How to evaluate a business by analogy: A methodological guide. Elena ChirkovaHow to value a business by analogy: A guide to using comparative market ratios How to value a business by analogy buy

Editor Vyacheslav Ionov

Chief Editor S. Turco

Project Manager O. Ravdanis

Corrector E. Chudinova

Computer layout A. Abramov

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- OK then! - Marya Nikolaevna finally decided. “Now I know your estate... as well as you.” What price will you put for a soul? (At that time, prices for estates, as is known, were determined by heart to heart.)

“Yes... I suppose... you can’t take less than five hundred rubles,” Sanin said with difficulty.

I.S. Turgenev. Spring waters

Sometimes there is more to a stock's valuation than the P/E ratio.

Warren Buffett
Letter to Berkshire Hathaway Shareholders, 1988

introduction

Dear readers! I am pleased to present to your attention the fourth edition of my book. I began to develop the topic of valuation using comparative market ratios (or multipliers) from a methodological point of view back in 2000, when, while working in the investment banking division of an investment company, I realized that the theoretical knowledge that can be gleaned from classical financial textbooks is clearly not enough . Each time we had to speculate on something, guess about something, be faced with the impossibility of giving a reasonable interpretation of the results obtained, etc. For example, we were always faced with a huge (twice or more) gap in the company’s valuation when using different multipliers , and the question constantly arose which of the estimates was closer to the truth. It was then that I began to systematize the evaluation work carried out by me and my colleagues and the results obtained during it and to “complete” for myself the theory of comparative ratios, which was very sparingly presented in finance textbooks.

Not much has changed since then. None of the currently available open sources provides the necessary amount of knowledge for practical mastery of the entire range of assessment methods, taking into account the nuances of using each of them. Much knowledge is only “in the heads” of practitioners and is passed on literally from mouth to mouth. And this circumstance creates a serious problem when improving the qualifications of financial analysts.

The realization that there is not a single systematic guide to such an important practical aspect of financial analytical work, combined with my personal experience, prompted me to create this book. It is based on the knowledge I acquired over several years of consulting and investment banking practice; Most of the examples given in the book are real calculations carried out by the team I worked with during the course of projects, or calculations that I encountered while being on the “other side” of the transaction...

My goal is to provide financial analysts with the theoretical knowledge and practical skills needed to:

Determine the appropriateness of using multiplier valuation in each specific case and understand when which valuation method is preferable to use;

Select multiples that are most suitable for valuing a particular company;

Competently calculate multiplier values;

Be able to interpret the results obtained when estimating using multipliers, i.e. understand all the distortions and errors associated with the use of this evaluation method.

Thus, we will talk about the limits of applicability of the method. All of the steps described below are aimed at obtaining a more accurate assessment of both companies and their securities, the value of which is invaluable when making an investment decision.

You have probably already noticed the second epigraph, which seems to contradict the content of the book. It would seem that if the author is going to talk about the use of comparative market coefficients (multipliers) in valuation, then why include in the epigraph a phrase according to which the valuation should go beyond the scope of their calculation? In fact, there is no contradiction, because the purpose of this methodological manual is precisely to teach you the creative and meaningful use of multiples to evaluate companies and to show that the simplest comparisons do not always lead to the desired result.

When choosing a presentation style for my book, I was guided by readers with basic financial training. To understand the text, you will need knowledge of terms such as “discount rate”, “discounting”, “discounted cash flow”, “weighted average cost of capital”, “fixed income security”, “Gordon dividend model”, “financial asset pricing model” "(capital asset pricing model - CAPM). In addition, basic financial reporting skills are required. No special training in the field of valuation activities is required. I expect that those familiar with the basics of corporate finance will understand almost every word in this book.

And now briefly about the differences between the new edition of the book and the previous one. It contains two fundamental additions.

First. A new chapter has appeared in the book - “Using multipliers to assess the overvaluation and undervaluation of the stock market as a whole.” In previous editions of the book, and in this one too, I talk a lot about the fact that valuation multiples are a relative valuation, it allows you to calculate the value of an asset based on the value of similar assets, but does not say anything about whether the value of similar assets is fair, Is it possible to rely on it? This is a serious problem when valuing multiples. It is partially solvable. Very often, the revaluation of shares of a specific group of companies, for example, an industry one, is associated with overheating of the market as a whole. And the revaluation of the market as a whole can be tested using multipliers, in particular historical averages. This will be discussed in the new chapter.

Second. I was faced with the fact that, even after studying the theory, analysts do not always have an idea where to get data for calculating multipliers - look at possible analogue companies, analyze whether they are suitable, find transactions with similar assets, find their financial indicators, and in some cases and ready-made multipliers. Therefore, I have prepared for you a list of the main sources of information, which includes more than 20 resources both on international companies and transactions, and on Russian ones. A significant part of them is paid, but large companies have signed up for a lot or are ready to subscribe if necessary.

I also updated the statistics, made a list of sources on the topic, and made other changes that seemed necessary to me.

