market value
of those assets as on then, when the valuation is taking place. And the market value of those
assets can be more or less than the book value. So, accordingly this adjustments are done
and then value per share is found out. So, in the… we can take a simpler example here
in the subsequent slide here.
In this case, one can look at that, this there is a company as a company a or b or x company,
which has got the net fixed assets; when you say net fixed assets it is net of accumulated
depreciation. So, that book value is 200 whereas, the same fixed assets can be sold in the market
or can be acquired from the market, for that matter and the same condition, it will be
actually having 220 million rupees million as value. Similarly, the company has investments
worth 100 million and when market value of these investments can be actually 110 and
company has inventory of 30 million, where the market value of the inventory could be
32. This book value is some assets which are actually reflected in the balance sheet and
market value is found out by the valuer by applying certain mechanism.
And finding making a survey and from in the market and they find a put a value as per
market value access. Then comes receivables, though it is 50 million rupees is the book
value, but possibly one can realize only 48 million from the data’s of any receivables.
And cash and bank in obviously, will there will not be any change as from market value
book value is concerned. And there is a fictitious asset like miscellaneous expenses to the extent,
it will not written off that is 2 million; obviously, there has no market value assets
and this company has an outsiders liability of 200 million and that is also taken as a
market value to only that is in the liability holder like to get 200, for what about 200,
they have 200 million, for what about 200 million they have actually give in.
So, in that way the total value of the all the assets, except this miscellaneous expenses
to the extent not written here, because there is a fictitious asset. So, they should not
eligible for valuation of the equity assets. So, the valuation of eligible assets this
200 till 40 comes to 420 and then valuation of assets less liability is 200 that comes
to 220. So, 420 minus 200 comes to 220 and the number of shares in million is 10 and
say the value per share becomes now 220 divided by 10 that is rupees 22.
This is the value per share as per the book value approach is concern, the historical
value is concern and since we have discussed that is historical value of the assets, can
be something different then the market value; so in this example, already will have the
market value figures for the different assets. And the market value term we combination of
this five assets comes to 450 million and the 200 is the outsiders liability when you
take it out, so the value becomes now 250 million for all the equity share holders and
so, per share value comes to 250 divide by 10 that is 25.
So, as per historical value, book value, that is rupees 22 if the per share, whereas as
per the adjusted book value approach that comes to rupees 25. So, if somebody is relying
on the book value of equity formula for valuation of share, it is better that the investor or
the valuer relying more on the market value of the assets and then find the value per
share instead of the historical value, because market value is supposed to reflect the true
value of the company as per the market condition for that matter.
Then, we have the next category of valuation methods that is the valuation multiples or
relative valuation as we have discussed earlier. In this case, the valuation a particular company
is based on the value of the peer group a particular company. So, when you say the peer
group, we talk about the peer group means, the company should be the comparable company
should from the same sector. So, if you are valuing company in a pharmaceutical,
we should have the comparable company from the pharmaceutical sector only, not that we
find the companies from the steel sector and take the benchmark whatever they derived of
the steel sector companies and apply that to value the pharmaceutical company because,
there two sectors are totally different, if the risk involved in those two business are
totally different, the type of value are going to totally different.
So, it is not right that, one should go for a different sector for valuing one more other
sector for that matter. So, what are the different methods or different approaches here? That
is we have, in this case we have, the ratio of a firm or if instead of firm it can be
also equity value, to certain aspects of the firm’s economic activity. The major activity
it could be cash flow, it could be sales, it could be earnings before interest, taxes
depreciation, amortization, it could be anything which is of important nature as per the financial
parameters is concerned. So, you find a valuation multiple for different
based on different factors and whatever the factor, that multiple you find, based on the
factor that is applicable for the target company, we find a value of the particular company.
So, what happens? The basic principles that we have here is that, the multiples are used
appropriately when comparing two assets that are similar in nature, that we discussing.
