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| Type | Master's Thesis |
| Scope | Discipline-based scholarship |
| Title | The accuracy of various multiples in relative valuation. The issue of selecting comparable firms and the performance of different multiples |
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| Institution | University of Zurich |
| Faculty | Faculty of Business, Economics and Informatics |
| Number of Pages | 81 |
| Date | 2020 |
| Abstract Text | Relative valuation, as opposed to the dividend discount model (DDM) and the discounted cash flow (DCF) model, is less cumbersome to implement and it is less influenced by certain assumptions when facing valuation questions involving IPOs, corporate restructuring (mergers and acquisitions), financial analysts’ recommendations and investment bankers’ opinions. For this reason, practitioners such as investment bankers and portfolio managers, more often than not, also tend to adopt a relative valuation approach in their analyses due to its straightforward application. However, even though it is easier to implement, its successful prediction is strongly affected by the choice of comparable firms that are being designated according to, among various criteria, industry, risk and earnings growth. Additionally, as far as relative valuation is concerned, it is not always evident to choose among a series of different multiples used to estimate corporate value. Indeed, investors may opt for earnings, book value and sales multiples, and between equity and enterprise value accounting ratios in their decision-making process. Consequently, the apparently easy application and usefulness of this valuation approach call for a more in-depth examination, as performed in this thesis, of the previously explained difficulties in order to identify comparable firms systematically and to know whether there are any multiples performing better than others in specific circumstances. The empirical analysis of this work has been performed on the constituents of the Eurostoxx 600 index in 2010, 2014 and 2018, and represents a complement to the reference’s works of Alford (1992) and Lie and Lie (2002) that performed a similar analysis in the United States. The concepts of valuation accuracy and bias are used to evaluate the effects of the set of comparable firms on the accuracy of the P/E ratio valuation technique, and to evaluate the performance of different multiples being used in business valuation. Additionally, as far as the creation of the comparable firms’ portfolios is concerned, some statistical tests such as the Friedman, Wilcoxon signed-rank and Wilcoxon sum-rank tests are performed. Overall, the industry membership generates the most accurate estimates among all the other criteria tested in the definition of the peers’ groups. In addition, any proxy for risk or earnings growth can reach a similar precision. Moreover, the different levels of leverage across firms do not improve the accuracy, implying that in a European setting the industry classification can detect the majority of the cross-sectional variation in the P/E multiple. The performance of various accounting ratios is thus tested with the adoption of the industry method in the selection of comparable firms. The results suggest that earnings multiples perform better than the book value and sales ones in the analysis of the whole sample, and for a subgroup of only non-financial companies. The forward P/E generates more precise estimates than the trailing P/E and the EV/EBITDA ratio is more accurate than the EV/EBIT. These results are also consistent in the analysis of the companies of these same samples evaluated based on their size and profitability. By turning towards the analysis of financial firms, the equity multiples generate more satisfying results than the enterprise value ones. Again, the forward P/E results are more precise than those from the trailing one. Finally, as far as the selection of peers is concerned, this thesis confirms the result of the paper of Alford (1992). However, the analysis of different multiples ends up providing different findings from the one of the works of Lie and Lie (2002). Additionally, by considering that incredibly little literature has been devoted to the study of relative valuation, the final results of this research seem to add more shadows than lights on the clarity of this topic. |
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