1

EQUITY RESEARCH
23MBADSE316
Dr. Pujari Sudharsana Reddy

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Module 3

Relative Valuation - Metrics Ubiquity of relative valuation

Reasons for Popularity and Potential Pitfalls- Four Basic Steps
to using Multiples: Price to Earnings Ratio, Price to Book Ratio,
Price to Sales Ratio, Enterprise Value ratios, Exercise on
Relative Valuation using Banking Sector. Reconciling relative
and discounted cash flow valuations*.

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What is Valuation
Valuation is the process of determining the monetary worth of an asset, investment, or
business. It involves analyzing various factors to estimate its fair market value or intrinsic
value, which can be used for investment decisions, acquisitions, or other financial
transactions.

Intrinsic value is the true, underlying worth of an asset (like a stock, business, or property) based
on its fundamentals – not just what the market is currently paying for it.

Fair Market Value (FMV) is The price a willing buyer and seller agree on in an open market (no
pressure to buy/sell).

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 Valuation

Absolute Relative Asset-Based

Valuation Valuation Valuation
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 Comparison

Aspect Absolute Valuation Relative Valuation Asset-Based Valuation

Market comparisons Tangible net assets (balance
Core Principle Intrinsic value (future potential)
(peers/transactions) sheet)
- DCF - Comparable Company Analysis
- NAV
Key Methods - DDM Uses multiples (P/E, EV/EBITDA)
- Liquidation Value
- Residual Income
Data Required Forecasts (cash flows, growth) Market data (multiples, deals) Balance sheet (assets/liabilities)

- Independent of market noise - Quick & market-reflective - Objective (hard numbers)

Strengths
- Captures unique advantages - Easy benchmarking - Safe for distressed firms

- Highly sensitive to assumptions - Requires good comparables - Misses intangibles (brand, IP)
Weaknesses
- Complex for volatile industries - Ignores intrinsic value - Depreciation skews book value

- Startups - Public companies - Real estate

Best For - Unique businesses - IPOs - Manufacturing
- Long-term investors - M&A pricing - Bankruptcy cases
Valuing SpaceX using DCF (future Valuing Netflix using P/E vs. Valuing a coal mine based on
Example
Mars missions) Disney+ machinery/land
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 What is Relative
Valuation

• Relative valuation means

estimating a company's value by
comparing it to similar companies
using multiples financial ratios
(such as P/E, P/B, EV/EBITDA, etc.)

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Relative Valuation
• A relative valuation model is a business valuation method that
compares a company's value to that of its competitors or
industry peers to assess the firm's financial worth.
• A relative valuation model compares a firm's value to that of its
competitors to determine the firm's financial worth.
• One of the most popular relative valuation multiples is the price-
to-earnings (P/E) ratio.
• A relative valuation model can be used to assess the value of a
company's stock price compared to other companies or an
industry average.
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Example
Scenario:
You are planning to sell your residential flat of
2000 Sq ft and want to determine a fair asking
price. a similar flat in your neighborhood of
1500 sq ft was sold for Rs. 45 Lakhs.

Using relative valuation Determine the

Estimated value of your flat

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Step 1 Calculate the price per square foot of the comparable flat:
4500000
= 𝑅𝑠. 3000 𝑝𝑒𝑟 𝑠𝑞. 𝑓𝑡.
1500

Step 2 Apply this price per square foot to your flat:

𝑅𝑠. 3000 𝑋 2000 = 𝑅𝑠. 6000000

So your Flat Valuation is Rs. 60 Lakh

That is Relative Valuation comparing similar assets/equity

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 Relative Valuation Metrics

Metric Formula Used For

P/E Price ÷ Earnings per Share Valuing profitable companies
P/B Price ÷ Book Value per Share Asset-heavy firms (e.g., banks)
P/S Price ÷ Sales per Share Unprofitable or early-stage firms
EV/EBITDA Enterprise Value ÷ EBITDA Operational efficiency
EV/Sales Enterprise Value ÷ Revenue Startups or low-margin sectors

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5 Steps in Relative Valuation
• Analyze the Subject Companies
Step 1.