1. Introduction to the theory of multipliers

Imagine that you want to sell your two-room apartment in Moscow in a 9-story panel building built in the 1970s. You don’t trust realtors and want to evaluate it yourself first. And so you open a database of apartments for sale in your city and find that in the immediate vicinity of your house two more apartments are for sale - a “one-room apartment” in a 9-story brick “Stalinist” building across the street and a “three ruble” apartment in a “Khrushchev” in the yard of your house. For the first they ask for $2500 per sq. m. m, for the second – $1900. You call the advertisements, ask the agent, look at the apartments and as a result you learn the following. The area of Stalin's one-room apartment is 36 square meters. m - quite decent for a one-room apartment, there is a combined bathroom with a window, as is fashionable now, a large 20-meter room, a storage room, mezzanines, but the kitchen is a little small - only 7 sq. m. m. The apartment has been recently renovated, the “original” parquet is in excellent condition. The entrance is also renovated and equipped with an intercom. A significant disadvantage is that all the windows face a noisy avenue, although the new double-glazed windows muffle this noise. In addition, the ceilings in the house are wooden; there was no major renovation of the house. Floor - last. “Treshka” in “Khrushchob” is small in size, only 62 square meters. m: tiny kitchen, no auxiliary premises, the entrance is open and very dirty, there are scribbles on the walls and smells like homeless people, there is no elevator, and the apartment is on the fourth floor, but the house is located in the courtyard (all windows face the courtyard), very green and cozy. But it’s further from the bus stop than the “Stalinka” - there it is right in front of the windows.

Based on this information, you are trying to evaluate your “kopeck piece”, which is something between a “one-room apartment” and a “three-room apartment” - a more or less normal layout, it was recently renovated, but all the windows face the avenue, and the entrance is as dirty as in the "Khrushchev" Mentally, you make a list of factors that influence the price of an apartment: the prestige of the area, proximity to transport, the material of the house (panel, brick, monolith, etc.), its number of storeys, the condition of the house (floors, communications, how long ago major repairs were made), the condition of the entrance , neighbors (availability of communal apartments), presence of an elevator, garbage chute, availability of amenities (for example, main gas or a gas water heater), floor on which the apartment is located, windows - into the courtyard or onto the street, layout, condition of the apartment, etc., not to mention on the legal purity of documents. Having made a rough estimate, you decide to list the apartment at $2,300 per sq. m. m and gradually lower the price. Realistic situation, isn't it?

What we have now done is the assessment of an object (in this case, real estate) by analogy. Can you imagine how many factors need to be taken into account even to evaluate an apartment? Business is assessed in approximately the same way, only the task becomes more complex. It is more difficult to select analogues (they are not so obvious), the range of factors that influence the cost is wider, it is more difficult to formulate how our analogues (each of them) differ from the company being valued and what adjustments will need to be applied. This is what this book is about. But first, a few introductory paragraphs.

1.1. Terminology used

Anyone whose activities are related to the financial market has probably heard or said: “this stock is quoted at P/E ten,” “this security is overvalued at P/S.” Foreign abbreviations P/S and P/E refer to market ratios that are used to value companies and their securities.

In the English-language financial literature, I counted at least six terms denoting valuation based on market multiples:

Grade by multipliers(from the English multiplier - multiplier), since to obtain a result, any company indicator is multiplied by a certain coefficient;

Grade by the “reference” company method(guideline company), since the company being evaluated is compared with a reference company, the price of which is known in advance;

Grade Similarly(by analogy), since an analogy is drawn between the company being evaluated and the reference one;

comparative(comparable) valuation, because one security is valued by comparison with others;

relative(relative) valuation because one security is valued relative to others (on a relative scale);

market(market) assessment, since it is based on market information about a peer company.

In this regard, I remember this incident. Several years ago I was asked to give a lecture on multipliers to economics students, and it was presented as a presentation on the use of the market comparison method in valuation. Indeed, one can say this - the possible options for the name of this method are not exhausted by the above list.

The term analogical valuation was more common in the 1970s and 1980s than it is today; The term "benchmark company" is used more often by professional appraisers than by investment bankers, but the other four terms are, in my opinion, equally common. But they mean the same thing: the same method or approach to assessment, the same calculation algorithm, so the choice of the term rather reflects the professional affiliation of the author of the text than contains a hint of any nuances in the application of the method.

Multipliers are widely used for “instant” valuation of companies (securities). Moreover, during such an assessment, the object of assessment is compared with a certain analogue, the multipliers of which can be taken as a standard.

1.2. The concept of "multiplier"

The use of multipliers is due to the difficulty of establishing a direct relationship between the prices of shares of different companies.

Example 1 . Let's assume that companies A and B are identical in absolutely everything except the number of shares. Let's say the revenue of each company is $100, and the net profit is $10. Theoretically, the market capitalization, or market value of 100% of the shares, of companies A and B should be the same, since it does not depend on how many shares the company's capital is divided into. Let the market capitalization of both companies be $100. At the same time, company A has 10 shares outstanding, and company B has 20. Neither company has debts. In this case, one share of company A costs $10, and one share of company B costs $5. Thus, the share prices of these companies differ by a factor of two, and the only reason for this is the different number of shares.

Example 2. Now suppose that company A is similar to company B, but exactly twice as large, that is, its revenue is $200 and its net profit is $20. Meanwhile, the number of shares of companies A and B is the same - 10 pieces each. If the capitalization of company B is $100 and one share costs $10, then the capitalization of company A should be twice as large and be $200, and the cost of one share of this company should be $20.

