# Basics of valuation

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### Basics of valuation:

Basics of valuation Presented By : Prakash kumar Barnwal

### What we will cover:

What we will cover Purpose of valuation Basic valuation concepts Methods of valuation – critical appreciation of the methods with some examples

### Why valuation ?:

Why valuation ? Do you think the price of stock is reasonable? (equity research- investor) ‏ How much can you sell a company’s shares for? (Capital Markets IPO) ‏ How much should you pay for a business in an M&A deal? (Assets, shares - IB) ‏ How much can a PE house pay for a business? (IB) ‏

### Valuation concepts:

Valuation concepts Valuation of Business Vs. Value of Equity Value of the operational business i.e Enterprise Value - Value of debt (less cash) “ bondholder value” Value of Equity “ shareholder value” =

### Valuation concepts .. contd.....:

Valuation concepts .. contd..... The accounting balance sheet Cash Operational Liabilities Value of Equity Operational assets Debt =

### Valuation concepts .. contd:

Valuation concepts .. contd Market value Vs. book Value Cash Operational Liabilities Value of Equity Operational assets Debt = Off balance sheet value Value of Intangibles Many Industries have Market value > book value

### Valuation concepts .. contd:

Valuation concepts .. contd Market value of assets = Market value of liabilities Equity Net Operational assets Net Debt = Enterprise value (Markets opinion) ‏ Capital

### Calculation of enterprise value:

Calculation of enterprise value Given Cash = Rs.100, Debt = Rs.600, Equity = Rs.1200 find the EV?

### Calculation of enterprise value:

Calculation of enterprise value Given Cash = Rs.100, Debt = Rs.600, Equity = Rs.1200 find the EV? EV = Rs. 1700 Ie Market value of equity + value of net debt

### Calculation of enterprise value:

Calculation of enterprise value Given 1200 shares are outstanding at the valuation date with a share price of Rs. 15. Market value of Debt is Rs. 6000, Cash is Rs.200. What is EV?

### Calculation of enterprise value:

Calculation of enterprise value Given 1200 shares are outstanding at the valuation date with a share price of Rs. 15. Market value of Debt is Rs. 6000, Cash is Rs.200. What is EV? 1200*15 + 6000 – 200 Rs.23800

### EV of unlisted company ?? :

EV of unlisted company ?? Use methods like DCF, multiples to arrive at EV. Then calculate the implied share price.

### An Example:

An Example EV = 10000, Investments = 2000, Cash = 500, Debt = 5000, Number of shares = 200. What is the share price?

### An Example:

An Example Given :EV = 10000, Investments = 2000, Cash = 500, Debt = 5000, Number of shares = 200. What is the share price? (10000 + 2000 + 500 - 5000)/200 Rs. 37.5

### EV – Summing it all up:

EV – Summing it all up Enterprise value is the market value of net operational assets which must equal the market value of net funding THUS : EV = Equity + Debt - Cash

### EV a comprehensive picture:

EV a comprehensive picture Cash + Cash equivalents + Non controlled Investments + Non-core assets + Enterprise value (net operating assets) ‏ Debt Preference Shares Minority interest - Ordinary Equity value =

### Concept of trading value Vs transaction value:

Concept of trading value Vs transaction value Trading value is the equity value of an enterprise without control ie when a small quantity of shares is bought, IPO, Rights issue. Can also be used to value the total minority stake in an enterprise

### Concept of trading value Vs transaction value:

Concept of trading value Vs transaction value Transaction value is the enterprise value with control. Eg is when there is a buying of more than 50% of the equity of the company.. Takeover etc. There is a premium involved when there is such a transaction known as Control premium

What is control premium? It is the excess price paid over the pre-acquisition stock price. Reasons : synergies perceived, strategy for future etc.

### Methods for valuation:

Methods for valuation Multiples based method Discounted Cash flow method

### Multiple based method:

Multiple based method Based on linking VALUE with its VALUE DRIVERS ie earnings with value Cash Enterprise value Debt Equity Interest income Interest expense Net income EBIT EBITDA Valuation Value drivers

### Multiples : Generally used:

Multiples : Generally used Sales : (EV/Sales) Fast growing, loss making companies EBITDA : EV/EBITDA where leverage differs, acqns are generating amortizations EBIT : EV/EBIT where leverage differs PE : MPS/EPS for stable companies in mature inds. Lev. Is the same

### Multiples : industry wise:

Multiples : industry wise Energy : EV/reserves of oil,gas Mining : EV/reserves or production ton Media: EV / Subscribers Banks : Price / Book value Hotels : EV / no. of rooms Telecom EV/ Subscribers no.

### Discounted cash flow valuation:

Discounted cash flow valuation Valuation method based on the forecast of future cash flows Advantages are incorporates the time value of money, can subject to sensitivity analysis Useful in valuation of Early stages companies, projects with finite lives, valuing divisions of companies, valuing synergies.

### Discounted cash flow valuation:

Discounted cash flow valuation Has helped in identifying overheated market or an undervalued market Independent of accounting assumptions and estimates

DCF - Disadvantages Requires a lot of assumptions : Long term growth, discount rate. Complex and time consuming

### DCF Calculation – Steps involved:

DCF Calculation – Steps involved Forecast the company’s free cash flow Calculate the WACC Calculate terminal value and DCF Using the above calculate EV Convert EV into implied share price

### What is Free cash flow ?:

What is Free cash flow ? Different for different purposes FCF : The cash flow from operations of the business available to pay out debt and equity holders after investing for future growth. ( ie increase/decrease in capital expenditure and working capital) ‏

### Period for forecasting:

Period for forecasting Period for forecasting must be till the business reaches a Steady state Steady state is characterized by low growth rate, ROIC just above or approximates WACC, and capital investment is low, company is a cash cow and pays out most of its earnings.

### WACC - Calculation:

WACC - Calculation WACC = Wt. Cost of equity + Wt. cost of debt Cost of equity is ascertained by using the CAPM model. Cost of Debt is the post tax cost of debt Capital = market value of equity + market value of debt.

### Calculation of Terminal value:

Calculation of Terminal value Terminal value is given by : (Steady state FCF) * (1+ g) (WACC – g) ‏ Where g is the long term growth rate into perpetuity. REMEMBER g should not be larger than the nominal GDP growth rate.

### To conclude ::

To conclude : Generally using the implied values of shares a value is arrived at which may be median value or wt. avg. etc.

Thank you