MSU Student Investment Association

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MULTIPLES: USE IN RELATIVE VALUATION

February 8th, 2012

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MULTIPLES OVERVIEW

• Main Uses– Relative Valuation– DCF

• Many– Price/Earnings– Price/Book– Price/Sales– Enterprise Value/EBITDA

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WHAT IS THE SIGNIFICANCE?

P/E P/B P/SResearch in Motion

20.00 3.50 2.00

Nokia 15.00 3.50 1.50Apple 12.99 4.73 3.33

Phone Manufacturers

Note: numbers are made up

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IT’S A RATIO!

AppleSupermarket Price:

$5

$5/Apple

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IT’S A RATIO!

CompanyPrice-to-Earnings

(P/E)

$ Dollars/$1 Earnings

Ex: P/E: 8.5x – you are paying $8.5 for $1 in earnings

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WHAT’S WRONG WITH THIS PICTURE?

Supermarket Prices

$2 $3 $7

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WHAT SHOULD HAPPEN

Supermarket Prices

$2 $3 $0

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WHAT’S WRONG WITH THIS PICTURE?

Bad Company

Good Company

Better Company

P/E: 50x

P/E: 10x

P/E: 12x

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WHAT SHOULD HAPPENBad Company

Good Company

Better Company

P/E: 5x

P/E: 10x

P/E: 12x

A Company with worse prospects should trade at a lower multiple!

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EXAMPLE

P/EResearch in Motion

20.00

Nokia 15.00Apple 12.99

RIMM: Bad Prospects, but trading at a higher multipleVerdict: Overvalued! Compared to Apple

Apple: Crushing it, but trading at a lower multipleVerdict: Undervalued! Compared to RIMM

Note: numbers are made up

MSU Student Investment Association

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PITFALL: LOW MULTIPLE = UNDERVALUED

Understand competitive position in the industry

P/EResearch in Motion

3.89

Nokia -Apple 13.58Note: Real numbers (close: 2/8/2012)RIMM: Low P/EVerdict: Undervalued! Compared to Apple

Apple: High P/EVerdict: Overvalued! Compared to RIMM

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IT’S ALL RELATIVE

• Low/High Multiple has no meaning without relation

• Compare to: Industry/Competitors– Tech: 10x P/E is considered a low

multiple– Shipping: 10x P/E is considered a high

multiple

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QUESTIONS?