Example 3. Finally, let's assume that company A is twice as large as company B (as in the previous example), but it has half as many shares (10 and 20 shares, respectively). Then one share of company A should cost $20, and one share of company B should cost $5.

From the above examples it is clear that there are two fundamental factors on which, other things being equal, the price of one share depends: the total number of shares and the size of the company. Thus, in order to answer the question of whether Company A's shares are overvalued or undervalued compared to Company B's shares, it is necessary to consider both the size of the company and the number of shares it has issued. Agree that when calculating, it is quite difficult to control these two factors simultaneously, even in such simplified examples as ours, not to mention more complex situations when the number of shares is in the millions (and this number is unlikely to be round). In addition, a third factor always arises: the company being evaluated and its standard are not absolutely similar: for example (very simplified), their revenue differs by one and a half times, and their net profit differs by only 30%.

To simplify cost analysis, the method of multipliers (comparative coefficients) was invented, which allows you to elegantly abstract from the influence on the share price of the two factors mentioned above - the size of the company and the number of shares into which its share capital is divided. In other words, this method allows calculations to be made as if the companies being compared were the same size and had the same number of shares. Stock price comparisons are made in relation not to a company's revenue or net income, but to revenue or earnings per share. If we divide the share price by revenue or profit per share, we will get the P/S ratios, where P is the price and S is the volume of sales in monetary terms, which is usually , is identical to revenue, and P/E is the ratio of the share price to net profit per share (earnings per share - EPS).

Multipliers allow you to think about the value of shares not as stock quotes, but as quotes of the company’s financial or physical indicators (revenue or net profit). They show how much, for example, one dollar of company A's revenue is valued higher than one dollar of company B's revenue, thus being relative, or comparative, company valuation indicators.

Now let's get back to our examples. The idea of multipliers is based on the economic law of one price, which states that two identical assets should have the same market prices. In this ideal model:

If companies differ from each other only in the number of shares (example 1), then their P/S and P/E values are the same;

If companies are similar, like maps of the same area at different scales are similar, or like geometric shapes can be similar, and they have the same number of shares (example 2), then their multiples are also the same;

Moreover, even when companies are similar, but they have miscellaneous the number of shares (example 3), their P/S and P/E still coincide (see calculations in Table 1).

Thus, as a result of the transition to calculations per share, the cost analysis procedure was significantly simplified and a fairly effective way was found to compare companies of different sizes with different numbers of shares. This simplification is based on two additional assumptions:

The market's valuation of a company does not depend on the number of its shares;

The market values shares of large and small companies equally if the companies are similar.

The first assumption looks quite plausible and does not threaten the financial analyst with any complications. It is known, for example, that stock splits do not lead to a change in the company's market capitalization. In the case of the second assumption, the situation is not so clear. (This will be discussed in more detail in Section 11.5.)

1.3. Application of the multiplier-based valuation method

The main area of application of multipliers is the valuation of companies (shares). Multiple-based valuations are very popular among financial analysts.

First, it is used by financial asset managers, financial analysts and traders to evaluate listed securities (i.e. those that already have a market price) in order to determine whether it is advisable to purchase them at the current market price. In other words, multiples help answer the question: “Is a particular security overvalued or undervalued compared to other securities of companies in the same industry, country, etc.?”

Secondly, this method is used to value closed or unquoted companies, i.e. those whose shares do not have a market quote. Such an assessment is necessary: when carrying out mergers and acquisitions of closed companies; during an initial public offering of shares; when the share of one of the shareholders is bought out by other shareholders; when transferring company shares as collateral; for restructuring, etc. - in a word, wherever the assessment is applicable.

It is clear that in the first case it is assumed that the market may be irrational, i.e., value financial assets not at their fair value, and in the second - vice versa: the valuation is made on the basis of market prices of similar companies, and thus it is implied that these market prices fair.

Strictly speaking, valuation by multiples is not the main method for valuing shares (companies). It is traditionally believed that the most accurate, although more labor-intensive, method of business valuation is discounted cash flows. However, in practice, discounting is not always applicable, and in many cases it becomes necessary to supplement it with an assessment based on multipliers. It applies in particular in the following situations:

When required "instant"(read – simplified) assessment;

if there is insufficient data for assessment by discounted cash flows;

if it is impossible to provide accurate forecasting for a long period;

when it is necessary to impart objectivity to the assessment(when assessed using multipliers, this is ensured through the use of market information);

if you need to check the assessment using other methods, that is, when auxiliary verification methods are needed.

Let's consider these cases in more detail.

Instant assessment. A financial analyst may simply not have time to do the calculations. Often a situation requires making almost instantaneous financial decisions, this especially often happens when trading securities, when a trader is forced to decide in a matter of seconds whether to buy or sell them. Valuation based on multipliers is, of course, the simplest and fastest of all known methods, which, in fact, explains its widespread use recently.

Lack of data. A financial analyst may not have enough data to build complex financial models. Such situations arise all the time, for example:

When buying and selling shares by a portfolio shareholder who does not have sufficient information about the company;

When conducting an assessment for the purposes of a hostile takeover, which does not imply full disclosure of information on the part of the acquired company;

When assessing a young company (startup) that does not yet have its own history of operations.

