Hello! Currently prepping for HF interviews and opening up a new thread for a practical question for valuation typically seen at HFs - following a more conceptual thread on what a good variant view actually consists of: https://www.wallstreetoasis.com/forum/hedge-fund/…
Key qq is (using Lowe's Pershing presentation from Nov 2011 as the example): if we agree that our variant view is that EPS in 2015 will be $2.60 (as per p.21 here: https://www.10xebitda.com/wp-content/uploads/2016…), what is the right multiple to conclude to our price target? It seems that there are two options: 1. The multiple on 2015 consensus EPS (21.50/2=10.8x) or 2. the current/ NTM multiple (13x; as Pershing does). Created an editable excel here if you want to edit https://cryptpad.fr/sheet/#/2/sheet/edit/A-X4XHW0…
As I've so far understood from a current PM, it's the former. This would imply: does 2. work for Pershing because they assume a holding period of 3 years (which most HFs wouldn't take as they're looking at max holding period of ~18 months)? Would be very helpful if current practitioners in the field could confirm or enlighten me.
Valuation doesn’t happen in a vacuum. If the EPS beat/miss is material to the debates on the stocks, the assumptions on TV, risk, profit growth (top line/margin expansion) and cap intensity may shift on a probability weighted basis. This would change how you forecast the DCF, and therefore would change the multiple too.
Useful to look at peers, and the historical range/relationship. What drives historical decouplings or divergences/convergences, what are key operating metrics across the sector and how do they relate to valuation.
And then on a historical basis for the stock too, what has the historical multiple range been, what’s the KPI trajectory been and the corresponding P/E. What was management tone, sellside sentiment etc, is there an obvious peak/trough range.
Stocks can move on EPS upgrades/downgrades, and on re/deratings. What the multiple will be is an art, as much as it is a science. Will the upgrade/downgrade cycle materially alter the narratives of the value drivers?
Thank you, this is all helpful!
1- When you say, "when you forecast the DCF, the multiple changes too", can you explain exactly how (only case I can think of is TV via multiple)? Otherwise, would assume that with a DCF, we conclude to a target price without further direct implications for multiples?
2- Taking a step back (correct me if I'm wrong here), for a stock pitch there are two valuation methodologies: A. DCF, B. Multiples (like the Pershing example). Which one is used when or are they always used in tandem? For multiples and the actual example of Lowes, are both methodologies above (multiple on 2015 consensus vs. NTM multiple) valid? If so, when to use which?
A DCF and a multiple are effectively the same thing. You shouldn't really be using two separately, the DCF is usually a sense check.
When I say multiple changes, I mean to say that a DCF and multiples are valuation techniques. There's only one target price, if you think of your DCF, and you change any of your assumptions: rate of margin expansion, revenue CAGR, sales:capex ratio, TGR etc the target price will materially change. That means if you were valuing a stock on a multiple, the multiple must also change to reflect the different assumptions.
Multiple is a shorthand for a DCF. If this doesn't make intrinsic sense to you, I'd suggest building out a DCF and playing around with it.
I already answered your last question on which multiple to use. The phrasing of your question leads me to think you might not quite get what a multiple is. The idea is that the multiple is effectively the same as the DCF. If your EPS beat/miss is coming from material changes in ROIC, your multiple should probably be changing too.
Thank you for these fundamental comments. All makes sense!
Conscious I'm trying to get to a very specific answer here, but I'm currently writing a stock pitch and get stuck at the target price calculation via multiples. I've built a DCF for sense check as you say but when using multiples, I don't know which multiple to use - either the NTM multiple on my variant metric in 2025 (equivalent of 13x above) or the current multiple on 2025 consensus (equivalent of 10.8x above). The target price difference in my case is 2x... Grateful for a tactical answer as long as this aligns directionally with what you'd find acceptable.
What the above commenter is saying vs. the question you're trying to answer are different. You are asking what multiple to use, when the above commenter (who is correct) is trying get you to understand that you have already used the multiple.
If you take your DCF target price and divide it by your NTM target EPS, you would get your implied P/E multiple, so, inherently, you are using your NTM multiple and not the consensus 2015 10.8x. If you take your DCF target price and divide it by your 2015 target EPS, you will be inherently using your own 2015 P/E multiple and so on and so forth.
The way to compare consensus vs. your own assumptions is to take the current company valuation and divide it by your target metric. In the case of P/E, you'd take the current stock price and divide it by your target EPS. If your 2015 multiple is lower than consensus' 10.8x, then you believe that the company EPS will be higher and is undervalued and that consensus is not clearly reflecting the potential margin expansion, top-line growth, and/or earnings growth and vice versa if your multiple is above consensus.
Pershing takes the whole PE approach to public markets and you very rarely assume multiple expansion in a PE investment. What Pershing is effectively showing is "LOW currently trades at 13x and, if the multiple doesn't change, if it reaches X EPS number, the stock price should be 13 x X = Y (target price)." The reason why you do this is to show that the downside risk is limited. They believe that this 13x is a trough multiple and it can't get any lower than this. Any multiple expansion on top of the top operational improvements of the business is the cherry on top.
As the above commenter said, a multiple is just a simple reflection of DCF assumptions and an apples to apples way to compare different assumptions between different companies. When not doing a DCF and only using multiples how I've been told is to take in a bunch of different information to find out what multiple to use. What this means is analyzing what does its peers trade at? What are recent transactions? How do other companies with similar growth rates and margins trade? Where has it traded historically when it achieved X growth and Y margins? And a bunch of other questions.
Hopefully this makes sense.
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