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Valuation Terms and Ratios

Valuation Terms and Ratios. Tanveer Chandok (Director of Mentorship). Last Time. Time value of money Financial Statements Balance Sheet Income Statement Statement of Cash Flow 10Q 10K. Important Terms. ttm – trailing twelve months yoy – year over year mrq – most recent quarter

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Valuation Terms and Ratios

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  1. Valuation Terms and Ratios Tanveer Chandok (Director of Mentorship)

  2. Last Time • Time value of money • Financial Statements • Balance Sheet • Income Statement • Statement of Cash Flow • 10Q • 10K GTSF Investments Committee

  3. Important Terms • ttm – trailing twelve months • yoy – year over year • mrq – most recent quarter • fye– fiscal year ended (followed by a date) • 5ye – 5 year expected • Price – market price of 1 share • EPS – earnings per share • Market Cap = (price * outstanding shares) GTSF Investments Committee

  4. Valuation • What is valuation? • Who uses valuation? • What are some of the most common metrics used when valuing a company? • What are some of the different ways to value a company? GTSF Investments Committee

  5. Valuation Basics • Valuation is the procedure of calculating the worth of an asset, security, company, etc... • Valuation is one of the primary tasks done by investment banks • Being good at providing valuations for companies is an invaluable skill set used in all facets of finance • There are 4 main ways to value companies • Comparable Companies (“comps”) • Precedent Transaction (“M&A comps”) • Discounted Cash Flow Modeling (“DCF”) - video • Leverage Buyout Modeling (“LBOs”) GTSF Investments Committee

  6. Commonly Used Metrics • One way to value a company is to compare it to its peers (Comparable Multiples Method) • There are a multitude of multiples used • The most common are: • Enterprise Value (EV) /EBITDA • Price/ Book Value • Price/Earnings • PEG • EV/Sales • Price/Sales GTSF Investments Committee

  7. Enterprise Value (EV) • Value of the entire firm including both debt and equity • EV = Market Value of Equity + Debt + Preferred Stock + Minority Interest - Cash • Why take out cash? • Cash is already counted in market value in equity (in theory) • You can use cash to pay down debt or pay a dividend • You would not buy a company for its cash GTSF Investments Committee

  8. EBITDA • Earnings BeforeInterest, Taxes, Depreciation and Amortization • Good way to evaluate a company’s profitability • EBITDA = Revenues - Expenses (excluding taxes, interest, depreciation and amortization) • Represents the earnings that can effectively service debt • Eliminates the effects of financing and accounting decisions • Non-GAAP metric GTSF Investments Committee

  9. Free Cash Flow (FCF) • Simply the amount of free cash a company has • Capital Expenditures less Operating Cash flow • Formula: • Working Capital = Current assets - Current liabilities • Why do we use (1-Tax Rate)? • Why subtract Change in NWC and Capital Expenditures? GTSF Investments Committee

  10. Important Ratios • EV/EBITDA • P/B • P/E • PEG • P/S • Current Ratio • Debt/Equity • Quick Ratio • Interest Coverage Ratio • Operating Margin • Profit Margin • ROE • ROA • ROIC GTSF Investments Committee

  11. EV/EBITDA • Essentially “at what multiple of earnings is the entire company valued at” • EV/EBITDA is the most common metric used when doing comparable multiple analysis • Varies greatly with industry • If the industry average EV/EBITDA multiple is 6X and your company has an EBITDA of $100MM what is your company’s EV? • Low ratio – company might be __________? • Higher EV/EBITDA ratio in ____ growth industries (like technology/biotech) GTSF Investments Committee

  12. Price/Book (P/B) • “Compares the cost of a stock to the value of the company if it was broken up and sold today” • P/B = Stock Price ÷ Book Value • Book Value = Total assets - Intangible assets - Liabilities • Book value is the theoretical value of assets that would be recovered in the event of a total firm liquidation • Assume • Total assets = 10MM • Intangible assets = 1MM • Liabilities = 6MM • Stock Price = $21 • Outstanding shares = 1MM • Price/Book? GTSF Investments Committee

