TRADING COMPS QUESTIONS WITH
COMPLETE SOLUTION
a Why we use trading comps to value companies - The purpose of a trading comps analysis is to
determine what is the "appropriate" value of a
company, based on the market values of operationally similar companies.
When you try to gauge the fair value of your house by comparing to the values of houses
nearby, you're doing a comps analysis.
How are comps analyzed? - We don't compare absolute values but rather multiples to account for
differences in a company.
Non-operational differences that shuld be taqken into account so as to not distort the comparison - •
Financial leverage differences
• Accounting differences (depreciation method, useful life assumptions)
• Temporary distortions (nonrecurring items)
• Other accounting differences (lease classification, LIFO vs. FIFO)
• Business life cycle differences
What are examples of measures independent of leverage1 - EV, Revenue, EBITDA, EBIT, Unlevered free
cash flow
Nonrecurring items in historical profits - must be taken out of profits in order to exclude the distortion
What to do when companies are in different stages in their life cyucle - Multiples like pEG standardize
against different long-term growth rates
Ev/revenue facilitate comparisons for early stage companies generating loses.
PE ratio defn and description - share price/EPS
Equity Value/ Net income
, EPS is used as a proxy for economic equity value
Issues with P/E - EPS is a measure of accounting profit only during a particular period
Accounting profits can be misleading because they include noncash and
nonrecurring items, and accounting assumptions , and can be manipulated
Also, high PE valuation relative to peers could be justified when high PE firm has higher growth prospects
Less relevant for high growth companies
EPS is most appropriate for - • Mature lifecycle companies
• Companies with positive earnings
• Companies with similar capital structures
PEG ratio defn and issues - PE ratio / long-term growth rate
Standardizes PE ratios against companies' expected growth rates (g)
• Higher PEG ratio companies are considered overvalued
Issues with PEG ratio - • EPS is a measure of accounting profit only during a particular period
• Accounting profits can be misleading because they include noncash and
nonrecurring items, and accounting assumptions (such as historical vs.
market costing), and can be manipulated
PEG ratio is most appropriate for - • Companies with positive earnings but at different lifecycle stages
• Meaningless for negative earnings or negative growth
Price to book ratio defn and description - 1. Equity value / book value of equity
2. Equity value per share / book value of equity per share
3. Book value is often adjusted to exclude goodwill ("tangible book value")
COMPLETE SOLUTION
a Why we use trading comps to value companies - The purpose of a trading comps analysis is to
determine what is the "appropriate" value of a
company, based on the market values of operationally similar companies.
When you try to gauge the fair value of your house by comparing to the values of houses
nearby, you're doing a comps analysis.
How are comps analyzed? - We don't compare absolute values but rather multiples to account for
differences in a company.
Non-operational differences that shuld be taqken into account so as to not distort the comparison - •
Financial leverage differences
• Accounting differences (depreciation method, useful life assumptions)
• Temporary distortions (nonrecurring items)
• Other accounting differences (lease classification, LIFO vs. FIFO)
• Business life cycle differences
What are examples of measures independent of leverage1 - EV, Revenue, EBITDA, EBIT, Unlevered free
cash flow
Nonrecurring items in historical profits - must be taken out of profits in order to exclude the distortion
What to do when companies are in different stages in their life cyucle - Multiples like pEG standardize
against different long-term growth rates
Ev/revenue facilitate comparisons for early stage companies generating loses.
PE ratio defn and description - share price/EPS
Equity Value/ Net income
, EPS is used as a proxy for economic equity value
Issues with P/E - EPS is a measure of accounting profit only during a particular period
Accounting profits can be misleading because they include noncash and
nonrecurring items, and accounting assumptions , and can be manipulated
Also, high PE valuation relative to peers could be justified when high PE firm has higher growth prospects
Less relevant for high growth companies
EPS is most appropriate for - • Mature lifecycle companies
• Companies with positive earnings
• Companies with similar capital structures
PEG ratio defn and issues - PE ratio / long-term growth rate
Standardizes PE ratios against companies' expected growth rates (g)
• Higher PEG ratio companies are considered overvalued
Issues with PEG ratio - • EPS is a measure of accounting profit only during a particular period
• Accounting profits can be misleading because they include noncash and
nonrecurring items, and accounting assumptions (such as historical vs.
market costing), and can be manipulated
PEG ratio is most appropriate for - • Companies with positive earnings but at different lifecycle stages
• Meaningless for negative earnings or negative growth
Price to book ratio defn and description - 1. Equity value / book value of equity
2. Equity value per share / book value of equity per share
3. Book value is often adjusted to exclude goodwill ("tangible book value")
