Valuation at Hedge Funds
Hey everyone,
I just recently started my own PA and was wondering how analysts at equity long/short funds value companies. From my reading, people in the real world (outside academia) rarely use things like the DCF, DDM, etc. Most people use ratios like EV/EBITDA, P/E and other things like that.
The part that confuses me is how analysts get price targets. Let's say that the price target for a company is acquired through an EV/EBITDA ratio. Wouldn't both the numerator and denominator be projected figures, which are both dependent on the analyst's assumptions? Isn't that the prime reason people don't use the DCF to value companies in the real world? I guess what I'm trying to ask is how people use ratios to value companis.
Thanks for any responses.
Here's a good thread on the topic: http://www.wallstreetoasis.com/forums/if-not-dcfs-then-what-is-used
Thanks
Hedge funds usually value companies on a relative basis (using comparables like EV/EBITDA or FCF yield) and defend their valuations on an absolute basis (DCF, people never use DDM). On both a relative and absolute basis, when using forward projections, analysts use a range of figures, supported by research, to account for different scenarios. Also, the buy-side is a lot better at valuing companies and projecting earnings than the sell-side, for obvious reasons. Buy-side analysts spend weeks on research for one idea, while Morgan Stanley analysts spend around 8 hours on one report. Many fund managers I know will use a sell-side DCF and modify figures in accordance with their research. Rarely do seasoned hedge fund managers actually use sell-side valuations. The only purpose of sell-side reports to most fund managers is gathering insight about the company and industry.
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