Equity valuation: Do HFs always use multiples?

A quick question for those who work(ed) at equity-focused hedge funds. When you're trying to determine what a stock is worth, do you generally use multiples (whether EBITDA based or EPS based) or do you actually use DCF in any meaningful way? And do technique like sum of the parts come into play in unique situations like potential sale or breakup? I ask because there are so many methods that are taught in schools/textbooks and could be used in theory, but from the few presentations that I've seen the "smart" money put out, the multiple method dominates.

Thanks for any help!

 
Best Response

Depends on the context. Sometimes, using a DCF may not be useful as the company is still burning through cash (i.e., biotechs). So at that point, the sum-of-the-parts analysis definitely takes precedence. Comps and ratio multiple valuation (i.e., P/S, EV/REVENUE, EV/EBITDA) may also be important, but again, depends on the industry and company in question.

 

I derived the FCFF starting with CFO, but the CFO itself has to go through so many adjustments starting with net income. However net income in past years is distorted due to non-recurring items, so how do you account for that? The link between sales and net income can be muddied up, if that makes any sense. Therefore, whatever sales growth projection I have would have to account for non-recurring items?

 

for the non recurring items, remove them, so the Opt Cashflow and ultimately the free cashflow will flow through the net income WITHOUT the non-recurring items (call it adjusted net-income if you want).... and DO NOT use the non-recurring items in the projections so that should take care of that issue....as for the links between the sales and net-income issue, personally I would use the McKinsey approach so the re-organized statements EBITA, NOPLAT, Invested Capital, FCFF, will ignore the non-recurring items and concentrate on the operations of the business

 

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