So, for a finding a pharmaceutical company, we should take a comparable company like pharmaceutical
company, so they should be comparable in nature. And also one more comparison can be there
is not that a new generation pharmaceutical company can be compared to the old generation
pharmaceutical company. The company which has established for longtime
may not to be a necessary comparative company for a company, which is actually set up just
now. So, in that case even if you are going to compare those two companies also, one has
to make certain necessary adjustments to the financial parameters, and then proceed with
the valuation. Blindly comparing a 100 year old company with a one year old company is
not justified as far as the relative valuation measures are concerned.
Then multiples will be very easy to use when they are stable across similar assets. If
we find that multiples are going to be changing from time to time, for a one company more
than other company, so they are not stable, they are not behaving as particular passion,
then it is better that we drop those things or drop those companies which are having a
erratic behavior in the multiple assets. And we can have certain companies where the multiples
are actually stable across the time period and then you use that for that matter, but
at the same time multiples on its own can vary from time to time.
So, when you say it is stable means, comparably in the same sector all the companies should
show around same multiple, it should be that one multiple is some case, one company is
just 3 and another company’s case is 15, for an average it something 10 to 12 is the
multiple for that matter. So, this 3 and 15 can be taken out and 10 and 12 range that
can be taken as the base for the multiple valuation multiple assets.
Then coming going further about the relative valuation, different steps that we have here,
the market multiples will be generally drawn from the stock price of the public companies
or prices from the completed transactions. So, if we are going to value a particular
target company, so we are going to have a set of comparable companies and we are going
to have the prices, stock prices of those companies, which are actually listed in the
market. So that means, comparable company should necessarily listed because that only
gives a market price and then we go for a price multiple, and then we are apply that
multiple to value the particular target company. So, there is no point in having a set of comparable
companies which are not listed in the market, but in case of mergers and acquisition, one
can as usual go for the transactions, that what type of such or mergers acquisition have
taken place in that particular sector and in that case, one can go for a what are different
types of has taken place. And from there, the value what I was in paid by the company
and the basic parameters that is we are using or the earnings or earnings before interest
taxes depreciation amortization that is called a for that matter or book value could be the
factor there. So, find the transaction based multiples instead
of the market based multiple, because transaction based multiple depends up on the price paid
by the acquirer to the target company. So, instead of taking the market price based multiple,
one can take the transaction based multiple and apply that particular thing for valuing
a target company in case of mergers and acquisition. So, as we discussed earlier, in this case
if you are going to find the price multiple as per the market price and if you are going
to value a company for mergers and acquisitions, whatever price we find by applying the market
multiple, trading multiple then that case you have to add certain things like control
premium. If it were are going to value a target company for acquisition access whereas, if
you are using the transaction multiple of the based on different mergers acquisition
transaction that has taken place in that particular sector, there is suppose to be taken care
that control premium suppose to have been taken care in those transaction multiple,
that is the value of the target company, when the target was valued by the acquirer.
So, there is no need to have any control premium adjustments. So, that is the difference between
the market trading based multiple and the transaction based multiple as far as mergers
and acquisitions are concerned. So, these are two multiples, we have trading multiple
and transaction multiple. So, what we do? Different stage that we have here, either
we search from the target companies, and then we select the comparable companies based on
the target companies profile and then what you do?
There could be certain accounting adjustment that we will be discussing subsequent slides
and there could be certain accounting principles followed, we say different in nature as far
one company to another company is concern. So, for instance as far as the depreciation
method is concern, one company may follow straight line method, and another company
may be following determine value method. So, if that is the case that is realized that,
this two different companies comparable companies are having different accounting methods, then
one has to adjust for those methods, different methods and so that those companies, the peer
group companies are really comparable with the target company. And once you have the
adjustment to the financial figures, then we find the multiple and from there you find
the average multiple and for the average multiple, it is always better that one can go, one can
use something like a median instead of a simple average because median is suppose to take
care of the extreme value. So, extreme out layers from the series of data can be taken
out. So, that whatever relevant range is there
and that is from there the average is taken. So, in that case, the median is the best average
as far as the valuation multiples are concerned. The moment one has the average multiple, so,
let us say if I having that a particular series of different multiples of different companies
1 to company n.
So, the median multiple is, if it is x and that the factor which was used for the multiple
and that is let say y, then the value of the share of the company will be now the median
multiple x multiplied with y, that is going to be the value of the share of the company.
