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```					BM409 Investment Management Academy

Valuation 7:
Relative Value Models
Objectives

 A. Understand how we apply relative value
models

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Relative Value Models

 We have developed a framework for valuation that
includes key models and metrics. Key valuation models
fall under four main types. They are:
• 1. Intrinsic Value models
• 2. Relative Value models
• 3. Acquisition/Breakup models
• 4. Technical models
• 5. Quantitative/other models
 The first three classes are fundamental models. Within
each of these models, there are many different types of
models that can and are being used. We will explain the
models we use in this class.                              3
Relative Value Models

 We currently use three relative value models in
our research
 1. Relative value versus the S&P 500
• You will compare your company versus the
S&P500
• How has it traded historically versus the S&P?
• You set the Buy and Sell range for where you
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Relative Value Models (continued)

 2. Relative value versus the S&P 500 Industry
Sector
• You will comparing the relative value of your
company versus the S&P500 industry sector
benchmark
• How has it traded historically versus the sector?
• You set the Buy and Sell range for where you

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Relative Value Models (continued)

 3. Relative value versus select peers
• You will compare the relative value of your
company to a portfolio of peer companies that you
choose
• We use ten different metrics:
• PTNI, PTB, PTGP PTS, PTEBITDA,
EVTNI, EVTB, EVTGP, EVTS, and
EVTEBITDA
• We then calculate these metrics for up to 10
• Based on averages for the companies, you
can calculate the price of your company      6

based on the average metrics of the peers
Relative Valuation Models

 What are relative valuation models?
• Models which provide information about how the
market is currently valuing stocks at several levels:
• The market level
• The industry level, and
• Comparative stocks in the same industry space
• These are often called “comps” or
“comparables” of similar companies or
industries

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Relative Valuation (continued)

 What is relative value?
• It is the value of the company relative to other
stocks, or stocks in the same market or industry
 Which relative valuation methods are used most often?
• Generally, the most used in the industry is Price
Earnings. However, PTNI, PTB, PTGP PTS,
PTEBITDA, EVTNI, EVTB, EVTGP, EVTS, and
EVTEBITDA are also used

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Relative Valuation (continued)

 How do you use relative valuation methods?
• You compare your company’s valuation ratio to the
market, industry, its history, or other companies
• If you notice a change in relative valuation, i.e. it is
cheaper (expensive) than it has been historically, it
may signal it may be a buy (sell) assuming no other
major changes in the company and industry
 In the Apple case, we used PE relative to the market.
Can we use price earnings relative to the industry?
• Yes, although it is harder to find good forecast data
on the industry, as most industry indices do not
have forecasts.                                           9
Relative Valuation (continued)

 How do I determine my buy and sell range?
• This is one of the most difficult challenges of being
an analyst. Here is where the art comes in!
• Look to company history
tight range, the likelihood is that it will
continue
• If your company is volatile, it will be more
difficult
• You will need to make the best decision
you can
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Relative Valuation (continued)

• I always recommend using wisdom and
judgment
• Determine whether you think it’s a buy, sell
or hold, then set your relative value
consistent with that view
• Make sure you have other factors

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1. Relative Value versus S&P 500

 What is the process for relative value?
• The process is the same, whether you calculate
relative value versus the S&P 500 Index or versus
the S&P Industry Indices
 What is that process?
• It is a seven-step process
• You do this in your Financials Tab, Exhibit 4
Section 2: Price/Earnings
• This calculates your company PE for both the
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historical and forecast periods
Relative PE Versus the S&P 500 (continued)

 2. Calculate your PE for the S&P 500 index
historically and for the forecast period
• You do this in your Financials Tab, Exhibit 4
Section 18: S&P500 Market Price/Earnings
• This is why you added this data
for both the historical and forecast periods

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Relative PE Versus the S&P 500 (continued)

 3. Calculate the relative PE (i.e. the company
PE / market PE) for all periods
• You do this in your Financials Tab, Exhibit 4
Section 3: Relative PE Versus the S&P500 Market
PE
for both the historical and forecast periods and
the S&P 500 PE for both the historical and
forecast periods
• Now just divide them
• This gives how your company has performed (on a
PE basis) versus the S&P 500 Index                    14
Relative PE Versus the S&P 500 (continued)

 4. Look at the trend for the relative PE
• Has it historically traded at a discount (relative PE <
1.0) or premium (relative PE . 1.0) to the market
• What does it look like in the forecast period?
• Is it still in that same range

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Relative PE Versus the S&P 500 (continued)

 5. Determine your sell differential over your
• What is the range, relative to the S&P 500 Index,
that you would sell the stock
• It is in percentage or relative terms
stock
• The tighter this range, the lower your
potential upside

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Relative PE Versus the S&P 500 (continued)

 6. Based on that trend, determine what you
consider to be a fair relative PE range
• This tells at what relative PE would you buy the
stock, and at what relative PE would you sell the
stock
• This is a critical decision
• The formula is:
• Relative PE range * market PE * firm EPS =
Future Price
• We actually take the average of the buy prices   17
for each of the forecast years
2. Relative PE Versus the Industry Index

 This type of relative value model follows the
exact format as the Relative Value versus the
S&P 500 Index
• The process is the same
• The framework is the same
• The only difference is that instead of using the S&P
500 Index, you are using your Industry Index

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Limitations of Relative Valuation
Models
 When is it most appropriate to use RVM?
• When you have a good set of comparables, i.e.
industries/companies in terms of size and risk
• When the aggregate market is not at a valuation
extreme, i.e. it is neither over or undervalued
 When are they inappropriate?
• When you have poor comparables
• The current market level is at extremes.
• If you compare the value of a company to the
very overvalued market, you might believe it is
cheap. However, you may be wrong as company
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may be fully valued and the benchmark, the
market, is overvalued.
Review of Objectives
 A. Do you understand the importance of relative
valuation models?

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 views: 1 posted: 3/10/2012 language: English pages: 20