Understand relative - comparable valuation — Hinglish notes

2.6.5 · Stock-Market › Valuation Methods

Intuition Core Intuition: "Real Estate Appraisal" Method

Socho tum apna ghar bech rahe ho. Tum koi complex cash-flow model nahi banate future rent income ka. Bajaye iske, tum apne neighborhood mein similar houses dekhte ho jo recently biki hain. Agar tumhari street pe 3-bedroom houses $500K mein biki hain, toh tumhara ghar bhi lagbhag usi value ka hoga.

Yahi hai relative valuation: ek company ki value estimate karo usse similar companies se compare karke, simple ratios (multiples) use karke. Agar similar tech companies 15× earnings pe trade karti hain, aur tumhari company $10 M k amaa t ihai, t o h u s k i v a l u er o ug h l y$ 150M hogi. Yeh kaam kyun karta hai: Markets collective intelligence hoti hai. Agar investors Company A ke liye certain prices pay karte hain, toh woh Company B ke liye bhi similar prices pay karenge agar woh truly comparable hain. Market tumhare liye valuation ka bhaari kaam khud kar leti hai.

Relative Valuation Kya Hai?

Relative Valuation Exist Kyun Karta Hai

Fundamental reason: Absolute valuation (DCF, DDM) require karta hai:

10+ saal ke cash flow forecasts (highly uncertain)
Terminal growth rates (kisi ko pata nahi)
Discount rates (subjective WACC calculations)

Relative valuation kehta hai: "Mujhe 'true' intrinsic value pata nahi, lekin mujhe pata hai ki is company ki pricing un companies jaisi honi chahiye."

Practical advantages:

Speed: 30 minutes mein 5 multiples calculate karo vs. 8-ghante ka DCF model
Market-Grounded: Current investor sentiment reflect karta hai, theory nahi
Easy Communication: "Hum 12× earnings pe trade karte hain vs. peers ke liye 18×" — yeh ek dum clear hai

The tradeoff: Tum market ki mis-pricing inherit karte ho. Agar poora sector overvalued hai, toh tumhari valuation bhi hogi.

Key Valuation Multiples

Figure — Understand relative - comparable valuation

1. Price-to-Earnings (P/E) Ratio

Formula P/E Ratio Derivation

Hum kya chahte hain: Investors ek dollar earnings ke liye kitna pay karte hain.

$P/E Ratio = \frac{Market Price per Share}{Earnings per Share (EPS)}$ Yeh form kyun?

Numerator (Price): Jo tum company own karne ke liye PAY karte ho
Denominator (Earnings): Jo company tumhare liye annually PRODUCE karta hai
The ratio: "Main $1 ann u a l p r o f i tp an e k e l i y e$ 15 pay karta hoon" → P/E = 15×

Alternative form (poori company ke liye): $P/E = \frac{Market Capitalization}{Net Income}$

First principles se derivation: Gordon Growth Model se shuru karo: $P_{0} = \frac{D _{1}}{r - g}$

Dividend payout ratio: $Payout = \frac{D _{1}}{E P S _{1}}$

Toh $D_{1} = Payout \times E P S_{1}$

$\frac{P _{0}}{E P S _{0}} = \frac{Payout \times E P S _{1}}{( r - g ) \times E P S _{0}} = \frac{Payout \times ( 1 + g )}{r - g}$

Insight: P/E ratio inke saath badhta hai:

Higher payout ratio (zyada dividends)
Higher growth rate $g$
Lower required return $r$ (kam risky)

P/E kab use karein:

✅ Mature, profitable companies (banks, consumer goods)
❌ Loss-making companies (negative earnings P/E ko meaningless bana dete hain)
❌ Capital-intensive businesses (depreciation earnings ko distort karta hai)

Worked example P/E Multiple Valuation

Setup: Tum ek retail company "ShopCo" ko value kar rahe ho jiska Net Income = $50M hai.