So, for instance, if the median multiple we are taking let us say price to earnings ratio
as the multiple, the median multiple is 18 and the factor that is earnings are in this
case if that becomes rupees 5 for the target company, that is for the target company.
In that case, the value per share will be the median multiple that is 18 this is this
one into the target company’s earnings per share that is rupees 5. So, rupees 90 becomes
the value per share as far as this particular company is concerned. So, similarly instead
of price the earning ratio, one can take price to book value ratio, one can take to some
other ratios are also, but and accordingly if you take the price to book value ratio
as the figure, then we will have a different multiple here.
It could be x1, then we will have a some other values; in this case, we will take instead
of earnings per share, we will take book value per share and there you will be let us see
that is taken as a y 1, the valuation of the company will be in that case will be x 1 into
y 1. And one can note down, note here that the valuation as per price earning multiple
and the valuation of price to book value ratio multiple can be totally different. So, it
is not necessary that, if you one uses different methods of values in multiple, we are going
have same answer. So, it all depends whether we will use the
price to earnings ratio multiple or you are going to use the price to book value per share
multiple, that depends on that particular industry or company that you are talking about.
It is not necessary that always we go for a particular multiple, for each type of company
each sector of companies for that matter.
So, having done that, we have to also look at others things here about the subject target
company, who is company you are target that has to be looked at. So, we have to look at
how this target company create value does this and what drives its financial performance,
who are its customers and suppliers, with whom does they compete, what risk does it
face, what happens? When you come to create the valuation access,
as we have discussed in the asset based valuation measure, so we discuss that, if that measure
will be appropriate for certain companies, which are values driven by actually book value
of assets held by the particular company. So, in that case, if you are going for a valuation
multiple, then price to book value of assets multiple if one can find out, then book value
of a asset per share or the value of the company to value of the assets for the company that
multiple can be used their for the target company, because the value is driven by the
assets held by the company. Whereas, if it is the value is not necessarily driven only
by assets, but by several other things in that case, the asset price to book value method
will not be suitable. So, in that case what will happen? One can
go for something like earnings based valuation measure or whatever that measure which is
driving the value of the company that should be taken as the base and accordingly is the
target comparable company should be selected. Similarly, like value what drives its financial
performance the financial performance like profit, sales what about depends up on what?
That also has to be taken and accordingly the comparable companies can be selected.
And then we also have to look at who are the customers and suppliers access. For instance,
if we have a got a particular sector company which depends up on outsiders for sourcing
of raw material, in that case what happens? If you are comparing a company with all those
who do not depend up on outsiders for sourcing of raw material, then they are not truly comparable
because, the target company is subject to risk involved in sourcing a material from
outside, it could be foreign exchange risk, it could be the political risk that is faced
in the country from where the goods are being imported.
So, in that case, we have to look at that whether the supplier base is almost same from
the at least for the domestic only. Similarly, there could be two different companies and
where one company may have this sales are more export related, the majority sales goes
as export whereas, the target comparable companies we had we may end up that they are already
having the domestic sales and their export sales are quite different.
In that case, these two companies are actually facing different types of risk, one company
which is having only the more majority of the sales has exports, they are having a lot
of foreign exchange risk and the business condition risk as per the particular country
where the goods are actually exported, whereas domestic the company which has got most sale
domestic that is a subject to own the Indian market risk for that matter. So, in that case
they are not truly comparable. So, one has to again go on further search
and find out which could be comparable companies, having a same almost same type of customer
profile or a supplier profile for that matter, it is very difficult to find out this same
type of company which have got same cost and profile. But, one should at least make an
effort to find out such they should not be drastically different as far as the profile
of the customer’s profile, suppliers are concerned. So, this is a challenge for relative
valuation, whether to find out who could be the comparable companies to compare with this
particular target company that we are going to value as such.
Similarly, we have some other things that we talk about, ultimately we have at a inclusive
list that is the list of all types of company in that particular sector, then based on this
condition that we discussed in this, how does it create value? What drives the financial
performance? Who are the customers based on that? Then we have a certain exclusive list,
then you do a proper one more filtration could be that, we have a exclusive list of 30 companies,
but possibly for all 30 companies, the financial parameters, financial values are not available.