  13. Price/Earnings (P/E) • The PE ratio of a firm is the multiple at which the stock price is trading as compared to earnings per share (EPS) • “How much do you pay per dollar of earnings?” • P/E ratio = Current stock price ÷ EPS • Stock Price - 502.20 • EPS - 40.44 • P/E - ? • What do you do if you have negative EPS? • Trailing P/E vs. Forward P/E GTSF Investments Committee

  14. PEG • Price to Earnings to Growth • P/E ratio divided by the growth of the earnings over a specified period of time • (P/E) ÷ (EPS Growth) • Can be in the past or the future (trailing vs. forward) • Expected growth is almost impossible to forecast accurately • PEG takes into account the growth of earnings and helps to give a more complete picture of relative price • If our firm’s P/E was 15and our annual EPS growth rate was 20% what is our PEG? GTSF Investments Committee

  15. Price/Sales and EV/Sales • Price/Sales (ttm) • Share Price ÷ Revenue per share • EV/Sales • Enterprise Value ÷ Annual Sales • “How much it costs to buy the company’s sales” • Takes into consideration debt, while P/S does not • If GOOG generated $32MM in sales has a market cap of $640MM , debt of $17MM and cash on hand of $20MM what are the P/S and EV/Sales ratios? • Name 2 companies for which Price/Sales is a good metric and 2 for which it is bad GTSF Investments Committee

  16. Other Ratios • Current Ratio • Current Assets ÷ Current Liabilities • What do we want? High/Low? • Debt/Equity • Total Liabilities ÷ Shareholders Equity • Indicates proportion of equity and debt the company is using to finance its assets • Quick Ratio • (Current assets – Inventories) ÷ Current Liabilities • Indicator of a company’s short-term liquidity. Dollar amount of liquid assets available for each dollar of current liabilities GTSF Investments Committee

  17. Other Ratios • Valuation ratios are used to determine how a stock is valued in the marketplace • All the metrics described depend on the current price of the stock or the current market capitalization of the company • These ratios are often swayed by market dynamics which are not always accurate • Efficiency ratios help us to simply look at the effectiveness of the company without the market’s interference GTSF Investments Committee

  18. Efficiency Ratios • Allow investors to see how effectively a firm is using its resources • The most common are; • Operating Margin • Profit Margin • Return on Equity • Return on Assets • Return on Invested Capital GTSF Investments Committee

  19. Operating and Profit Margin • Allow investors to see what percentage of each dollar made translates to the company’s bottom line • Operating Margin • Operating Income ÷ Net Sales • Gives an idea of how well management has been at generating income from the operation of the business • “How much a company makes on each dollar of sales” • Operating Income includes all revenues, not just sales • Profit Margin • Net income ÷ Sales • “How much out of every dollar of sales a company actually keeps in earnings” GTSF Investments Committee

  20. Income Statement GTSF Investments Committee

  21. ROE and ROA • ROE = “Return on Equity” • Net Income ÷ Shareholders Equity • “How much profit a company generates with the money shareholders have invested” • ROA = “Return on Assets” • Net Income ÷ Total Assets • “How efficient management is at using its assets to generate earnings” GTSF Investments Committee

  22. ROIC (Return on Invested Capital) • (Net income – Dividends) ÷ Total Capital • “How well capital is being used to generate profits” • Use the balance sheet and income statements on the next slides to calculate Return on Equity, Assets and Invested Capital GTSF Investments Committee

  23. Income Statement GTSF Investments Committee

  24. GTSF Investments Committee

  25. Ratios in Perspective • Ratios help to clarify investing theses • It is important to use ratios and numbers to backup your thoughts about a company • There is no “magic ratio” • Learning which ratios work the best takes time and experience • Ratios need to be compared horizontally (to other companies/industry) and vertically (through time) • The one thing you NEVER use to decide on an investment PRICE GTSF Investments Committee

  26. Next Time • Fundamental Evaluation • Macroeconomic Analysis • Microeconomic Analysis • Growth Drivers • Intro to Fixed Income GTSF Investments Committee

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