M& a Valuation

8/8/2019 M& a Valuation

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M& A VALUATIONS-


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Price-Earnings Ratio - P/E Ratio

What Does Price-Earnings Ratio - P/E Ratio Mean?A valuation ratio of a company's current share price compared to its per-share earnings.

Calculated as:

For example, if a company is currently trading at $43 a share and earningsover the last 12 months were $1.95 per share, the P/E ratio for the stockwould be 22.05 ($43/$1.95).

EPS is usually from the last four quarters (trailing P/E), but sometimes it can

be taken from the estimates of earnings expected in the next four quarters(projected or forward P/E). A third variation uses the sum of the last twoactual quarters and the estimates of the next two quarters.

Also sometimes known as "price multiple" or "earnings multiple".


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Title In general, a high P/E suggests that investors are expecting higher

earnings growth in the future compared to companies with a lower P/E.However, the P/E ratio doesn't tell us the whole story by itself. It'susually more useful to compare the P/E ratios of one company to othercompanies in the same industry, to the market in general or against thecompany's own historical P/E. It would not be useful for investors using theP/E ratio as a basis for their investment to compare the P/E of a technology

company (high P/E) to a utility company (low P/E) as each industry hasmuch different growth prospects.

The P/E is sometimes referred to as the "multiple", because it shows howmuch investors are willing to pay per dollar of earnings. If a company were

currently trading at a multiple (P/E) of 20, the interpretation is that aninvestor is willing to pay $20 for $1 of current earnings.

It is important that investors note an important problem that arises with theP/E measure, and to avoid basing a decision on this measure alone. Thedenominator (earnings) is based on an accounting measure of

earnings that is susceptible to forms of manipulation, making the quality ofthe P/E onl as ood as the ualit of the underl in earnin s number.


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What Does Enterprise-Value-To-Sales - EV/SalesMean?

A valuation measure that compares the enterprise value of acompany to the company's sales. EV/sales gives investors anidea of how much it costs to buy the company's sales. Thismeasure is an expansion of the price-to-sales valuation,which uses market capitalization instead of enterprise

value. EV/sales is seen as more accurate because marketcapitalization does not take into account as well as enterprisevalue the amount of debt a company has, which needs to bepaid back at some point. Generally the lower the EV/sales themore attractive or undervalued the company is believed to be.


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Title

The EV/sales measure can be negative when the cash in thecompany is more than the market capitalization and debtstructure, signaling that the company can essentially be boughtwith its own cash.

The EV/sales measure can be slightly deceiving: a highEV/Sales is not always a bad thing as it can be a sign thatinvestors believe the future sales will greatly increase. A lowerEV/sales can signal that the future sales prospects are not veryattractive. It is important to compare the measure to that ofother companies in the industry, and to look deeper into thecompany you are analyzing.


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Price-To-Sales Ratio - Price/Sales

A ratio for valuing a stock relative to its own past performance, other companies or the market itself. Price to sales is calculated by dividing astock's current price by its revenue per share for the trailing 12 months:

The ratio can also be referred to as a stock's "PSR".

The price-to-sales ratio can vary substantially across industries;therefore, it's useful mainly when comparing similar companies. Because itdoesn't take any expenses or debt into account, the ratio is somewhatlimited in the story it tells.


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Replacement Cost

The price that will have to be paid to replace an existing asset with a similarasset.

This is relevant because the replacement cost will most likely be different

than fair market value or net realizable value.

In a few cases, acquisitions are based on the cost of replacing the targetcompany. For simplicity's sake, suppose the value of a company is simplythe sum of all its equipment and staffing costs. The acquiring company canliterally order the target to sell at that price, or it will create a competitor forthe same cost. Naturally, it takes a long time to assemble goodmanagement, acquire property and get the right equipment. This method ofestablishing a price certainly wouldn't make much sense in a serviceindustry where the key assets - people and ideas - are hard to value anddevelop


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Discounted Cash Flow (DCF)

There are many variations when it comes to what you can use for yourcash flows and discount rate in a DCF analysis. Despite the complexityof the calculations involved, the purpose of DCF analysis is just toestimate the money you'd receive from an investment and to adjust forthe time value of money.

Discounted cash flow models are powerful, but they do haveshortcomings. DCF is merely a mechanical valuation tool, which makesit subject to the axiom "garbage in, garbage out". Small changes ininputs can result in large changes in the What Does Discounted CashFlow-DCF Mean?