In the absence of time and sufficient information, valuation based on multipliers is practically the only way out, although not ideal.

Impossibility of accurate forecasting. Multipliers are often used within the discounted cash flow method. As a rule, in this case they are used when assessing the residual, or final, value of a business ( terminal value – TV). In the book [ Copeland, Koller and Murrin 2008] used the term continuing value, translated into Russian as “extended value”. This use of market ratios is due to the fact that a cash flow model is never built for an infinitely long period. A certain forecasting horizon is selected, say 10 years, and the value of the business is calculated as the sum of discounted cash flows for a given period plus the present value of the residual value of the business at the end of the selected period. The residual value, in turn, is calculated through a multiplier, for example, as the profit of the “final” year, multiplied by a certain coefficient. Section is devoted to the use of multipliers to calculate the residual value of a business. 9.2, which will discuss the choice of forecasting horizon, as well as the specifics of using multipliers for these purposes.

Objectivity. In Western countries, especially the United States, multiplier-based valuation is widely used by the judiciary. From a legal point of view, it is sometimes quite difficult to prove how fair (objective) an assessment is based on the future net cash flows of the company being valued, since we are talking about forecasts that can be very subjective. In this sense, market valuation is considered fairer and is therefore taken into account in court cases. This practice is gradually beginning to take root in Russia.

In Japan, for example, until 1989, legislation was in force according to which banks were the underwriters of initial issues of shares ( initial public offering – IPO) were required to calculate placement prices using the multiples of three comparable companies, and the multiples P/E, P/BV (an abbreviation for the expression price to book value ratio– the ratio of the market value of assets to their book value) and P/DIV ( price/dividends– “price/dividends”). This was done to ensure that underwriters did not underestimate the placement price of the initial issues (as is known, the undervaluation of shares during an initial placement averages 16–17% of the market price on the first day of trading), however, practice has shown that this measure does not lead to the disappearance of undervaluation IPO, since the underwriting bank usually selected from possible comparable companies those that had lower multiples [ Ibbotson, Ritter 1995].

Checking the assessment using other methods. Estimation based on multipliers appears to be a good complementary check of results obtained using other methods. If the analyst has a gut feeling that a valuation based on multiples is close to fair, then a significant discrepancy between the valuation based on discounted cash flows and the valuation based on discounted cash flows will most likely indicate errors in the financial model (however, a discrepancy in the valuation based on discounted cash flows and in the valuation based on multiples may also indicate an incorrect choice of analogues). If there were no errors in the calculations, then the valuation results obtained by these two methods should coincide or at least be within a fairly narrow range (of course, such a statement implies that we are not talking about serious market anomalies).

Here it is necessary to clarify that it is better to compare the prices of one share, and not the capitalization of different companies, since in the long term it is necessary to evaluate the results that the company shows per share, so as not to “mix” with the operating results the impact on the capitalization of mergers and acquisitions, issues and repurchases of shares, etc. This is logical from the point of view of the company’s shareholders, who, during mergers and acquisitions and when issuing new shares, retain the same number of shares in their hands as before, and only their share in the company changes ( unless they invest in it by buying shares of an additional issue, or sell shares when they are repurchased by the company). For more information about this, see section. 3.1.

The term terminal value is also used, which is often translated either as “tracing paper” from English - “terminal value”, or “final value”. The term postprognosis value is also used. I prefer the good Russian expression “residual value”.

The book by the famous finance specialist Elena Chirkova is devoted to one of the least developed aspects of corporate finance - the applicability and correct use of the comparative method in valuation. The author not only helps the financial analyst understand the theoretical principles of comparative valuation and the nuances of using certain comparative ratios, but also reveals the specifics of working with companies operating in emerging markets and primarily in Russia. The book is written on extensive practical material and contains examples from the author’s personal experience. It is the first special textbook entirely devoted to comparative assessment, and has no analogues both in Russia and in the world. 4th edition, corrected and expanded.

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by liters company.

1. Introduction to the theory of multipliers

1.1. Terminology used

In the English-language financial literature, I counted at least six terms denoting valuation based on market multiples:

Grade by multipliers(from the English multiplier - multiplier), since to obtain a result, any company indicator is multiplied by a certain coefficient;

Grade by the “reference” company method(guideline company), since the company being evaluated is compared with a reference company, the price of which is known in advance;

Grade Similarly(by analogy), since an analogy is drawn between the company being evaluated and the reference one;

comparative(comparable) valuation because one security is valued by comparison with others;

relative(relative) valuation because one security is valued relative to others (on a relative scale);

market(market) assessment, since it is based on market information about a peer company.

1.2. The concept of "multiplier"

The use of multipliers is due to the difficulty of establishing a direct relationship between the prices of shares of different companies.

Example 1 . Let's assume that companies A and B are identical in absolutely everything except the number of shares. Let's say the revenue of each company is $100, and the net profit is $10. Theoretically, the market capitalization, or market value of 100% of the shares, of companies A and B should be the same, since it does not depend on how many shares the company's capital is divided into. Let the market capitalization of both companies be $100. At the same time, company A has 10 shares outstanding, and company B has 20. Neither company has debts. In this case, one share of company A costs $10, and one share of company B costs $5. Thus, the share prices of these companies differ by a factor of two, and the only reason for this is the different number of shares.

