Beginners Guide to Valuation and Metrics By Sector
Inspired by comments from this: //www.wallstreetoasis.com/forums/basic-guide-ramping-up-on-a-company-with…
Lets just jump in.
Technology: In this space there are really two metrics that matter the most, sales growth and EPS growth. EV/Sales will be used if you are thinking about investing in growth companies (IPO valuations). To keep the post short if you’re investing in large tech it is more about EV/EBITDA (cash flow) and P/E’s, if you’re investing in growth stocks it is more about year over year sales growth and EPS growth since many do not have positive earnings.
Metrics Basis: IT spend will help tech companies, GDP is usually a driver for IT spend, changes in products impact margins (software has higher margins for example) also you should track the cost of items going into each tech product (example: if the glass on the iPhone increases by 200% that will hurt Apple margins)
(to WSO comments, software would be similar but it gets a higher multiple due to higher margins ie: gross margins are usually near 90's, this is why take out multiples for software companies would be higher than say a hardware company, better margins drive better multiples)
Consumer: This space is about sales growth, operating margin growth (look for earnings growth, P/E multiples) and returns on your assets. For the consumer segment you want to open stores with or without debt, get them cash flow positive, open more stores and repeat. So with this in mind ROA, ROE and margins become significant metrics to follow. Finally, you want to make sure your debt load is manageable.
Metrics Basis: Weather impacts consumer sales (warm weather means more people shopping), Sales/square foot is a good metric to follow (how efficient are your stores), monthly data comes out regarding sales for consumer companies and same store sales calls are also tracked religiously.
Auto/Transport: Auto: This space is also heavily focused on EBITDA and some will use metrics such as EBITDAP (the P stands for pension obligations which makes sense for a company like Ford). In addition, this space can utilize the DCF valuation as cash flow is much more predictable relative to a small medical technology stock. Transport: Similar to Auto, the focus is again on EBITDA or EBITDAR (the R stands for rent). Again this depends on the company but with a gun to your head stick with simple EBITDA metrics for both.
Metrics Basis: In this industry one key point of course is IHS Automotive data (Worldwide sales, European vs. North America etc.). In addition, when looking at the auto space one should look at the Seasonally Adjusted and Annualized Rate (referred to as the SAAR). Finally, one should remember Automotive is highly cyclical, recall the 2008 disaster so GDP growth is also a factor for auto sales.
Financials: Another large industry but key metrics here include book value, returns on assets and equity and of course loan ratios. Companies will trade on P/BV ratios and tangible book value per share will also be a key metric. The space is broad for example a REIT will see more focus on consistent dividends and of course interest rates while banks zero in on loan ratios and tangible book value and finally credit card companies track charge-offs and portfolios of loans.
Metrics: Needless to say, changes in interest rates impact bond prices and loans in general so this is always a key metric to watch. Credit companies will look for charge offs and as mentioned with REITs you are looking for stable book value and consistent dividend payments.
Medical: The medical space is tougher to value with simple metrics because if a product is approved and is a game changer (for example a cure for cancer) the stock will move triple digits within days. With that said a good way to value the firm is by valuing their product lines or using a sum of the parts analysis. If you believe product X is worth $5 per share and has a 50% chance of being approved then it would add $2.50 to your stock price. As you grow to a major medical company the DCF becomes more relevant.
Metrics: Available market is put in both metrics and valuation as the market you are attempting to penetrate will determine the value of your product, again if you can cure cancer you have addressed a major market with an extremely desirable and valuable solution. Beyond product approvals you are also looking for changes in governmental laws
Oil & Gas: In this space we again turn more to EBITDA metrics (or EBITDAX which excludes some differentiated tax issues) as we are dealing with large numbers and recurring income which allows for the use of a DCF as well. Finally for oil and gas you can use the Net Asset Value model (NAV) where you no longer assume perpetual growth and instead look at reserves moving to zero.
Metrics: Simplistically you are looking for large reserves and production of oil/gas or otherwise. In addition, changes in legislation and drilling rights/laws significantly impact your financial model. Finally, a large disaster (plants being destroyed etc.) can be major detriments to Oil and Gas.
Also attached is a quick printable tear sheet.
Feel free to post more specific ?'s will try to get you guys back over the weekend have a good Friday.
Slight update to notes due to questions via PM, if people are interested we may go through a few sector specific looks on a company basis similar to the Facebook example
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thanks so much. this is great.
I would be careful of the traditional DCF in respect to oil&gas, I use a NAV / sum of parts model always. The large CAPEX required in oil&gas depresses free cash flow and normally will trainwreck the DCF
Yep that is why included in the write up is "NAV". For a internship/entry interview or something light it's usually safer to just say dcf because then you can let the interviewer ask you if you know what NAV is... Then you have the answer and look good.
Lower expectations, deliver higher results. The Wall Street way. Ha.
This. DCF is only really useful in a steady state type of analysis (i.e. REIT AFFO), in which case you must apply the correct multiples. Otherwise capex through the cycle wrecks the valuation.
In general, this guide, while a helpful primer, does not go into enough detail. Highly recommend the Paine Webber Handbook as it gives a solid (if dated) overview of key industry metrics and why they are used.