A valuation method used to estimate the attractiveness of an investmentopportunity. Discounted cash flow (DCF) analysis uses future free cashflow projections and discounts them (most often using the weightedaverage cost of capital) to arrive at a present value, which is used toevaluate the potential for investment. If the value arrived at through DCFanalysis is higher than the current cost of the investment, the opportunity

may be a good one.


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Calculated as;

Also known as the Discounted Cash Flows Model.

There are many variations when it comes to what you can use for your cashflows and discount rate in a DCF analysis. Despite the complexity ofthe calculations involved, the purpose of DCF analysis is just to estimate themoney you'd receive from an investment and to adjust for the time value ofmoney.

Discounted cash flow models are powerful, but they do have shortcomings.DCF is merely a mechanical valuation tool, which makes it subject to theaxiom "garbage in, garbage out". Small changes in inputs can result in large

changes in the value of a company. Instead of trying to project the cashflows to infinity, terminal value techniques are often used. A simple annuityis used to estimate the terminal value past 10 years, for example. This isdone because it is harder to come to a realistic estimate of the cash flows astime goes on.


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Weighted Average Cost Of Capital - WACC

A calculation of a firm's cost of capital in which each category of capital isproportionately weighted. All capital sources - common stock, preferredstock, bonds and any other long-term debt - are included in a WACCcalculation. All else equal, the WACC of a firm increases as the beta andrate of return on equity increases, as an increase in WACC notes adecrease in valuation and a higher risk.

The WACC equation is the cost of each capital component multiplied by itsproportional weight and then summing:


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Where:Re = cost of equityRd = cost of debtE = market value of the firm's equityD = market value of the firm's debtV = E + DE/V = percentage of financing that is equityD/V = percentage of financing that is debtTc = corporate tax rate

Businesses often discount cash flows at WACC to determine the Net Present Value(NPV) of a project, using the formula:

NPV = Present Value (PV) of the Cash Flows discounted at WACC.

Broadly speaking, a companys assets are financed by either debt or equity. WACCis the average of the costs of these sources of financing, each of which is weighted

by its respective use in the given situation. By taking a weighted average, we cansee how much interest the company has to pay for every dollar it finances.

A firm's WACC is the overall required return on the firm as a whole and, as such, it isoften used internally by company directors to determine the economic feasibility ofexpansionary opportunities and mergers. It is the appropriate discount rate to use for

cash flows with risk that is similar to that of the overall firm.


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Fair Market Value

Fair market value (FMV) is the highest price obtainable in an openand unrestricted market between knowledgeable, informed and

prudent parties acting at arms length, with neither party being underany compulsion to transact.

Key phrases in this definition:1. Open and unrestricted market (where supply and demand can freely

operate )

2. Knowledgeable, informed and prudent parties

3. Arms length

4. Neither party under any compulsion to transact.


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EBITDA

Earnings Before Interest, Taxes,Deprciation and Amortization. An approximatemeasure of a company's operating cash flow based on data from the company'sincome statement. Calculated by looking at earnings before the deduction of interestexpenses, taxes, depreciation and amortization. This earnings measure is ofparticular interest in cases where companies have large amounts of fixed assetswhich are subject to heavy depreciation charges (such as manufacturing companies)or in the case where a company has a large amount of acquired intangible assets on

its books and is thus subject to large amortization charges (such as a company thathas purchased a brand or a company that has recently made a large acqusition).Since the distortionary accounting and financing effects on company earnings do notfactor into EBITDA, it is a good way of comparing companies within and acrossindustries. This measure is also of interest to a company's creditors since EBITDA isessentially the income that a company has free for interest payments. In general,

EBITDA is a useful measure only for large companies with significant assets, and/orfor companies with a significant amount of debt financing. It is rarely a usefulmeasure for evaluating a small company with no significant loans. Sometimes alsocalled operational cash flow.


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CASH FLOW

Definition of Cash flow:

A measure of a company's financial health. Equals Cash receipts minus cash

payments over a given period of time; or equivalently, net profit plus amounts

charged off for depreciation, depletion and amortization.


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Amortization

Definition :

The gradual elimination of a liability, such as a mortgage, in regular payments over a

specified period of time. Such payments must be sufficient to cover both principal

and interest.

Writing off an intangible asset investment over the projected life of the assets.


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Return on Equity

ROE . A measure of how well a company used reinvested earnings to generate

additional earnings, equal to a fiscal years after tax income (after preferred stock

dividends but before common (stock dividends) divided by book value, expressed

as a percentage. It is used as a general indication of the company's efficiency; in

other words, how much profit it is able to generate given the resources provided by

its stockholders, investors usually look for companies with returns on equity that

are high and growing

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M& a Valuation