Example 2. Now suppose that company A is similar to company B, but exactly twice as large, that is, its revenue is $200 and its net profit is $20. Meanwhile, the number of shares of companies A and B is the same - 10 pieces each. If the capitalization of company B is $100 and one share costs $10, then the capitalization of company A should be twice as large and be $200, and the cost of one share of this company should be $20.

Example 3. Finally, let's assume that company A is twice as large as company B (as in the previous example), but it has half as many shares (10 and 20 shares, respectively). Then one share of company A should cost $20, and one share of company B should cost $5.

From the above examples it is clear that there are two fundamental factors on which, other things being equal, the price of one share depends: the total number of shares and the size of the company. Thus, in order to answer the question of whether Company A's stock is overvalued or undervalued compared to Company B's stock, it is necessary to consider both the size of the company and the number of shares it has issued. Agree that when calculating, it is quite difficult to control these two factors simultaneously, even in such simplified examples as ours, not to mention more complex situations when the number of shares is in the millions (and this number is unlikely to be round). In addition, a third factor always arises: the company being evaluated and its standard are not absolutely similar: for example (very simplified), their revenue differs by one and a half times, and their net profit differs by only 30%.

Now let's get back to our examples. The idea of multipliers is based on the economic law of one price, which states that two identical assets should have the same market prices. In this ideal model:

If companies differ from each other only in the number of shares (example 1), then their P/S and P/E values are the same;

Moreover, even when companies are similar, but they have miscellaneous the number of shares (example 3), their P/S and P/E still coincide (see calculations in Table 1).

The market's valuation of a company does not depend on the number of its shares;

The market values shares of large and small companies equally if the companies are similar.

1.3. Application of the multiplier-based valuation method

The main area of application of multipliers is the valuation of companies (shares). Multiple-based valuations are very popular among financial analysts.

When required "instant"(read – simplified) assessment;

if there is insufficient data for assessment by discounted cash flows;

if it is impossible to provide accurate forecasting for a long period;

when it is necessary to impart objectivity to the assessment(when assessed using multipliers, this is ensured through the use of market information);

if you need to check the assessment using other methods, that is, when auxiliary verification methods are needed.

Let's consider these cases in more detail.

Lack of data. A financial analyst may not have enough data to build complex financial models. Such situations arise all the time, for example:

When buying and selling shares by a portfolio shareholder who does not have sufficient information about the company;

When conducting an assessment for the purposes of a hostile takeover, which does not imply full disclosure of information on the part of the acquired company;

When assessing a young company (startup) that does not yet have its own history of operations.

In the absence of time and sufficient information, valuation based on multipliers is practically the only way out, although not ideal.

In Japan, for example, until 1989, legislation was in force according to which banks were the underwriters of initial issues of shares ( initial public offering – IPO) were required to calculate placement prices using the multiples of three comparable companies, and the multiples P/E, P/BV (an abbreviation for the expression price to book value ratio– the ratio of the market value of assets to their book value) and P/DIV ( price/dividends– “price/dividends”). This was done to ensure that underwriters did not underestimate the placement price of the initial issues (as is known, the undervaluation of shares during an initial placement averages 16–17% of the market price on the first day of trading), however, practice has shown that this measure does not lead to the disappearance of undervaluation IPO, since the underwriting bank usually selected from possible comparable companies those that had lower multiples [ Ibbotson, Ritter 1995].

1.4. Limitations of the multiplier valuation method

Due to the apparent simplicity and speed of the calculations, the comparative assessment method has become widespread, but we must not forget that “free cheese is only in a mousetrap”: you have to pay for speed and simplicity, and first of all – the accuracy of the assessment. English-speaking financiers use the expression quick and dirty valuation(quick and dirty assessment). This is what is called valuation based on multipliers. When making such an assessment, two types of errors arise.

Firstly, the error arises due to the fact that when valuing using multiples, it is sometimes extremely difficult to select a group of analogue companies that are as similar as possible to the company being valued. Just as there are no two identical people, there are no two identical companies. If we don’t know the company being valued well enough to build a net cash flow model for it, then we also cannot accurately select analogues for it, not to mention the fact that sometimes close analogues objectively do not exist. Working with multipliers, we really get a comparative, or relative, assessment in the full sense of the word - an assessment compared with the group of analogues (or relative to it) selected by the appraiser. However, whether such an assessment is close to a fair price is an open question.

Secondly, if with an error of the first type we are talking about a human error in the selection of analogous companies, which may be forced due to a lack of information, then an error of the second type arises regardless of the will and qualifications of the analyst. A multiple valuation is a market valuation and uses relevant market indicators calculated either from the stock prices of public companies or from the prices of acquisitions of similar companies. The company being evaluated is compared on the basis of these indicators with a group of peer companies. Assuming that the market is rational and always values companies fairly (based on the present value of future cash flows), then the difference in multiples for two companies may only reflect the extent to which they are different. If we assume that the market can be wrong, then different multiples may also reflect market errors - overvaluation or undervaluation of the shares of one company relative to another. To use multiples correctly, we must be sure that our group of peer companies is valued correctly, that is, the market, on average, fairly “valued” the securities of the industry that the group of peers represents on a specific date. However, without a fundamental analysis of the situation on the financial market as a whole, there can be no such confidence.