Then we go for a for further filtration, for where for those companies where the finance
data are ((available)) particular period of time and then it becomes a small group of
company and that group of company becomes our the sample set and from that financial
data of those companies, then we find the valuation multiple and go further as the valuation
of the share is concern. So, it is possible that, we can have multiple
list also depending the target companies, not necessary if I lets say valuing two different
two companies in same sector, we may need not have two different we need not have one
set to compare, we can as usual go for two different sets. For instance, the company
which has a turnover of 100 crore possible we should go for a set of companies, which
has got the financial parameter same type of industry at the same time their turnovers
would be around 100 crore, may be 75 to 200 something like that. But, not that you are
having a target compares turnover 100 crore, then we are going for comparable companies
like all the comparable companies have got 1000 crore plus turnover, which is not a right
comparison as such. So, similarly for a 100 crore turnover company,
we have a comparable list like that and another if you have a something like 300 crore turnover
company, then we go for another list which are the sales service *** target sorry comparable
companies should be around 300 crore something plus something minus. So, for that matter,
we can go for multiple assets and not necessarily that we go for a single asset of comparable
company and compared with any target company, even though the target companies are in same
sector or same industry.
Moving further, as we discussed, we may have certain accounting or valuation related adjustments,
the fastest set of adjustment is known as the adjusting the market value. So, one has
to be careful here, whether you are going to find the value of the firm or value of
the equity. When you talk about the value of the firm, then essentially when you apply
that multiple, the multiple is based on value of the firm and whatever value that you are
going to derive that multiple, we apply to the target company’s parameter and then
we end of finding the value of the firm for that matter. And from the value of the firm
one can again go for value of the equity. But, is also quite possible that we from the
beginning itself, we have the parameters based on the value of equity so that, we can directly
find the value of equity the target company with the help of the average multiple that
we have already found out. So, that is one, similarly coming to the next thing that you
have got the book value or market value of debt that we are going to talk about. So,
when you are going to find out the market value of particular company or the comparable
company, one can have a condition like this.
Let us say the comparable company, we have a target company called t and you have got
a comparable company like C1, C2, C3 like that up to c n. So, what you do here? We end
of finding the value of the company and when we say value of the company or firm, we say
the value of the entire assets and entire that is there in the company access. So, in
that case, we can say the value of the total assets, when you go for the value of the equity
of the company, what you do? whatever You have the value of total assets, less value
of liabilities, which are essentially outsiders liabilities we do that. When you come to the
extent of value of liability, there the question arises should you take the book value or market
value. The major problem in this book value or market
value of the debt is that so many companies, the market value of debt may not be available.
Since that is the case, so one can take the book value of debt as the deduction from the
value of assets, and then can go find out the value of the company, of the comparable
company and then one can go for the multiple for that matter. So, what happens in this
case? That market value of the equity that is not available. Let us say the market value
of debt is available, the debt are listed in the market price can be found out then,
it is ideal that one can go for market value. So, otherwise book value of debt can be taken
as a proxy for the market value; one cautionary note is that, whatever value we take let us
say book value of debt or market value of debt for this, it should be consistent across
the comparable companies. For one company we should not take market value and another
company, we should not take we should take book value for that matter.
So, if you are taking book value from all the companies, from in the target such that
comparable company should be taken as book value, if it is market value it should be
taken as market value. So, mostly the market value is not available. So, end of taking
a valuation of debt as the book value of the debt access.
Then we may have some special cases of like convertible instruments like convertible bond
and convertible then de-ventures then we may or convertible preference here. Then we can
also have warrants, warrants are such things which are instruments, which can be exercised
and by paying certain amount a shares can be issued by the particular company at a particular
value. So, the warrant holder has a right to buy the share of a particular company or
a particular predetermined price may be related to the market price with the discount in that
whatever that for that matter. So, when you are valuing a company at a particular
point of time, if you have got warrant holders, we have to find the value of warrants like
a value of something like option that is also consider and those value of warrants should
be taken out from the value of the firm that you have already found out. Because that is
the value of the firm or value of the company as per the present stake holders are concerned,
warrant holders are the potential stake holders the company. So, the potential stake holders
may have some value as per the warrants are concerned. So, that is taken out from these
values, so what happens? If we find the value of a particular firm is rupees 100 crore and
the value of the warrants outstanding which are not yet exercised by the investors is
rupees 500 crore, then we say rupees 95 crore is the value of company as far as our further
comparison, valuation multiple calculations are concerned.