• Select Comparable Companies

Step 2.

• Select the Valuation Multiple(s)

Step 3.

[Link] • Calculate the valuation multiple for the comparable companies

4.

• Apply to Target (Subject) Company

Step 5.

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 12

Steps in Relative Valuation

1. Analyse the subject company –
- Product portfolio and market segments covered by the firm
- Availability and cost of inputs
- Technological and production capability
- Market image, distribution reach and customer loyalty
- Product differentiation and economic cost position
- Managerial competence and drive
- Quality of human resources
- Competitive dynamics
- Liquidity, leverage and access to funds
- Turnover, margins and return on investments
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2. Select Comparable Companies

Selecting companies which are similar to the subject company
in terms of the lines of business, nature of markets served,
scale of operation etc.
Its very difficult to find truly comparable companies. Hence
the analyst should carefully look at 10 to 15 companies in
the same industry and select at least 3 to 4 which come ‘as
close as possible’ to the subject company.
A good deal of subjective judgement is involved in this
process.
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Example
Understand the Company
• Business model, products, markets, costs, margins,
ROI

Select Comparable Companies

• Choose similar firms (same industry, size, growth)

Example:
Valuing Lupin Ltd. (Pharma) Compare with Cipla, Sun
Pharma, Dr. Reddy’s, Torrent Pharma

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 Step 3: Choose the Valuation Multiple(s)
After selecting the peer group, you need to choose the valuation multiples to use in the analysis.
The choice of multiples depends on the industry, business model, and availability of reliable data.
Broadly, valuation multiples fall into two categories:

1. Equity Valuation Multiples: These focus only on the shareholders (owners of the company).

2. Enterprise Valuation Multiples: These look at the entire company, including debt and cash.

Since none of the valuation techniques are perfect, at least two to three multiples that are
appropriate for the companies.
Generally, the valuation multiples used in enterprise valuation are EV-EBITDA ratio, EV-book value
ratio and EV-sales ratio.

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Equity Valuation Multiples
a) Price-to-Earnings Ratio (P/E)
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝑃/𝐸 =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆)

Where:
𝑃𝑟𝑜𝑓𝑖𝑡 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐸𝑃𝑆 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑠ℎ𝑎𝑟𝑒𝑠

• Or for the whole company:

𝑀𝑎𝑟𝑘𝑒𝑡𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
𝑃/𝐸 =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

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Equity Valuation Multiples
(b) Price-to-Book Value Ratio (P/B)
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟𝑆ℎ𝑎𝑟𝑒
𝑃/𝐵 =
𝐵𝑜𝑜𝑘𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

Where:
𝑇𝑜𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝐸𝑞𝑢𝑖𝑡𝑦
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠

Or at company level :

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟𝑆ℎ𝑎𝑟𝑒

𝑃/𝐵 = 𝑇𝑜𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝐸𝑞𝑢𝑖𝑡𝑦

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Equity Valuation Multiples
(c) Price-to-Sales Ratio (P/S)
𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
𝑃/𝑆 =
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑆𝑎𝑙𝑒𝑠

Where:

𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 × 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠

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 Enterprise Valuation Multiples
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐸𝑉) = 𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝 + 𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 − 𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠

Or
𝐸𝑉 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 + 𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 + 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝑀𝑖𝑛𝑜𝑟𝑖𝑡𝑦 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡

Or
𝐸𝑉 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 + 𝑁𝑒𝑡 𝐷𝑒𝑏𝑡

Where:

 Market Capitalization = Share Price × Number of Outstanding Shares

 Total Debt = Short-term Debt + Long-term Debt

 Preferred Equity = Value of preferred shares (if any)

 Minority Interest = Portion of subsidiaries not owned by the parent company

 Cash and Equivalents = Liquid assets held on the balance sheet

 Net Debt = Total Debt – Cash and Cash Equivalents

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Enterprise Valuation Multiples
a) EV/EBIT
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒
𝐸𝐵𝐼𝑇
Where:

EBIT= Revenue − Operating Expenses (excluding interest and taxes)