Thus, the multiplier valuation method is fraught with certain threats that arise due to the fact that when using market information it is extremely difficult to correctly take into account market sentiment. The market as a whole may be “overheated” or, conversely, susceptible to investor panic, and in addition, it may overestimate or underestimate companies in a particular industry that is currently “in fashion” or “out of fashion,” etc. In such cases, the values of the multiples for a group of peer companies turn out to be distorted compared to the values calculated on the basis of their fair prices. Consequently, the advantages of multipliers are a continuation of their shortcomings. As has been said many times, valuation based on multipliers is called relative, or comparative, i.e. we estimate the cost of a particular security only in relation to to the group of peer companies (or in comparison with it) that we have chosen, and our method turns out to be vulnerable if, say, the market as a whole is “overheated” or a particular industry is overvalued, as has recently happened, for example, with Internet shares companies.

It is appropriate here to make a brief but extremely important note regarding the efficient market hypothesis. According to this hypothesis, the market price of a quoted asset is an unbiased estimate of its fair value. With a weak degree (weak form) of market efficiency, it is required that the price of an asset immediately takes into account information that affects its price (but it is not determined which one exactly), with a medium degree (semistrong form) it is stipulated that we are talking about all publicly available information, with a strong form – about absolutely all information, including insider information. Often the hypothesis about market efficiency is interpreted as follows: “market prices for securities are fair at each point in time.” But such an interpretation is incorrect even for the hypothesis of a strong degree of market efficiency. In an efficient market, asset prices can be higher or lower than their fair values, as long as the deviations of real prices from fair prices are random. Thus, with equal probability, each security can be either undervalued or overvalued, even in an efficient market. Moreover, most corporate finance experts currently agree that the hypothesis that financial markets are efficient is incorrect. And this concerns efficiency not only of a strong degree (which was recognized quite a long time ago and even by the author of this hypothesis, the American economist Eugene Fama), but also of a moderate degree. Enormous statistical material has already been accumulated in support of this opinion.

It turns out something like a contradiction. On the one hand, the multiplier valuation method itself carries an error, since the market prices of peer companies may be unfair. On the other hand, the comparative method is used to evaluate a quoted company, i.e., already valued by the market, precisely for the purpose of checking whether our company is undervalued or overvalued by the market at a given time in comparison with a group of peer companies. And it is the multiplier valuation method that allows us to assess the fairness of the company’s market price.

Warren Buffett, who owns the words in the epigraph of the book, prefaced the conclusion contained in them with the following story. When he was 24 years old, he worked for the New York company Rockwood & Co., which specialized in the production of chocolate products. Beginning in 1941, when cocoa beans sold for 50 cents per pound, the company used the LIFO (last in, first out) inventory valuation method. In 1954, a poor cocoa harvest pushed cocoa prices to 60 cents a pound, and before prices fell, the company decided to quickly sell off most of its inventory. If they had simply been implemented, the income tax at the rates in effect at the time would have been 50%. Meanwhile, in 1954, the United States adopted a new tax code that allowed companies to avoid paying this tax if their inventory was distributed to shareholders as part of a business reorganization plan. Under these conditions, the management of Rockwood & Co. decided to close the sale of cocoa butter as a separate type of business and stated that inventories of 13 million pounds of cocoa beans were attributable to it. The company offered its shareholders to buy out their shares in exchange for cocoa beans and was ready to give 80 pounds of cocoa beans per share. Before the announcement of the repurchase, one share of the company cost $15, and after the repurchase its price rose to $100, despite the fact that during this period the company suffered large operating losses. $15 is much less than the market value of cocoa beans on the balance sheet per share. On the other hand, if the quote reaches $100, then this means that the investor buying the shares gets the right to sell cocoa beans for $48 (80 × $0.6) and own an ownership interest in Rockwood & Co., which he values at $52 ( $100 – $48), while the company's inventories will decrease as a result of the restructuring. In other words, an investor is willing to pay $52 for shares of a company with less reserves than the company had on its balance sheet when its shares were worth only $15. This example suggests that the stock was either undervalued before the buyout announcement or overvalued after it.

The inaccuracy of multiple valuations does not mean that they should be abandoned. Inaccurate estimates are perfectly acceptable as long as the analyst understands the limitations that the simplified cost analysis method imposes on the result obtained and its reliability. It is much worse if quick assessments are not fully comprehended and not filled with real content. The use of multiples for valuation sometimes amounts to a routine calculation that requires familiarity with the basics of finance and knowledge of the four basic operations of mathematics, and this approach seems accessible to everyone. Meanwhile, the competent and creative use of multipliers can significantly increase the accuracy of the assessment, i.e., if possible, mitigate the shortcomings of the method, as well as understand the causes and extent of inaccuracies, which is extremely important for making financial decisions. Thus, in assessment it is important interpretation result, and only a thorough understanding of the method used allows these interpretations to be made.

With a reasonable approach to estimating multipliers and competent use of all its advantages, the analyst can turn a “dirty” assessment into a masterly and meaningful one, although in this case it will not be so “fast”.

1.5. The place of comparative assessment in the classification of assessment methods

Security Question 1

Next, we will talk about how the valuation of the company itself, its investment projects and securities relate. However, I invite the reader to test his knowledge and, before he looks into the depths of the book, answer this question himself. So how do you think they compare?