Another random thought is that often the best way to learn about an industry is start with the unit economics. Key questions to think about are:
What is the value of a loan, a car rental or a piece of software to the customer? What is the cost to produce a marginal unit? What about total cost to produce over the product's lifecycle? How can either the value or the costs change over time with the economic cycle, competition, input costs, etc.
Is this the PW book you are talking about? If so, does anyone have it in pdf format? Thanks.
http://www.amazon.com/Paine-Webber-Handbook-Stock-Analysis/dp/0070595763
NAV is by definition a DCF.
In the case of oil and gas, NAV is a well-driven DCF where you model out the cash flows for each well, and then make assumptions about when wells will come online and discount appropriately.
I think this is a key point. Several models are DCFs.
So yes, it is a cash flow based model and those cash flows are inherently discounted to their present value in order to adjust for the time value of money, but the approach is vastly different than a typical DCF model like you would see within a consumer or industrials company.
A common term used is four wall margins, can you expand on this a bit? Is this basically looking at margins in retail at the store level, averaged for mature stores?
So basically the four walls or four R's is. Return on assets, return on invested capital, return in capital employed and returns on income statement.
Before attacks come in regarding all the 4 R's or 4 walls or whatever, the idea is you want to keep profitable returns on stores over and over.
Example: store 1 opens with 90% debt. But if you get it profitable to pay off debt interest payments + aome positive cash flow by year 1 or month 6... You open another and keep on rolling.
Efficiently opening stores, making hem profitable fast repeat.
As a quick example it is a snowball game, you want to keep opening get profitable, open another more debt, keep getting higher returns on the store than debt load, repeat over and over.
Maybe there is a specialist on consumer on this forum, no idea, but if so they can chime in.
Thanks for the great post.
Great post, thanks!
Thanks !
Internet: EV/Pageview, EV/Unique Visitors
This is awesome. Thank you!
This is great! Thanks so much
thanks, this is awesome! +1 and bookmarked
Sorry if this is a dumb question, but do M&A analyst generally need to know all the various industry multiples?
This depends. If you are interviewing for say Quatalyst then you only really need to know technology, if you are interviewing for a generalist group then you need to know the broad spectrum (not what industries use what though)
Example: if you know it is only tech, focus in on P/E's, ebitda, and the metrics noted above. Go through some companies so you have a tech sector well understood under your belt.
Example 2: generalist group. You need to know more multiples but less about the space. So know the multiples in the post.
Basically, if it is sector specific they will expect you to know more about what drive stocks/industry valuation. So you should know the four walls for retail, the growth aspect for technology (run at loss usually pre-IPO), the imprtance of drug approval etc. if it is generalist they will expect you to know a broad basic set, p/bv for financials, p/e for tech etc, but won't expect you to be as detailed as a sector group.
Hope that helps.
Thanks for sharing! This is really useful!
Any thoughts on Aviation (carriers) and Aerospace & Defense (OEMs)? I've generally seen EV/ LTM EBITDA or EV/LTM Sales, but I cant help but thinking sum of parts is the only real metric to use, despite how cumbersome it can be for some of the larger primes.
What stocks specifically, A&D is broad, shoot some tickers here and will get back to you. If I can't help will also post here and say I don't got anything.
DCO, ERJ, LUV
Curious how the comps change through the value chain of aero structures-->frames-->carriers
Awesome! Wil be useful in for interviews. Anyone got more stuff on FIG? I'm aiming for a position in a FIG group.
You referring to insurance companies? Investment Banks? What specifically are you targeting
FIG = Financial Institutions Group
Includes banks, insurance companies, other specialty finance companies (i.e. mortgage lenders/originators, payday loan companies, etc.).
It's generally based on BV and TBV.
Check out the Ohlson Valuation Model. Shifts much of the liquidating (terminal) value up front thereby allowing the analyst to include explicit assumptions in most of the valuation vs. DCF where ~70% of value is based on terminal g, r, and FCF_{n}.
Lol, gotta love academic speak.
Haha...well you should still check it out! The model also has self-correcting features as it allows residual income to trend towards zero (based on market competition increases). Also it is equivalent in value (but better IMO) to the DDM.
For companies like Fluor (FLR), CBI, Jacobs Engineering, KBR, what multiples/metrics would you use?
For high Capex companies what type of multiples do you see being used?
This is somewhat similar to Boeing.
Your comment on capex is a bit broad. Essentially when capex is high, you should not use EBITDA as a proxy for Cash flow. You should use real FCF numbers at all times because it is a major outlay for the company.
Great response and info! Thanks.
Re. Capex.....Often the companies that work for an EPC have very large capex and hold these long term assets through multiple business cycles. An example would be a heavy equipment rental company. If they are not making large capex at least every other year they stand a chance at losing market share or missing an upturn in the cycle. Usually high debt. FCF makes sense.
this's a great post! thank you!!
Excellent post. Thank you
Agree, wondering if he wanted a specific sector because financials is listed in the OP.
massive thanks!
Thanks for the thread. Any thoughts on construction machinery or diversified manufacturing?
bump
mark
The financials section seems a bit watered down. We use DDM/SoTP models to value banks/insurance companies, but DCF is also quite prevalent is sectors like CMS/Market Infra.
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