Industry specific valuation

ewongI have an interview tomorrow and some of my friends have told me that the questions will be in regards to valuation of certain companies/industries. In terms of DCF, comps, multiples, and asset based, which industries require which one?

example questions: "in what way would you valuate a mcdonalds vs a smaller chain restaurant (think chipotles)?"

"how would you valuate an oil company in these unstable times"

Any help would be appreciated thanks.

Hello ewong:

A few thoughts. A bit scattered today, so definitely welcoming anyone else's input as well.

1. First off, realize that all the valuation methods can be used across industries, in theory. The trouble (like in any valuation) is the quality of the inputs. So, DCF (and its variants), comparable firms and transaction multiples are all viable tools to use when looking at any asset.

So, let's look at something like NetFlix when they came out in 1997 or so. All valuation methods should be considered, but let's see: the firm had no/negative cash flows, there were no real comparables (I'm sure Blockbuster was commonly used, but consider that their core business models are very different, though they are both in the same industry. Tech ER analysts like Henry Blodget suggested Amazon was a better "comp" than Blockbuster. Though it might be different when you are using valuation as part of a sales shows (ie IBD sponsors that are making a dog and pony show out of the firm), in ER you have a bit more free reign, imo. So, we'd need to make a few judgements.

From there, we realize there is little data out there to help the robustness of our Netflix valuation. So we've got to stretch our assumptions. Though the firm is not producing cashflow yet, perhaps we can consider how similar tech companies have been valued. We believe that the number of customers the company has will define its value. So we use a ratio like Sales/customer, or make up some other ratio that we consider a proxy for value. Again, how credible/accurate these assumptions are depends on our information, which in this example, isn't much.

1. To answer your question without that probably-scattered rant is:

-think about the core business. Is the firm stable/stable cash flows/growth, etc.? If not, how sensitive are our inputs to change?

-For comparables, what are the key operating assets and how much value do we get out of them? For instance, capital-intensive firms are sometimes compared by (some cash flow)/capex, etc. Tech firms or network-intensive companies are sometimes judged on the cash flow/customer size, etc.

-Tech companies are usually more difficult to value with DCF (save large, established firms). You've got it backwards, there. All else being equal, tech companies usually have untested products, hard-to-size markets, etc. making a DCF (more importantly the assumptions that go into it) difficult to justify.

Hope that helps. You really should consult a few solid resources out there: www.damodaran.com, (I know there are a few ER-focused sites out there for interview prep.