Traditionally, there are three methods for valuing a company (business):

1) according to discounted cash flows (the so-called income method or income approach);

2) by assets (cost method or approach);

3) according to multipliers (comparative assessment or comparative approach).

In order to determine the place of comparative assessment among all possible methods, we would like to construct the classification somewhat differently. To this end, it is necessary to introduce three contrasts.

An assessment based primarily on information about the company itself, compared with an assessment by analogy with other companies (comparative assessment).

The valuation of a company based on its projects, in other words, its future cash flows, compared to the valuation of a company based on its current tangible and intangible assets.

Valuation based on the past versus valuation based on the present and future.

The value of a company (or business) can be represented in different ways, for example, as the sum of assets and as the sum of liabilities of a given business (the sum of assets is equal to the sum of liabilities).

On the liability side, this value can be thought of as the value of the company's shares plus the value of its long-term liabilities, as well as hybrid or derivative securities, that is, those that have features of both stocks and bonds. (For simplicity, in our further discussions, we will, as a rule, abstract from hybrid instruments.) The cost of shares indicates the share of the company’s assets “as if belonging” to its shareholders, and the cost of liabilities indicates the share of creditors in the company’s assets.

On the other hand, the value of a company can be represented as the sum of its assets, and this can be done in at least two ways (a simplified division is presented in the table below).

Firstly, assets can be divided or grouped, so to speak, “per project”. For example, they can be divided into assets used for current activities, new investment opportunities (projects in the portfolio) of the company, and those assets that are not (and will not be) involved in either current activities or new projects. In this case, the current activity itself can be considered as an investment project with zero initial investment. When we deal with assets, it is important to ensure that none of them are forgotten and at the same time that double counting does not occur, such a mistake is quite easy to make. When it comes to projects, we evaluate them by discounted cash flows, that is, by the income they will bring in the future. This is future-based assessment.

Secondly, assets can be grouped as balance sheet items, where they are divided into fixed and current, tangible and intangible, etc. When considering assets as fixed and current assets, all three valuation options are possible - based on the past, present and future:

future-based assessment- this is an assessment by discounting cash flow, which, however, is generated not by the company in general and not by its business unit, but by a specific object. For example, you can assume that a company will lease out its building or land owned by it, and discount the cash flows associated with this operation;

assessment based on past history(or the so-called cost method) represents the historical amount of investments or the purchase price of a particular object minus its depreciation. For example, equipment with a service life of 10 years was purchased 5 years ago for $100, therefore, now its value is $50 (not taking into account revaluations due to inflation);

assessment based on the present represents the current market price at which a given asset can be sold or bought, or its replacement cost, i.e. the price at which the same asset can be built (taking into account depreciation). The market price is usually calculated based on the value of similar properties that have been sold and the price of which is known. For example, you can determine the price of a building based on its area and price per 1 sq. m. m, calculated on the basis of sales prices of similar buildings. This assessment is comparative. In this example, we used the comparative method to value only one of the company's assets. Other types of assets may be valued using different methods.

Simplified in the first case, our balance looks like this:

...and in the second case like this:

However, the path of analogy, or comparison, could have been followed from the very beginning. Then, to value a company's shares, it was not necessary to evaluate its assets either in the form of the sum of projects or in the form of the sum of factors of production. The shares could be evaluated directly: by comparison with the securities of other companies.

What is the difference between our classification and the commonly used one? When the company's assets are presented not as the sum of projects, but as the sum of tangible and intangible objects, i.e. assets in the accounting sense, then practically the same valuation methods are applicable to each specific asset as for the company as a whole (valuation at discounted prices). cash flows and comparative valuation), therefore, strictly speaking, asset-based valuation is not an independent valuation method. Rather, it is a way of dividing a company into elements and then evaluating each of them. I mention this to lead you to the idea that comparative valuation is a method that allows you to evaluate not only the company as a whole, but also its individual assets.

1.6. Disadvantages of working with databases containing information on multipliers

Before moving on to the question of building multipliers correctly, I would like to say a few words about why you will have to do it yourself every time. Currently, paid sources of financial information are available, which provide analogues for a specific company and even calculate their multipliers. It would seem that now there is no need to know the rules for their calculation if the computer has already calculated everything “itself”. However, with the exception of individual cases, we do not recommend working with “ready-made” multiples due to the fact that with this approach it is extremely difficult to obtain a meaningful assessment of the company that interests you.

End of introductory fragment.

* * *

The given introductory fragment of the book How to value a business by analogy: A manual on the use of comparative market ratios (E. V. Chirkova, 2017) was provided by our book partner -

How to value a business by analogy. Chirkova E.V.

Methodological guide to the use of comparative market ratios when valuing businesses and securities.

M.: 2005. - 190 p.

The book is written on extensive practical material and contains examples from the author’s personal experience. It is the first special textbook completely devoted to comparative assessment and has no analogues both in Russia and in the world.

The book is intended for financial analysts, investment valuation specialists, teachers and students.

