Trading Comps Modeling Exam
Why we use trading comps to value companies - ANSWER 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? - ANSWER 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 - ANSWER • 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 - ANSWER EV,
Revenue, EBITDA, EBIT, Unlevered free cash flow
Nonrecurring items in historical profits - ANSWER 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 - ANSWER
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 - ANSWER share price/EPS
Equity Value/ Net income
EPS is used as a proxy for economic equity value
Issues with P/E - ANSWER 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 - ANSWER • Mature lifecycle companies
• Companies with positive earnings
• Companies with similar capital structures
PEG ratio defn and issues - ANSWER 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 - ANSWER • 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 - ANSWER • Companies with positive earnings
but at different lifecycle stages
• Meaningless for negative earnings or negative growth
Price to book ratio defn and description - ANSWER 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")
• Compares market value of equity to book value of equity
• Solves "only one period" problem of PE ratios
• For financial institutions whose equity is marked to market, also solves
some of historical cost problems
Issues with PB ratio - ANSWER • For non-financials, book value usually not an
accurate measure of true
equity value because of the historical nature of the balance sheet
• Book value may be negative (large historical losses) making the ratio not
meaningful
PB ratio is most appropriate for - ANSWER • Banks / manufacturing / other asset-
intensive businesses
EV/EBIT ratio def and description - ANSWER Enterprise value / Earnings before
interest & taxes
• Isolates core operations without impact of financing decision (interest
expense) and taxes
Why we use trading comps to value companies - ANSWER 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? - ANSWER 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 - ANSWER • 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 - ANSWER EV,
Revenue, EBITDA, EBIT, Unlevered free cash flow
Nonrecurring items in historical profits - ANSWER 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 - ANSWER
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 - ANSWER share price/EPS
Equity Value/ Net income
EPS is used as a proxy for economic equity value
Issues with P/E - ANSWER 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 - ANSWER • Mature lifecycle companies
• Companies with positive earnings
• Companies with similar capital structures
PEG ratio defn and issues - ANSWER 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 - ANSWER • 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 - ANSWER • Companies with positive earnings
but at different lifecycle stages
• Meaningless for negative earnings or negative growth
Price to book ratio defn and description - ANSWER 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")
• Compares market value of equity to book value of equity
• Solves "only one period" problem of PE ratios
• For financial institutions whose equity is marked to market, also solves
some of historical cost problems
Issues with PB ratio - ANSWER • For non-financials, book value usually not an
accurate measure of true
equity value because of the historical nature of the balance sheet
• Book value may be negative (large historical losses) making the ratio not
meaningful
PB ratio is most appropriate for - ANSWER • Banks / manufacturing / other asset-
intensive businesses
EV/EBIT ratio def and description - ANSWER Enterprise value / Earnings before
interest & taxes
• Isolates core operations without impact of financing decision (interest
expense) and taxes
