A Business Valuation Article: Relative Valuation uses the valuation ratios of Comparable publicly traded companies and applies that ratios to the comapny being valued subject to necessary adjustments. Key Issues in Relative Valuations- a) Peer Selection, b) Current Multiples or Forward Multiples, c) Adjustments to the Value...

2. What is relative Valuation? Disadvantages of Using Relative Multiples
Relative Valuation uses the valuation ratios of Comparable publicly x Simplistic: A multiple has a great deal of information into a single
traded companies and applies that ratio to the company being valued number. By combining many value drivers into a point estimate,
subject to necessary adjustments. The valuation ratio typically multiples may make it difficult to disaggregate the effect of
expresses the valuation as a function of a measure of financial different drivers, such as growth, on value. The danger is that this
performance or Book Value Multiples (e.g. Revenue, EBITDA, EBIT, encourages simplistic – and possibly erroneous – interpretation.
Earnings per Share or Book Value).
x Static: A multiple represents a snapshot of where a firm is at a
This technique hinges upon the efficient market theory which indicates point in time, but fails to capture the dynamic and ever-evolving
that the price of exchanged securities in the market reflects all readily nature of business and competition.
available information, as well as the supply and demand effects of
educated and rational buyers and sellers. In other words, the market is x Difficult to compare: Multiples are primarily used to make
continuously evaluating each company and expressing that valuation in
comparisons of relative value. But comparing multiples always
bids and offers for its stock.
challenging, because there are so many reasons that multiples
can differ, not all of which relate to true differences in value. For
Advantages of Using Relative Multiples example, different accounting policies can result in diverging
multiples for otherwise identical operating businesses.
x Usefulness: Valuation is about judgment, and multiples provide a
framework for making value judgments. When used properly, Key Issues in Relative Valuation
multiples are robust tools that can provide useful information about x Peer Selection
how similar assets are placed in the market.
x Current Multiples or Forward Multiples
x Adjustments to the Value
x Simplicity: Their very simplicity and ease of calculation makes
multiples an appealing and user-friendly method of assessing
value. Issue 1 - Peer Selection
x Relevance: Multiples focus on the key statistics that other investors For Relative valuations, identification of appropriate peers is a
use. Since investors in aggregate move markets, the most prerequisite. Peers taken should be as close as possible to the
commonly used statistics and multiples will have the most impact. company being valued. It is preferred that the peer companies should
These factors, and the existence of wide-ranging comparables, have a similar:-
help explain the enduring use of multiples by investors despite the
rise of other methods. Most Valuation in stock markets are done x Business model,
through this method. x Accounting policies,
x Growth pattern
x Return on Capital Invested
x Financial and operational risk.
In case peers in the domestic country are not available, then global
peers can also be taken but subject to certain adjustments which are
discussed in Issue 3.

3. Therefore, to select the peer group of a company, it is important to Issue 3 - Adjustments to the Value
understand the business of the company being valued. Normally the
peer group will be based on companies from the same industry. Valuation derived from relative valuation method is based on a certain
Selecting the most appropriate peer group is thus not easy task. multiples like EBITDA/Sales or Profit etc. It does not take into
consideration other factors which are not reflected by the earnings
Issue 2 - Current or Forward Multiples such as:-
Generally to the latest financials of the company a prevailing market x Surplus/Non Operating assets
multiple of the comparable companies is applied to arrive at the value Surplus Assets/ Non Operating Assets does not reflect its
of the company being valued. However while valuing early stage value in the operating earnings of the company. Therefore the
companies whose values of financials in future years are considered Fair Market Value of such Assets should be separately added
as they provide a much better picture of the true value potential of the to the Value derived through other valuation methodologies to
firm. arrive at the value of the company.
However it is pertinent to mention herein that the Investors
The second limb then remains of Multiples of Comparable may not be willing to pay for these surplus/ Non Operating
Companies. Assets which may call for reorganization of the company.
x Current Multiple of Peer Companies – Incase the peer companies x Adjustments for Global peers
are mature as on the valuation date, their prevailing valuation If the valuation of a company is based on comparison with the
multiple may be applied to the forward stabilized financials of the global peers, then it should be adjusted for some differences
company being valued . such as:-
This will yield value of the company for the year for which earnings
are taken. Therefore this value has to be discounted back to get the x Difference of tax rate in the 2 countries.
forward present value of the company. x Difference in Growth & Inflation rate of the 2 countries
x Difference between the levels of competition in the 2
(Discounting can be done using the cost of capital of the
countries.
company or the cost of equity for the time period for which
x Difference in the country risk of the 2 companies
forward earnings are taken.)
x Difference of Accounting Treatment in the 2 companies
x Forward Multiple of peer companies-Forward Multiple of peer Thus there are many changes that are required to be made when
companies is applied when the entire Industry is in evolving stage choosing global peers & therefore domestic peers are always
and no Comparable Mature company exist on the Valuation date. preferred for relative valuations since they are more comparable.
In this case there is no need for discounting. Forward looking
Earnings are generally preferred for valuation purposes. Valuation
is generally done with a forward looking view and the value of a Our Comments:
company depends more upon how much in the future could the
company/business earn than how much it has earned till date. A key benefit of Relative Valuation analysis is that the methodology is
Therefore Forward Multiples are preferred more than Current based on the current market stock price. The current stock price is
Multiples. generally viewed as one of the best valuation metrics
because markets are considered somewhat efficient. But applying
multiples is not a straight forward technique and many considerations
have to be kept in mind when valuing a company. Sanity check is
advised by using other valuation methods as well.

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