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Relative Valuation: Tests

Relative Valuation: Tests. Information requirements.

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Relative Valuation: Tests

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  1. Relative Valuation: Tests

  2. Information requirements • An analyst tells you that he never does DCF valuation because it requires too many assumptions (about cash flows, growth and risk). He argues that it is far simpler to use a multiple (EV/EBITDA, PE etc), obtained by looking at other firms in the sector, to estimate value. Is he right? • Yes • No • Explain.

  3. Distributional assumptions… • If you estimate the PE ratio for all companies and graph out the frequency distribution, can the distribution be normal? • Yes • No • Why not? So what?

  4. Controlling variables? • You are trying to decide whether a software company is fairly priced, based upon its PE ratio. The company trades at a PE ratio of 12 and the average for the software sector is 20. Based on this comparison, you would conclude that • The stock is cheap • The stock is expensive • The stock is fairly priced • State your implicit assumptions.

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