So, this 5 crore is essentially taken out of this 100 crores; that means, we are saying
the potential stake holders of company who are the warrant holders now, they have a claim
on the as such the comment to the extent of rupees 5 crores. So, from out of 100 crore,
5 crore is taken out. So, 95 crore is the value of the company as far as the all the
present stake holders are concerned, this is the one can take out. Similarly, there
can be example of non operating assets, non operating assets means the company is holding
the asset, but is not generating any revenue or the cash flows in that case, a non operating
assets should not be consider the value of the company assets. So, for from all the comparable
companies, we should take out the value of the non operating assets and the value of
the company should be based on the operating assets than non operating assets. So, these
adjustments should be done to the value of the company access, so in the comparable company
approach, then some other adjustment that we have adjusting the operating metric.
One can note here, the market value is in the numerator and the operating metric will
comes in the denominator. So, ultimately valuation parameter will be the market value in the
numerator and the operating metric in the denominator.
So, in that case, one has to adjust for something like inventory accounting, certain companies
can be there which may follow inventory valuation like FIFO method or LIFO method for that matter.
So, if the companies are some companies are following LIFO method then, accordingly some
adjustments should done. So, that the companies are becoming comparable. Similarly, as you
discuss earlier, depression method could be different. So, one has to do those accounting
adjustments to inventory accounting, there could be some extraordinary items.
Let us say we are having a valuation multiple like value of the company to earnings before
interest and taxes. As we know, these earnings before interest in taxes can be affected by
certain extraordinary item that is typical to the particular company in that particular
year. Let us say earnings before an interest in
taxes a particular company is rupees 10 crore, there is an extraordinary item which was there
before EBIT is taken within income in nature, it was rupees 2 crore. In that case, the EBIT
should be adjusted back to rupees 10 crore minus rupees 2 crore for that particular target
company or for the comparable company. So, the adjustment that you do the operating metrics
it is not necessary that we do only for the comparable companies, we do it also for the
target company, so that the valuation parameters valuation metrics are common as far as the
different companies are concerned.
So, there is no discrepancy as per different methods followed, different accounting practices
followed like that, similarly there could be some non recurring items. So, we should
remove those items, then there may be certain companies which may claim certain compensation
to the owners as a salary, actually in that case the owner salary if it is already deducted
from the income and the then profit has been found out, in that case the owner salary has
to be added. For instance, in this case, even after adjusting
for 2 cr of extraordinary item, we got normal earnings for interest taxes of 8 cr. Let us
assume in this case, the target company let us say this is a target company, so earnings
before interest in taxes and the target company has got owners compensation paid by them as
rupees 1 cr during this particular year. Actually in that case, what will if the EBIT for our
comparison will be now rupees 8 cr plus rupee one 1 cr, so that is rupees 9 cr becomes the
comparable EBIT as per the target company is concern.
So, if such things are there, also in the comparable company that also has to be adjusted.
So, that is one, similarly there could be certain intangibles like that as research
and development expenditure, good will amortization. So, all those intangibles could be there or
the adjustments have been done and though the adjustments have lead to reduction in
the profit parameter like EBIT, EBITDA. So, in that case, one has to go for the adjustments;
that means, in that case one can go for multiple like before the adjustments of actually taken
place. So, in that case instead of EBIT, one can
end of having multiple based on earnings before interest, taxes, depreciation and amortization.
See the amortization that a in this EBITDA term takes care of the amortization of intangible
assets. So, that has to be taken out, so that it is not affecting the figure. So, before
amortization, what is the profit is there that could be the base as the comparable multiple.
So, these are the certain adjustments which the valuer should do, where before going for
the finding valuation multiple. And coming to the different types of multiple that we
have is, we can divide the market capitalization of the particular company divide by the profit
after taxes of the company.
