Abstract
Multiple based valuation is a valuation technique whose use is much frequent in many situations when it comes to equity valuation. According to Damodaran (2006) though Multiple based valuation method of valuing stocks has got very little theoretical evidence, but still it is the most popular in industry. It has even been likened to "an art form" (Bhojraj, 2002). Reason of its widespread use could be attributed to its ease of use, but does this method provide a good valuation tool and if yes, what sort of value drivers are most useful in predicting equity value?. To answer this question, FTSEALL index was considered as it represents more than 98% of the UK market in terms of capitalization. Valuation for each company in FTSEALL index was carried out on 8 separate value drivers, which included both historical and forward looking drivers, resulting in a set of 9 separate valuations or 'Predicted Values' for each company. These valuations were then compared with closing prices to compute the valuation errors, on which detailed statistical analysis was performed to observe which value drivers resulted in least amount of valuation error, indicating its robustness as a value driver.
Highlights
Background of the StudyIn literature equity valuation techniques have broadly been characterized into following groups: 1.1 Fundamental Analysis TechniquesRelative or Multiple Analysis TechniquesOf the two evaluation techniques much has been written about Fundamental Analysis
After EPS forecasted for year 1, 2 & 3, EBITDA per share valuation error has the least amount of Standard deviation at 46.52%, which is significantly higher as compare to Standard Deviation (SD) for valuation errors of EPS forecasted, which were 30% at most
In the previous section we analyzed the valuation errors of all value drivers that we considered with the help of descriptive statistics parameters including inter quartile range to assess the distribution of valuation error
Summary
In literature equity valuation techniques have broadly been characterized into following groups: 1.1 Fundamental Analysis Techniques. Fundamental analysis technique generally uses discounting on forecasted dividend or cash flows to arrive at a value for a particular stock. In relative or multiple analysis techniques no amount of extensive forecasting is required, rather valuation from market's current levels is taken. As true comparable firms with exact variables are hard to find in an industry, obvious solution is to take average for whole industry so that extremes "cancel out" each other and value for a "typical" company in industry is obtained. Another issue is that price multiples could be affected by "transitory" shocks or going through a phase of poor performance.
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