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I've heard of the "four valuation methods" but I haven't been able to find out what those are. Anyone have a link?

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Comments (36)

  • cplpayne's picture

    DCF, trading comps, Acquisition comps, and LBO

    "One should recognize reality even when one doesn't like it, indeed, especially when one doesn't like it." - Charlie Munger

  • monkeysama's picture

    What's the difference between trading comps and acquisition comps? I think that's where I'm stuck.

  • Mzz's picture

    Trading comps: market data on where peers trade, the metrics change as market prices change
    Precedent comps (aka, acquisition comps, transaction comps): shows at what valuation other peers were acquired in the past, the metrics do not change as the data is all historical

  • Mzz's picture

    To conclude. The first shows the market's valuation of the peer group. The second shows the actual buyers' valuation.

  • monkeysama's picture

    I don't know as much about equity research as I would like. That's why I asked.

  • El_Mono's picture

    What about DCF wacc, DCF APV, RIM and DDM?

    Valor is of no service, chance rules all, and the bravest often fall by the hands of cowards. - Tacitus

    Dr. Nick Riviera: Hey, don't worry. You don't have to make up stories here. Save that for court!

  • kingtut's picture

    I'd say those all fall under the "DCF" umbrella.

    What's ironic is there is a Google Banner next to this thread, at least for me, advertising a WallStreetPrep program that teaches you to "build lbo, dcf, m&a, and comps models"

  • In reply to El_Mono
    cplpayne's picture

    El_Mono:
    What about DCF wacc, DCF APV, RIM and DDM?

    Somebody correct me if I am wrong, but I think DDM is just something they like to teach in school and not really used much in the real world (not IBD at least).

    Isn't APV useful for an LBO?

    "One should recognize reality even when one doesn't like it, indeed, especially when one doesn't like it." - Charlie Munger

  • Race's picture

    There are multiple Methods but 3 main approaches to Business Valuations
    1. Income Approach - DCF Method + All discounted Cash and Earnings models, including debt assumptions
    2. Market Approach - Transactions Multiples Method + Guideline Comparables Method
    3. Asset Approach - Replacement Methods + All related liquidation Models

    The M&M theory says regardless of Debt added to the business the EV is still the same. In Leverage model, use the Ke for Equity CF, while in a Debt Free model use WACC, the PV should always be the same. LBO's, leverage leases, etc don't increase the EV, (Maybe the ROE).

    This is only a theory and I have never gotten the same answer using Ke & WACC, regardless of the type of debt, Project Finance, LBO, Leverage Lease, Bank loan, etc. This is due to a static WACC in my Debt free model.

  • In reply to cplpayne
    SHORTmyCDO's picture

    nonpog:
    El_Mono:
    What about DCF wacc, DCF APV, RIM and DDM?

    Somebody correct me if I am wrong, but I think DDM is just something they like to teach in school and not really used much in the real world (not IBD at least).

    Isn't APV useful for an LBO?


    Wrong. DDM is one of the primary valuation methods used in FIG groups.
  • In reply to Race
    bankbank's picture

    The "LBO method" isn't intended to give you the "intrinsic" value of the firm. All the LBO method does is tell you what valuation an LBO buyer could pay for the company to achieve a target equity return (usually around 20%+) assuming a leveraged capital structure. This valuation should be lower than a DCF because your discount rate (includes 20%+ "cost of equity") is higher. To calculate the LBO method value, all you do is build an LBO model with an equity IRR output and then goal seek the purchase price to target a 20% IRR.

    Also, capital structure will affect TEV to some degree (that's why there's an "optimal capital structure" that minimizes the firm's WACC...minimizing WACC increases TEV). Modigliani Miller (M&M) makes some assumptions (e.g., companies don't pay tax) that aren't realistic.

    Race:
    There are multiple Methods but 3 main approaches to Business Valuations
    1. Income Approach - DCF Method + All discounted Cash and Earnings models, including debt assumptions
    2. Market Approach - Transactions Multiples Method + Guideline Comparables Method
    3. Asset Approach - Replacement Methods + All related liquidation Models

    The M&M theory says regardless of Debt added to the business the EV is still the same. In Leverage model, use the Ke for Equity CF, while in a Debt Free model use WACC, the PV should always be the same. LBO's, leverage leases, etc don't increase the EV, (Maybe the ROE).

