1. Why re-lever beta based on the median percentage debt (as percentage of capital structure) of comps?

  2. Why calculate WACC weights based on median capital structure of comps?

  3. Why should the cap str of comps move you to the implied value? Isn't this relevant mostly for companies that are not mature? What if the company you are valuing is mature and its capital structure resembles that of the comps? 

  4. Do we take the median of comps because the law of large numbers? But within a set we would have only 5-10 companies usually so the law would not apply.

Thanks to anyone that takes a shot at this.

Comments (5)

Most Helpful
Dec 10, 2021 - 7:50am

Not an expert but will try to answer it anyway.

1) Cap structure (debt in this case) changes quite quickly sometimes multiple times between quarters. Market is driven largely by consensus of various estimates and investors anticipate that the current capital structure over time would change/evolve to the average (median or trimmed average but median is quicker) of what the industry has at the moment. Now if you are asking why "re-levering" as a concept, well plenty of easy reads around the forum or online but essentially since we know that Miller Modigliani does not hold in reality, it is appropriate to incorporate the effect of tax-deductible interest payments into beta which is a proxy of return sensitivity.

2) Same as answer 1) tbh

3) You raise an interesting point. Keep in mind that we are talking about an art here and not science. AM, HF, Banking etc. have different views on how to properly do comps. You are right, an established company like IBM would not see many changes in its cap structure. However keep in mind that when doing comps correctly, you are not just picking the ones listed on BBG or CapIQ and use the median. It takes hours sometimes, reading about their product offering, geographic exposure, maturity, and a series of other attributes to arrive at the best clone-like companies publicly listed. A good comp table sometimes may have just 2 or 3 peers depending on how niche is the company or industry.

4) Honestly, not much of a big difference here. If the comps table is done correctly, the difference between median and average is minimal as you have already excluded the outliers. By outliers we are not just talking about companies "structurally" different but sometimes companies "temporarily" different. Ex. if a company had a very bad quarter because its plantation in Togo got burned down, you should likely exclude it from the comps table as its numbers will be all over the place. Even tho it might be a very good comp in terms of all the other metrics. Or alternatively keep it and footnote it.

Keep in mind these answers are less targeted towards IB in which due to time constraints and standardization of processes, you don't have to spend an hour reading news articles about comps. But often time when we receive the decks from the sell side, we tend to add or delete names in the comps as we have our own views. Hope it helped!

Dec 11, 2021 - 4:29am

Gratitude for the comprehensive answer! It did help!

 Just some quick follow ups if you have the time:

1. What do you mean by "structurally" different? I always thought that we constrain the comps based on size, geography, and industry. Thus, we would have have similar discount rates and cash flows, isolating cash flow growth rate differences.

2. "...investors anticipate that the current capital structure over time would change/evolve to the average (median or trimmed average..." - do you know if this is a stylized fact, an axiom, an assumption, or a self-fulfilling prophecy? I could not find a paper on this based on a quick search. It sounds a bit like a regression towards the mean. 

Many thanks!

Dec 11, 2021 - 10:37am

I am glad it helped! Here is some reflections on your follows up. Again, take it with a grain of salt, I am no expert by any means ahaha

1) I can give you a quick example which is targeted to find the average/median EV/EBITDA (the most common multiple for PE and PD and the only reason you build comps table in those industries). You have 5 comps, same industry, similar geography, similar size etc. All have an EBITDA margin between 11% to 14% except one that has 20%. You start reading about this company to understand whether it has something different, a crazy profitable year or different products but you simply discover that is just more efficient in its operations. Nothing more. It's like the southwest airlines of the airlines industry. Even if the company under 95% of the metrics is identical to others, you should likely exclude it from your comps table as investors are willing to pay more (a higher EV/EBITDA multiple) for a company which is more efficient with its supply chain, SG&A costs etc. ceteris paribus. It has this structural difference that makes it different from all the others despite being more or less the same. It's weird I know ahahahah

2) This one is interesting. Not sure about the definition even tho I should considering I left uni a couple of months ago ahahah. I suggest you to read about the concept of "target capital structure", plenty of academic articles on this topic. Essentially, because we know that certain levels of debt contribute in making the company more profitable, there must a way to calculate what the perfect capital structure must be, since it should be only mathematical formulas. However, nobody really can because it is extremely complicated and often times spans across multiple disciplines such as organizational behavior, psychology etc. This is because studies have pointed out that CEOs working in overlevered companies, find ways to cut costs and make them more efficient (in order to avoid insolvency) that would have never crossed their minds if the company had a normal or even target capital structure. Today, if I am not mistaken, the industry has mutually agreed that the target capital structure of a company is the average/median of the industry. And investors expect the company to reach the target capital structure in the future, so applying it now in the re-levering formula is a good way to incorporate future expectations. The logic is here is "how can an entire industry operate at subpar levels? It can't. So that must be the target". Is it correct? Who knows honestly, it makes somewhat sense but it is also imperfect. It's like the concept of Beta. Used everywhere but it has so many holes that nobody is able to patch. How sense does it make to use a metric based on the average of the past 2 or 3 or 5 years company's returns to estimate the future returns of a company that has just changed its CEO, or done a major acquisition and expanded 50% of its portfolio in a new market, or just concluded its restructuring plan. No sense at all ahahaha This is as reliable as trying to drive on a new road by looking at the rear view mirror. It is what it is, everyone use it as there are no better alternatives for Beta. Same I think is for the "target capital structure" being the average of the comps.

Dec 14, 2021 - 8:30am


1) Wow, we might exclude a company because it is too efficient - very strange indeed haha. I see the logic in removing outliers, but this is weird.

2) The part about the target capital structure was brilliant - thanks! On calculating beta - also do not see much sense in using historical beta. What I have seen people do though, is taking the historical beta (average of past years) AND beta based on the median cap str of comps to calculate WACC. Then we have WACC based on historical beta (closer to the target's current value) and WACC based on a beta re-levered with the median cap str of comps (closer to implied value). Then, take the average of these WACC values.

Dec 10, 2021 - 7:58am

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