Step 1 - Comparables Select Karo: 4 similar retailers dhundho:

Retailer A: Market Cap $800 M, N e t I n co m e$ 40M → P/E = 20×
Retailer B: Market Cap $1.5 B, N e t I n co m e$ 100M → P/E = 15×
Retailer C: Market Cap $600 M, N e t I n co m e$ 30M → P/E = 20×
Retailer D: Market Cap $2 B, N e t I n co m e$ 80M → P/E = 25× (fast-growing e-commerce)

Step 2 - Median Multiple Calculate Karo: P/E ratios: 20×, 15×, 20×, 25× Median = 20× (hum median use karte hain, mean nahi, outlier distortion avoid karne ke liye)

Step 3 - ShopCo Pe Apply Karo: $Implied Market Cap = Net Income \times P/E Multiple$ $= $50 M \times 20 = $1, 000 M = $1 B$

Yeh step kyun? Hum assume karte hain ki investors ShopCo ki $1 e a r nin g s k o p eer s k i$ 1 earnings ke barabar value karenge.

Sanity check: Agar ShopCo peers se slow grow kar rahi hai, toh shayad 18× use karo (10% discount). Agar faster hai, toh shayad 22×.

2. Enterprise Value to EBITDA (EV/EBITDA)

Formula EV/EBITDA Derivation

P/E ki problem: Do identical businesses ka P/E alag ho sakta hai agar ek debt use kare, dusra nahi (interest expense earnings ko reduce karta hai).

Solution: Enterprise Value (EV) use karo — POORE business ki value — aur EBITDA (earnings before interest, tax, depreciation, amortization) — operating profit jo capital structure ignore karta hai.

$EV/EBITDA = \frac{Enterprise Value}{EBITDA}$ Building blocks: $Enterprise Value (EV) = Market Cap + Debt - Cash$ Kyun? EV "takeover price" hai:

Tum saare shares khareedte ho (Market Cap)
Company ka debt tumpe aata hai (+ Debt)
Company ka cash tumhe milta hai (- Cash)

$EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization$

Kyun? EBITDA inhe remove karta hai:

Interest: Financing decision (debt vs equity)
Taxes: Jurisdiction differences
D&A: Accounting choices, real cash nahi EV/EBITDA kya batata hai: "Main poora business khareedhne ke liye company ke annual operating profit ka 8× pay karta hoon."

EV/EBITDA kab use karein:

✅ Alag capital structures wali companies compare karne ke liye
✅ Capital-intensive industries (telecom, manufacturing)
✅ M&A analysis (acquirers EV care karte hain, sirf equity nahi)
❌ Banks/financial firms (debt unka product hai, financing nahi)

3. Price-to-Sales (P/S) Ratio

Use case: SaaS companies, biotech (pre-profit), retailers

4. Price-to-Book (P/B) Ratio

Use case: Banks, insurance, real estate (asset-heavy businesses)

Critical Step: Comparables Select Karna

Common mistake Mistake: "Same Industry Ki Saari Companies Comparable Hain"

Kyun sahi lagta hai: Coca-Cola aur Monster Energy dono beverage companies hain — toh comparable honi chahiye, hai na?

Kyun galat hai:

Coca-Cola: Mature, slow growth (3%), high margins (25%), massive scale
Monster: Fast growth (15%), smaller scale, alag distribution

Monster ka P/E (35×) Coca-Cola (P/E 20×) ko value karne ke liye use karna 75% overvalue kar dega!

Fix: Comparables inpe match karni chahiye:

Business model (subscription vs transactional)
Growth rate (±5% tolerance)
Profit margins (similar unit economics)
Size (small-cap vs large-cap alag behave karte hain)
Geography (alag market conditions)

Steel-man the selection: Hamesha pucho "Kya ek investor sach mein dono companies ke liye same multiple pay karega?"