    This is only a theory and I have never gotten the same answer using Ke & WACC, regardless of the type of debt, Project Finance, LBO, Leverage Lease, Bank loan, etc. This is due to a static WACC in my Debt free model.

  • In reply to bankbank
    SHORTmyCDO's picture

    bankbank:
    The "LBO method" isn't intended to give you the "intrinsic" value of the firm. All the LBO method does is tell you what valuation an LBO buyer could pay for the company to achieve a target equity return (usually around 20%+) assuming a leveraged capital structure. This valuation should be lower than a DCF because your discount rate (includes 20%+ "cost of equity") is higher. To calculate the LBO method value, all you do is build an LBO model with an equity IRR output and then goal seek the purchase price to target a 20% IRR.

    Also, capital structure will affect TEV to some degree (that's why there's an "optimal capital structure" that minimizes the firm's WACC...minimizing WACC increases TEV). Modigliani Miller (M&M) makes some assumptions (e.g., companies don't pay tax) that aren't realistic.

    Race:
    There are multiple Methods but 3 main approaches to Business Valuations
    1. Income Approach - DCF Method + All discounted Cash and Earnings models, including debt assumptions
    2. Market Approach - Transactions Multiples Method + Guideline Comparables Method
    3. Asset Approach - Replacement Methods + All related liquidation Models

    The M&M theory says regardless of Debt added to the business the EV is still the same. In Leverage model, use the Ke for Equity CF, while in a Debt Free model use WACC, the PV should always be the same. LBO's, leverage leases, etc don't increase the EV, (Maybe the ROE).

    This is only a theory and I have never gotten the same answer using Ke & WACC, regardless of the type of debt, Project Finance, LBO, Leverage Lease, Bank loan, etc. This is due to a static WACC in my Debt free model.

    Wouldn't an LBO valuation give you a higher valuation than a DCF? Here is my reasoning, you assume a purchase premium in the purchase price of an lbo, you assume that you can increase the CF's of the company when a PE firm acquires it by making management changes / rolling over other companies / imrpoving ops etc, so the CF's alone will grow at a higher rate than when oing a DCF. I am only a recent grad about to start as an analyst next month, but this is my understanding and was an answer I gave an interviewer and he moved on.

    Just would like some clarification.

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  • rafiki's picture

    DCF goes off management assumptions which are always overly optimistic is the explanation I heard.

  • In reply to rafiki
    SHORTmyCDO's picture

    rafiki:
    DCF goes off management assumptions which are always overly optimistic is the explanation I heard.

    Ya, but you still need to project a fully integrated three statement model for an LBO, it's not like your going to be using pessimistic assumptions, you are going to be targeting a specific IRR.

  • HFFBALLfan123's picture

    For interview purposes just look at Race's comment, that is what they are looking for. Don't talk about an LBO or DD or anything else.

  • monkeysama's picture

    It's amazing how many negative replies/thrown poop I've gotten on a question that most of you seem to disagree with. Wow.

  • HFFBALLfan123's picture

    Ya people are retarded and use this forum to talk about everything they learned 5 mins ago in financial managment. Just use exactly what Race said and you will be golden in interviews. Don't over analyze because i promise they are looking for those exact three answers, they don't want you to talk about a DD model or an LBO, and if you do that will open pandora's box of questions you are certainly not prepared for.

  • In reply to HFFBALLfan123
    SHORTmyCDO's picture

    HFFBALLfan123:
    Ya people are retarded and use this forum to talk about everything they learned 5 mins ago in financial managment. Just use exactly what Race said and you will be golden in interviews. Don't over analyze because i promise they are looking for those exact three answers, they don't want you to talk about a DD model or an LBO, and if you do that will open pandora's box of questions you are certainly not prepared for.

    That's not true, I've been asked what the 4 valuation methodologies are in multiple interviews and the answer they were looking or was an LBO analysis to back into a purchase price. What would you use as the 4th if they asked for 4 and you don't want to mention an LBO?

  • HFFBALLfan123's picture

    DCF, Comps, Comp. acquisitions, and replacement value.

  • Kenny_Powers_CFA's picture

    I'm editing this to be less harsh because I don't want to be mean, and as the other people on the thread are showing it's not 100% cut and dried.

