Trading Comps Modeling Wall Street Prep Exam Questions And Answers

Trading
Comps
Why
we
use
trading
comps
to
value
companies
-
ANS
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?
-
ANS
We
don't
compare
absolute
values
but
rather
multiples
to
account
for
differences
in
a
company.
Non-operational
differences
that
should
be
taken
into
account
so
as
to
not
distort
the
comparison
-
ANS
•
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
-
ANS
EV,
Revenue,
EBITDA,
EBIT,
Unlevered
free
cash
flow
Nonrecurring
items
in
historical
profits
-
ANS
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
-
ANS
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
-
ANS
share
price/EPS
Equity
Value/
Net
income
EPS
is
used
as
a
proxy
for
economic
equity
value
Issues
with
P/E
-
ANS
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
-
ANS
•
Mature
lifecycle
companies
•
Companies
with
positive
earnings
•
Companies
with
similar
capital
structures
PEG
ratio
defn
and
issues
-
ANS
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
-
ANS
•
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
-
ANS
•
Companies
with
positive
earnings
but
at
different
lifecycle
stages
•
Meaningless
for
negative
earnings
or
negative
growth
Price
to
book
ratio
defn
and
description
-
ANS
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
-
ANS
•
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