Control Premium

Agar acquisition ke liye value kar rahe ho: Control premium add karo (20-40%) kyunki buyer kar sakta hai:

Management replace karna
Costs cut karna
Synergies extract karna

Comparable multiples minority stakes reflect karte hain (passive shareholders). Acquirers zyada pay karte hain.

Normalization

One-time events ke liye adjust karo:

EBITDA se restructuring charges hatao
Net income se lawsuit settlements exclude karo
Unusual working capital swings ke liye adjust karo

Advantages aur Limitations

Advantages:

Market-Based: Current sentiment aur information reflect karta hai
Quick: Company ko ghanton mein value kar sakte ho
Intuitive: Non-finance logon ke liye bhi samajhna aasaan
Flexibility: Alag situations ke liye multiple metrics (P/E, EV/EBITDA, P/S)

Limitations:

Garbage In, Garbage Out: Agar comps mispriced hain, tumhari valuation woh error inherit karti hai
True Comps Dhundhna Mushkil Hai: Especially unique businesses ke liye (Amazon 2005 mein?)
Company-Specific Factors Ignore Karta Hai: Unique competitive advantages capture nahi karta
Market Mood Swings: Bubbles mein saare multiples expand karte hain; crashes mein saare contract karte hain

Doosre Methods Ke Saath Combine Karna

Recall Samjho Jaise Main 12 Saal Ka Hoon: Lemonade Stand

Socho tum aur 4 doston ke alag-alag street corners pe lemonade stands hain. Tum jaanna chahte ho ki tumhara stand kitne ka hai.

Tum har cup count kar sakte ho jo tum agli 10 saal mein bechoge (bahut mushkil aur shayad galat bhi ho).

YA tum dekh sakte ho ki doston ke stands ke liye logon ne kitna pay kiya:

Sarah ka stand $100/ s u mm er k amaa t ahai \to$ 500 mein bika (5× earnings)
Mike ka stand $200/ s u mm er k amaa t ahai \to$ 1,000 mein bika (5× earnings)
Tumhara stand $150/summer kamaata hai

Probably worth: $150 \times 5 =$ 750!

Yahi relative valuation hai. Tum keh rahe ho "Mere stand ki value similar stands jaisi multiple pe honi chahiye."

Tricky part: Kya hua agar Sarah ka stand zyada busy street pe hai? Ya Mike fancy organic lemonade zyada price pe bechta hai? Tab woh sach mein comparable nahi hain. Tumhe stands dhundhne chahiye jo TRULY tumhare stand se similar hों.

Isliye good comparables pick karna sabse mushkil (aur sabse important) part hai!

Connections

2.6.01-Introduction-to-valuation-methods — Teen core approaches mein se ek ke roop mein relative valuation
2.6.04-Understand-absolute-valuation-DCF — Relative valuation DCF ko kaise complement karta hai
2.6.06-Apply-valuation-to-stock-selection — Screening aur comparison ke liye multiples use karna
Financial-Ratios — P/E, P/B key profitability aur value metrics ke roop mein
Market-Efficiency — Comparable pricing kyun kaam karta hai (agar markets semi-efficient hain)

#flashcards/stock-market

Relative valuation kya hai aur yeh kya compare karta hai? :: Relative valuation ek company ki worth estimate karta hai usse similar publicly-traded companies se compare karke, valuation multiples (market value aur financial metrics ke ratios) use karke. Yeh similar businesses compare karta hai jo similar multiples pe trade karni chahiye.

Comparable company analysis ke teen steps kya hain?

1) Truly similar comparable companies select karo 2) Comps ke liye valuation multiples (P/E, EV/EBITDA, etc.) calculate karo 3) Target company ko value karne ke liye comp multiples apply karo.

P/E ratio formula likho aur explain karo ki yeh kya measure karta hai.