Format: djvu/zip

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CONTENT
Preface 7
Opening remarks 9
1 Introduction to multiplier theory 13
1.1. Terminology used 13
1.2. The concept of "multiplier" 14
1.3. The sophistication of valuation based on multipliers in financial literature and the idea of writing this book 18
1.4. Problems of book 22
1.5. Disadvantages of working with databases containing information on multipliers 23
1.6. Application of the valuation method based on multipliers 25
1.7. “Limitations” of the multiplier valuation method 29
1.8. The place of comparative assessment in the classification of assessment methods 34
1.9. Brief conclusions 37
2. What are multipliers, how did they arise and how are they used 39
2.1. “One Hundred Thousand Whys” - about animators 39
2.2. The logic of multipliers using the example of the price/net profit indicator 40
2.3. Brief conclusions 46
3 Numerator of multiplier 47
3.1. Price per share or 100% shares? 47
3.2. With or without options? 49
3.3. Market capitalization or business value? ... 52
3.4. Quotes or prices of large transactions? 57
3.5. Transaction prices for private or public companies? 62
3.6. Asset prices 65
3.7. Brief conclusions 66
4 Denominator of the multiplier 68
4.1. What indicators can serve as denominators of the multiplier 68
4.2. Questions of correspondence between the numerator of a multiplier and its denominator 73
4.3. Brief conclusions 74
5 “Profitable” financial multipliers 75
5.1. Income statement indicators used to calculate multipliers 75
5.2. Price/revenue multiplier 77
5.3. Share price to earnings before interest, taxes, depreciation, amortization and operating margin ratio 80
5.4. Price/net profit multiplier 84
5.5. Indicators based on cash flow 87
5.6. Price/dividend multiplier 90
5.7. Brief conclusions 94
6 Financial indicators based on asset value 97
6.1. Types of indicators based on asset value 97
6.2. Relationship between balance sheet multipliers and profitability multipliers 100
6.3. Advantages, disadvantages and applicability of balance sheet indicators 103
6.4. Brief conclusions 106
7 Natural indicators 108
7.1. Applicability of natural indicators 108
7.2. Main types of natural indicators 111
7.3. Brief conclusions 114
8 “Future multipliers” and growth multipliers 115
8.1. Multipliers based on current stock prices and future financial performance 115
8.2. Multipliers using growth rates 119
8.3. Multipliers based on future stock prices 121
8.4. Brief conclusions 129
9 Some special cases of using multipliers 131
9.1. Using multipliers when attracting credit financing 131
9.2. Using multipliers when calculating the residual value of a business 137
9.3. Using multipliers to express the value of a business as a formula 144
9.4. Brief conclusions 146
10 Selection of analogues 148
10.1. Key factors influencing the choice of analogues 148
10.2. Country factor 149
10.3. Industry factor 152
10.4. Time factor 155
10.5. Other factors 161
10.6. Brief conclusions 164
11 Methods for calculating multipliers and their applicability 166
11.1. Palette of methods for calculating multipliers 166
11.2. Methods for calculating the average value of the multiplier 167
11.3. Regression equation 169
11.4. Industry applicability of methods 174
11.5. Brief conclusions 176
12. Comparability of companies from developed and emerging markets: calculations and interpretations 177
12.1. Reasons for the valuation gap: difference in business profitability 178
12.2. Reasons for the valuation gap: differences in expected growth rates 179
13 Instead of conclusion 184
Answers to security questions 187
List of used abbreviations 192

The book by Elena Chirkova, a well-known financial consultant, co-head of mergers and acquisitions and fundraising in the Financial Services Department of Deloitte, is dedicated to one of the least developed aspects of corporate finance - the applicability and correct use of the comparative method in valuation. The author not only helps the financial analyst understand the theoretical principles of comparative valuation and the nuances of using certain comparative ratios, but also reveals the specifics of working with companies operating in emerging markets and, first of all, in Russia. The book is written on extensive practical material and contains examples from the author’s personal experience. It is the first special textbook completely devoted to comparative assessment and has no analogues both in Russia and in the world. The book is intended for financial analysts, financial consultants, professional appraisers, teachers and students.

1. INTRODUCTION TO THE THEORY OF MULTIPLIERS

2. WHAT ARE MULTIPLIERS, HOW THEY ARISED AND HOW THEY ARE APPLIED

3. NUMERATOR OF THE MULTIPLIER

4. DENOMINATOR OF THE MULTIPLIER

5. “INCOME” FINANCIAL MULTIPLIERS

6. FINANCIAL INDICATORS BASED ON ASSET VALUE

7. NATURAL INDICATORS

8. “FUTURE MULTIPLIERS” AND GROWTH MULTIPLIERS

9. SOME SPECIAL CASES OF USING MULTIPLIERS

The book by a well-known finance specialist, Associate Professor at the School of Finance at the National Research University Higher School of Economics, Elena Chirkova, is dedicated to one of the least developed aspects of corporate finance - the applicability and correct use of the comparative method in valuation. The author not only helps the financial analyst understand the theoretical principles of comparative valuation and the nuances of using certain comparative ratios, but also reveals the specifics of working with companies operating in emerging markets and primarily in Russia.
The book is written on extensive practical material and contains examples from the author’s personal experience. It is the first special textbook entirely devoted to comparative assessment, and has no analogues both in Russia and in the world.
The book is intended for financial analysts, investment valuation specialists, teachers and students.

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