When we say market capitalization, we may mean market that is also known as m cap popularly,
which is nothing but, market price per share into the number of equity shares. So, the
market price of particular company share is rupees 80 and the number of share is a 10
cr in number. So, the value of the market capitalization comes to 800 crore. So, this
is the value, which is an aggregate value, if we are taking the aggregate value of the
company companies equity, then the relative valuation what happens? We have a something
like a value here; we have got the valuation parameters of the metric for that matter.
So, if the value is taken as aggregate value like this 800 crore then, the metrics would
also be on the ways of aggregate, it should not be a power share value. So, if you are
going for a valuation multiple price to earnings ratio, in that case what you do? The price
is the market price per share and earnings e is earnings per share is this is market
price per share is earnings per share. So, that is the case if you are applying this,
we should not do the mistake of dividing the value by earnings per share.
This earnings per share is in power share where is value e is a aggregate basis, in
that case inserting earnings per share, we would take the market capitalization as the
value and in instead of earnings per share, we take the profit after taxes of the particular
company and whatever you do, whether m cap by profit after tax or price to earnings ratio,
the value as per the both measures are concerned that is going to be one and same, it will
not be different. So, one has to be careful if we are taking
in the numerator the aggregate value, then denominator also should be an aggregate value
that has to be done. So, in that case if you look at this particular slide, we have a market
capitalization divide by net income that is profit after tax, market capitation divide
by dividend, then market capitation could be divide a net cash flow, market capitalization
will divide by earnings before tax or market can be divide by the book value of the equity
of the company. So, in this case, we have some five multiples
we have here, so that means, the investor will end of finding out five different multiples
and so one will be the market capitalization to profit of tax, one is going to market capitalization
to dividend pair, like that five different multiples can be there and five different
multiples can end of finding of the five different value of the particular company.
So, that is one. So, what happens? The further step that we will do here, we will find the
market capitulation by net income or something like that.
We if have let us say comparable company C1, C2, C3, C4, C5 so like that, we have the market
capitulation by net income or profit after tax, we have certain figures let us say 5,
7, 8, 6 and let us say 9, so, what do we do here?
These are the valuation multiples of comparable companies and we go for an average, we can
go for average as a median or the range is not substantial between lower value higher
value, we can also go for a substance we can go for a simple average. So, in simple average
the combination of this is comes to 35 and average that is 5 companies are there that
becomes now, 7 is the average m cap to profit after tax multiple.
Now, what you do here? We should have the target company, let us say target companies
profit after tax is rupees 10 cr. So, the value or the market cap should be as per this
parameter should be rupees 10 cr into the parameter that is 7 cr. So, the value of the
companies around equity of should be rupees 70 cr. So, this is the way one can apply the
formula and find out this. So, what we did we found the multiple here for different companies,
we found the average of that and this average has been multiple of the parameter, the parameter
in this case is our profit after tax of this particular company.
So, if this company is listed in the market, then the market calculation will be approximating
towards rupees 70 crore base, that is which is based on the comparable company. So, like
that different other parameters like market would be market capitulation dividend, market
capitulation to sales, market capitulation to net cash flow, all those things can be
used and values can be found out the fundamental method remains one and same.
Similarly, next category that we have is instead of dividing the market capitalization by the
parameter like profit after tax or dividend for that matter, what you do here? We divide
the stock price by the parameter per share. So, when you took net income in the first
category, we are now taking net income per share that is price earnings per share. When
you took total dividends in this case, in this case you take dividend per share and
instead of taking market capitalization of the entire company, we take only market price
per share and then accordingly the division is done.
So, what happens? The stock price divided by the earnings per share or market capitalization
between net income per net income, we will end we will end of having the same value only.
So, you can go for aggregate basis in the numerator denominator, we can also go for
an individual power share basis also.