P/E = Market Price per Share / Earnings per Share (ya Market Cap / Net Income). Yeh measure karta hai ki investors ek dollar earnings ke liye kitna pay karte hain. P/E of 15× matlab tum

1 ann u a l p r o f i t k e l i y e

15 pay karte ho.

Enterprise Value (EV) kya hai aur iska calculation kaise hota hai?

EV ek business ki total value hai ("takeover price"). EV = Market Cap + Debt - Cash. Yeh represent karta hai ki tum saare shares acquire karne ke liye kitna pay karoge, debt inherit karoge, minus jo cash tumhe milega.

EV/EBITDA formula likho aur explain karo ki kuch comparisons mein yeh P/E se better kyun hai.

EV/EBITDA = Enterprise Value / EBITDA. Yeh alag capital structures wali companies compare karne ke liye better hai kyunki EV debt include karta hai aur EBITDA interest expense remove karta hai, isse capital-structure neutral banata hai.

EBITDA kya hai aur hum isse kyun use karte hain?

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization. Hum isse isliye use karte hain kyunki yeh operating profit represent karta hai financing decisions (interest), jurisdiction differences (taxes), aur accounting choices (D&A) se pehle.

P/E ratio ki jagah P/S ratio kab use karna chahiye?

P/S (Price-to-Sales = Market Cap / Revenue) tab use karo jab young companies ki negative earnings hon, jahan P/E meaningless ho, ya jab revenue earnings se kam manipulated ho. SaaS aur pre-profit companies ke liye common.

P/B ratio kya measure karta hai aur yeh kab sabse useful hai?

P/B = Market Cap / Book Value of Equity. Yeh market value ko accounting value se compare karta hai. Banks, insurance, aur real estate jaisi asset-heavy businesses ke liye sabse useful. P/B < 1 suggest karta hai ki market sochti hai assets stated se kam worth hain.

Comparable companies ko kin paanch factors pe match karna chahiye?

1) Business model 2) Growth rate (±5%) 3) Profit margins 4) Size/scale 5) Geography. Yeh ensure karta hai ki companies truly comparable hain aur investors se similar multiples command karengi.

Median multiple final answer kyun nahi hota?

Median sirf ek starting point hai. Tumhe adjust karna hoga quality differences (management, brand), growth differences (faster growth → higher multiple), aur risk differences (lower risk → higher multiple) ke liye. ±10-20% ka reasoned adjustment reasoning ke saath justify karo.

Control premium kya hai aur kab add karte hain?

Control premium (20-40%) tab add karta hai jab acquisition ke liye value karo. Buyers market prices se zyada pay karte hain kyunki woh management replace kar sakte hain, costs cut kar sakte hain, aur synergies extract kar sakte hain. Comparable multiples minority stakes reflect karte hain, control positions nahi.

Relative valuation mein normalization kya hai?

Normalization financial metrics ko one-time events (restructuring charges, lawsuit settlements, unusual gains) ke liye adjust karta hai, taaki sustainable, recurring performance reflect ho. Isse companies mein multiples zyada comparable bante hain.

Relative valuation ke teen main advantages kya hain?

1) Market-based (current sentiment aur information reflect karta hai) 2) Quick (DCF ke liye dinon ki jagah ghante) 3) Intuitive (communicate karna aasaan hai "hum 12× pe trade karte hain vs peers ke liye 18×").

Relative valuation ki teen main limitations kya hain?

1) Garbage in, garbage out (market mispricing inherit karta hai) 2) True comps dhundhna mushkil hai (especially unique businesses ke liye) 3) Company-specific factors ignore karta hai (unique competitive advantages capture nahi karta).

Sirf ek ki jagah multiple valuation methods kyun use karni chahiye?

Value ek range hai, single number nahi. DCF (intrinsic), relative valuation (market comparables), aur precedent transactions use karna triangulation create karta hai. Agar saare converge karein, confidence high hota hai. Agar diverge karein, investigate karo kyun, taaki risk/opportunity samajh sako.