Session 19: Revenue Multiples & Wrapping up

1. Aswath Damodaran Session 19: Revenue Multiples & Wrapping up

2. Top Line Multiples Aswath Damodaran

3. The EV/Sales Ratio - Drivers • The EV/Sales Ratio Equation g = Growth rate in after-tax operating income for the first n years gn = Growth rate in after-tax operating income after n years forever (Stable growth rate) RIR Growth, Stable = Reinvestment rate in high growth and stable periods WACC = Weighted average cost of capital Aswath Damodaran

4. The value of a brand name • One of the benefits of having a well-known and respected brand name is that firms can charge higher prices for the same products, leading to higher profit margins and hence to higher revenue multiples. • In general, the value of a brand name can be written as: • Value of brand name ={(V/S)b-(V/S)g }* Sales • (V/S)b = Value of Firm/Sales ratio with the benefit of the brand name • (V/S)g = Value of Firm/Sales ratio of the firm with the generic product Aswath Damodaran

5. Valuing Brand Name Coca Cola With Cott Margins Current Revenues = $21,962.00 $21,962.00 Length of high-growth period 10 10 Reinvestment Rate = 50% 50% Operating Margin (after-tax) 15.57% 5.28% Sales/Capital (Turnover ratio) 1.34 1.34 Return on capital (after-tax) 20.84% 7.06% Growth rate during period (g) = 10.42% 3.53% Cost of Capital during period = 7.65% 7.65% Stable Growth Period Growth rate in steady state = 4.00% 4.00% Return on capital = 7.65% 7.65% Reinvestment Rate = 52.28% 52.28% Cost of Capital = 7.65% 7.65% Value of Firm = $79,611.25 $15,371.24 Value of brand name = $79,611 -$15,371 = $64,240 million Aswath Damodaran

6. An Example: Let the market tell you what matters.. Social media in October 2013 Aswath Damodaran

7. Read the tea leaves: See what the market cares about Twitter had 240 million users at the time of its IPO. What price would you attach to the company? Aswath Damodaran

8. Market Regressions g =Expected Revenue Growth: Expected growth in revenues: Near term (2 or 5 years) ERP: ERP for country in which company is incorporated Tax Rate: Effective tax rate in most recent year; Operating Margin: Operating Income/ Sales

9. Choosing Between the Multiples • As presented in this section, there are dozens of multiples that can be potentially used to value an individual firm. • In addition, relative valuation can be relative to a sector (or comparable firms) or to the entire market (using the regressions, for instance) • Since there can be only one final estimate of value, there are three choices at this stage: • Use a simple average of the valuations obtained using a number of different multiples • Use a weighted average of the valuations obtained using a nmber of different multiples • Choose one of the multiples and base your valuation on that multiple Aswath Damodaran

10. Picking one Multiple • This is usually the best way to approach this issue. While a range of values can be obtained from a number of multiples, the “best estimate” value is obtained using one multiple. • The multiple that is used can be chosen in one of two ways: • Use the multiple that best fits your objective. • Use the multiple that has the highest R-squared in the sector when regressed against fundamentals. • Use the multiple that seems to make the most sense for that sector, given how value is measured and created. Aswath Damodaran

11. A More Intuitive Approach • Managers in every sector tend to focus on specific variables when analyzing strategy and performance. The multiple used will generally reflect this focus. Consider three examples. • In retailing: The focus is usually on same store sales (turnover) and profit margins. • In financial services: The emphasis is usually on return on equity. • In technology: Growth is usually the dominant theme. PEG ratios were invented in this sector. Aswath Damodaran

12. Relative versus Intrinsic Value • Assume you value the same company doing both DCF and relative valuation correctly, should you get the same value? • Yes • No • If not, how would you explain the difference? Aswath Damodaran

13. Reviewing: The Four Steps to Understanding Multiples • Define the multiple • Check for consistency • Make sure that they are estimated uniformly • Describe the multiple • Multiples have skewed distributions: The averages are seldom good indicators of typical multiples • Check for bias, if the multiple cannot be estimated • Analyze the multiple • Identify the companion variable that drives the multiple • Examine the nature of the relationship • Apply the multiple Aswath Damodaran