    But I am seriously recommending you spend less time posting on WSO and more time trying to actually learn. The major issues with your posts about 13-Fs could have been solved with 5 minutes on wikipedia and google.

    There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.

  • monkeysama's picture

    Kenny - respectfully I disagree.

  • In reply to HFFBALLfan123
    SHORTmyCDO's picture

    HFFBALLfan123:
    DCF, Comps, Comp. acquisitions, and replacement value.

    Thanks for that, appreciate your input. I'm not sure that is always the cut and dry case. I have responded LBO as the 4th valuation methodology in an interviewer, with the VP nodding his head and saying, "okay, that's the final one I was looking for."

  • In reply to HFFBALLfan123
    bankbank's picture

    Race's answer is what an accountant would say. Give that answer if they ask you for 3 (OP said 4) methods and you are interviewing at E&Y. Race's answer is what the accountants at my firm say when I tell them to do the FAS 157 valuations for my portfolio companies (afterwards, I take those valuations and throw them in the trash because they don't mean anything outside of the back office).

    If you are interviewing with an investment bank and they ask for 4 methods, they are probably asking for 1) DCF; 2) public equity trading comps; 3) comparable precedent transactions; and 4) LBO (as said in the first reply).

    Liquidation value makes sense and is good to consider if you are trying to make an intelligent investment with your own money. However, no M&A banker is going to go pitch an acquisition and show a football field with replacement/liquidation value on it because it's going to show a low-ass valuation and imply that the value of the acquisition target is way, way less than the seller's asking price. If the value of the acquisition target is way, way less than the asking price, then the deal doesn't make sense and the client should not do the deal and not pay the banker fees (oh yeah, banker's are always telling clients NOT to do the deal and not to pay them fees. *sarcasm*). This does not consider distressed/restructuring type situations where liquidation value would be more relevant.

    HFFBALL, you should pause and think a bit before you call people retarded. I have never in my life taken a financial management course, but I have worked in banking and private equity. If you are interviewing for a job in investment banking, you should absolutely mention LBO in your response to the question in the OP because LBOs are very relevant in investment banking. It would also make sense to mention liquidation/replacement value as a 5th method (or as the 4th method if you are grouping equity trading comps and comparable transactions into one "market approach" method), but you won't be dealing much with that method in your day-to-day IB analyst job unless you work in a restructuring group.

    HFFBALLfan123:
    Ya people are retarded and use this forum to talk about everything they learned 5 mins ago in financial managment. Just use exactly what Race said and you will be golden in interviews. Don't over analyze because i promise they are looking for those exact three answers, they don't want you to talk about a DD model or an LBO, and if you do that will open pandora's box of questions you are certainly not prepared for.
  • In reply to SHORTmyCDO
    SHORTmyCDO's picture

    [quote=
    Wouldn't an LBO valuation give you a higher valuation than a DCF? Here is my reasoning, you assume a purchase premium in the purchase price of an lbo, you assume that you can increase the CF's of the company when a PE firm acquires it by making management changes / rolling over other companies / imrpoving ops etc, so the CF's alone will grow at a higher rate than when oing a DCF. I am only a recent grad about to start as an analyst next month, but this is my understanding and was an answer I gave an interviewer and he moved on.

    Just would like some clarification.[/quote]

    Thanks for clearing that up bank. Would you be able to comment on if an LBO can ever have a higher valuation than a DCF based on the above thought process? Thanks again.

  • cplpayne's picture

    SHORTmyCDO......are you a Dec. grad starting as an analyst early? Curious because I will be graduating in Dec. and hope to start early if possible (if I have an offer). If so is it a boutique or BB?

    "One should recognize reality even when one doesn't like it, indeed, especially when one doesn't like it." - Charlie Munger

  • SHORTmyCDO's picture

    Yes I am. I am starting at a boutique, but was able to land two BB interviews for early start dates within the last month, they are just taking forever to move forward in the process and my agreed start date is coming up at the boutique. I would recommend graduating early. I didn't really interview with many BB's during recruitment because I targeted more MM banks since I have a 3.3 from a nontarget, but had 3 super days for MM firms to start in July. Graduating in December, if anything will leave you with more options because a lot of banks will realize they under hired that year, people quit and you can always start in July.

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  • Bondholm's picture

    Snootchie Bootchies