So, let us look at an example here, these are certain companies in the pharmaceutical
sector like Cipla limited lab. These are part of CNX nifty index in India and particular
date in march 2009 31st march 2009, the price earnings ratio of this companies are for Cipla
is 21.99, for sun pharmaceuticals it is 18.21 and there is certain companies also negative
multiple is also there. So, this negative multiple is actually reflected because the
earnings per share of this particular company could be negative and according there has
been found out. So, similarly we have the price earnings ratio
and what has been done here instead of techniques average? The median of this particular multiple
are 16.43 and one more thing here, whenever you have a negative multiple like this, it
is always better that we remove this things from the from this particular companies list,
it is always advisable. And in this case, this particular thing automatically when taken
out, because you have use median and median takes care of the extreme values; obviously,
among these set of 10 companies, this minus 3.4 is one of the extensive most of been taken
care by the median as such. So, 16.43 is the median price earning multiple.
So, with which we have a target company of earnings per share is rupees 5 on a particular
for a particular date on 31st march 2009 and in that case we multiply 5with 16.43. So,
value as per the p multiple average comes to 82.15, similar the price to book value
ratio of this company is also have been found out and for example, Divi’s Lab is a company
which has got 4.89 is price to book value per share company per share.
Similarly, we have about a company like doctor Reddy’s lab which is 1.57 and the median
price to book value per share is 3.67 and the book value per share of this particular
target company is its 25, presuming or assuming like that. So, value as per p y multiplies
now 91.75, so this is not necessary that, value as per p multiple should be same as
that value as per price to book value multiple. So, like that different multiples can be found
out for the comparable companies and then average can be found out and that can be used
to multiply the target companies appeared financial parameter and the value of the particular
company can be found out.
Going further, we can also have something like an enterprise value, where you talk when
you say enterprise value, it is not value of only equity shares, it is value of the
all the investors that the company has. And this enterprise value multiple essentially
end of find the value of the entire company, once you have the value of the entire company,
then you take out the value of the Liabilities, that becomes the value of equity and the value
of equity can divide the number of shares, that gives us the value per share of the particular
company.
For example, if you have got a enterprise value of companies and then EBIT of different
comparable companies that multiple is let us say average enterprise value of EBIT is
3 and the EBIT of a particular company, target company is rupees 20 cr. So, the enterprise
value becomes now 20 into average EBIT that is 3 that is rupees 60 cr.
So, this is the enterprise value from that, we less the value of liabilities with a let
say it is rupees 20 cr. So, the value of equity is now rupees 40 crore. So, this is the value
of the equity and then you divide this rupees 40 crore with number of equity shares that
gives the value per share. So, this is the way to find out the you have
a enterprise value multiple, then from the enterprise value multiple, we get the enterprise
value access and the enterprise value multiple can be with the help EBIT, EBITDA then you
have sales can be there, gross profit can be there, total assets can be there net fixed
assets can be there, different multiples can be there, then whatever is found out then
the value of the target company in terms of enterprise value also can be found out.
So, we may look at here, so value is in this case, market value equity plus market value
of debt divide by earnings before interest, taxes depreciation and amortization. Then
there is another formula which talks about there is a non no cash version, from the numerator,
we take out the cash and then when you take the cash, then if there is any income from
the this cash or and the security, that is also removed from the denominator and then,
the appropriate multiple is found out and this multiple can be used for different companies.
There are certain other multiples also, which are industry specific multiples, instead of
depending on the financial parameter, one can depend upon certain industry specific
multiple like a steel company multiple could be the market value of invested capital ton
of steel. So, because steel companies value is driven by more of how much the ton of steel
capacity this particular company has. So, accordingly if you have target company which
a ton of steel is also given, that can be used or the operating parameter and the multiple
can be use to find the value. Similarly, for a cable tv operator, we can
have number of subscribers the value driver there. So, accordingly we can have a value
for subscriber, similarly for retail company we have a market value of the square foot
because more for retail company to do good business, they should have as much square
foot area. So, that is the one of the value driver out till company.
So, accordingly bottlers have different cases, how many cases of bottlers are being sold.
So, like that technology based companies, will have patents based or scientists based.
So, these are the different parameters, which are financial parameters, which are non financial
parameters, which can be used also to find the value of the company.
So, in this module, we have discussed about the different methods of a valuation, in this
we particularly focused on the asset based valuation measures and the relative valuation
measures. And the subsequent session, we are going to talk about the valuation based on
the cash flow based, that are different multiple valuation methods as per cash flows are concerned,
thank you.