Relative Value Equity Funds and the Use of relative valuation methods
Going through CFA Level II right now, equity valuations, based on CFA, could be divided into absolute valuation methods (some sort of discounting) and relative valuation, such as EV/EBITDA, P/S, P/E, P/C, P/D, compared with other stocks in the present moment or the stock itself over its history. My question is, how often are these relative valuation used in real life? Do funds actually adopt these strategies and trade based on relative value? On that note, are there even relative value equities funds out there? google search wasn't much help, and WSO sees to have very few content on relative values. How profitable are these funds even if they do exist?
Thanks
I'm just an undergrad w/ some intern experience at an AM firm [not a hedge fund] so take what I say with a grain of salt and I can't really comment on the industry as a whole.
But the firm I was at is very much focused on relative value. In this case the fund invested in a specific asset class REITs with the goal of outperforming the major REIT indexes - the goal was for a good relative return [vs. the REIT index] and not necessarily a good absolute return. I.e, if we felt certain the REIT index would be down 20% across the board over the next 12 months, the goal would be to remain almost fully invested and try to only be down 10% or 15%. Holding large amounts of cash or other types of securities would not be an option.
Does that model work? I'm not really qualified to answer that. But I think it depends entirely on the type of fund. At the AM firm I worked for, the goal was to provide exposure to a certain asset class [in this case, REITs]. Providing exposure means that you're providing beta as much as you're trying to outperform. So really, in the best case scenario you provide exposure to real estate while giving investors a better return then they'd get through an index fund. So in theory, I'd say it makes sense - but on the other hand, trying to beat the index while taking more of a top down view than a bottom up view is really hard. It's a market-based investment strategy - you're anticipating what other market participants will do in the short run more than you are trying to estimate intrinsic value and buy at a discount. It becomes more speculation than investing. The performance of the fund I worked at has been above the index net of fees pretty consistently, but only by a small amount.
Now for HFs I can't really say, but relative value seems to be in conflict with what hedge funds were at least traditionally supposed to provide to clients. If you're looking to provide good performance across the board, good absolute performance, then it's not enough to buy assets that will outperform the market. You need to only buy at a discount to intrinsic value. If values can't be found, then you hold cash / equivalents. Now in reality I'd imagine a lot of HFs are probably investing based on relative value, even if they wouldn't say it. Seth Klarman talks about this in his book Margin of Safety, about how the typical institutional investor is thinking more about beating the index than about providing a good long-term return.
They're used just as often as investors run across particular situations. Depending on the company you're analyzing there may be some parts of the business which can be better valued using one method and the rest with others. Sometimes it makes more sense to value a situation using a discounted rate, but in the case of an unprofitable company it'd make more sense to do a liquidation analysis. Using different relative valuation methods also gives you a range of values which you can use against comparable companies.
Tl;dr - More choices to use
That being said, valuation alone is only going to make up one of many parts of the overall investment strategy
Relative Valuation (Originally Posted: 04/07/2010)
Hi, I need some help with relative valuation.
I currently have the following set up in a spread sheet.
LTM EV/sales 1.1x Metric $1415 Ev/Ebitda 7.0x Metric $215 EV/Ebit 8.6X Metric $175.0 P/E 11.8x Metric $1.70
When I add a new column for 2010E are all of my metrics based on the median number from the competitors, I have chosen? What I really want to know is how do I determine those multiples for my estimated years. I was searching through Damodaran's site and I could only find information relating to computing a regression.
If you just want to PM me thats fine.
clarify your question
Sorry I was busy at the time.
I'm working towards obtaining a valuation based on comp comparisons. I'm unaware however on the procedure that I must follow to obtain the price target. I was proceeding to base my comp analysis on the above but I'm confused In respect to the 2010E P/E. Is it the average or median P/E of the comparison firms?
i'm not sure if i understand your question... but if you want to find 2010E multiples, you should be finding 2010E estimates for each of your comparable companies (whether through research or a model) and applying those estimates for 2010 multiples. Also make sure to calendarize your 2010 numbers so you are comparing apples to apples.
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