Question

I just need some guidance on how i should go about doing this.

Now choose one of your firms and look up other firms in the same industry. (pick any) Perform a “Valuation by Comparables” analysis by looking at the price/earnings, price/book value, price/sales, and price/operating cash flow ratios of the firms relative to each other and to the industry average. Which of the firms seem to be overvalued? Which seem to be undervalued? Can you think of reasons for any apparent mispricings?

Answer 1

Comparable method - this is a method in which you compare the current value of a business to other similar business by looking at the trading factors like PE, EV/EBITDA and other many ratios. Let us discuss about each with one common example given below

Company name	Price/Earnings	Price/BV	Price/Sales	Price/ op cash flow
A Ltd	20	2	16	18
B Ltd	16	0.5	12	29

i) Price / earning ration - P/E ration relates to company's share price to its earning per share. A high P/E means that the company's share is overvalued. In the above scenario, A ltd has more when compared to B. So A ltd is overvalued than B

ii) Price / Book value - the P/B ratio measures the market's valuation of a company relative to its book value. The market value of equity is typically higher than the book value of a company. This ratio is used to identify the potential investment. A lower P/B ratio mean that the stock is undervalued. So in this case, A ltd is much beneficial.

iii)Price/Sales ratio - P/s ratio is a key analysis and valuation tool that shows how much investor is willing to pay per dollar of sale for a stock. A lower ratio implies that it is undervalued while a ratio that is higher than average could indicates that the stock is overvalued. So based on this ratio A ltd is overvalued.

iv)Price / operating cash flow results - The price to cash flow ratio is a multiple that compares a company's MV to its operating cash flow or its stock price per share to operating cash flow per share. A higher multiple implies that the stock is overvalued. As a result, based on price/ cash flow ration, B ltd is overvalued.