Or

• EBIT= Net Income + Interest + Tax

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Enterprise Valuation Multiples
b) EV/EBITDA
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒​
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡, 𝑇𝑎𝑥𝑒𝑠, 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛, 𝑎𝑛𝑑 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛

Where:

• EBITDA=Net Income + Interest + Tax + Depreciation + Amortization

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Enterprise Valuation Multiples
c) EV/Sales
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒​
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

d) EV/Book Value
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒​
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑠𝑠𝑒𝑡𝑠 𝑜𝑟 𝐸𝑞𝑢𝑖𝑡𝑦

Where:

• Book Value of Equity = Total Assets - Total Liabilities

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Enterprise Valuation Multiples
e) EV/ FCFF (Free Cash Flow to Firm)
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒​
𝐹𝑟𝑒𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 𝑡𝑜 𝐹𝑖𝑟𝑚
Where:

FCFF=EBIT× (1−Tax Rate) + Depreciation + Amortization − Capital Expenditures – Δ Working Capital

 EBIT = Earnings Before Interest & Taxes

 t = Tax Rate (in decimal form)

 Depreciation and Amortization (D+A) = Non-cash expenses

 CapEx = Capital Expenditures (money spent on fixed assets)

 ΔWC = Change in Working Capital (current assets - current liabilities)

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Step 4: Calculate the Valuation Multiples for the Comparables
Companies
• Next, calculate the selected valuation multiples for each comparable
company based on their financial statements. This involves computing
metrics like EV/EBITDA, EV/Sales, and EV/Book Value. The data must be
standardized — for instance, using the same time frame (e.g., trailing 12
months), adjusting for non-recurring items, and ensuring consistent
accounting practices.

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 For Example

Table 1: Financial Data of Comparable Companies

Suppose there are two comparable companies P and Q with the following
financial numbers:

Company Sales EBITDA Book Value of Assets Enterprise Value

P 3000 500 2000 4000

Q 5000 800 3000 5600

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Calculation for Company P:
4000
𝐸𝑉/𝐸𝐵𝐼𝑇𝐷𝐴 = = 8.0
500

4000
𝐸𝑉/𝑆𝑎𝑙𝑒𝑠 = = 1.33
3000

4000
𝐸𝑉/𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 = = 2.0
2000

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Calculation for Company Q:
𝐸𝑉 5600
= = 7.0
𝐸𝐵𝐼𝑇𝐷𝐴 800

5600
𝐸𝑉/𝑆𝑎𝑙𝑒𝑠 = = 1.12
5000

5600
𝐸𝑉/𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 = = 1.87
3000

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The valuation multiples for the companies are:

P Q Average
EV-EBITDA 8.0 7.0 7.5
EV-Book Value 2.0 1.87 1.94
EV-Sales 1.33 1.12 1.23

These average multiples — 7.5 (EV/EBITDA), 1.23 (EV/Sales), and 1.94 (EV/Book) —
are now used in Step 5 to value the subject company.
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5. Value the Subject Company

- Apply the average multiples of the comparable companies to the
relevant financial attributes of the subject company and obtain
several estimates of enterprise value for the subject company and
then take their arithmetic average.

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Now same in the Example from step 3

Now let’s value the Subject Company X. Suppose its financials are:
• Sales = ₹4,000
• EBITDA = ₹600
• Book Value of Assets = ₹2,500

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Now same in the Example from step 3

We take each multiple and apply it to the subject company’s number.

EV/EBITDA:
7.5×600=₹4,500

So, based on profit, the company is worth ₹4,500.

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EV/Sales:

1.23×4,000=₹4,9201.23×4,000=₹4,920

So, based on revenue, company is worth ₹4,920.

EV/Book Value:

1.94×2,500=₹4,8501.94×2,500=₹4,850

So, based on net assets, company is worth ₹4,850.

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Final Table

Multiple Used Value Used Estimated Value

EV/EBITDA ₹600 EBITDA ₹4,500
EV/Sales ₹4,000 Sales ₹4,920
EV/Book Value ₹2,500 Assets ₹4,850

Now take the average of the three:

₹4,500 + ₹4,920 + ₹4,850
= ₹4,757
3
Estimated Enterprise Value = ₹4,757

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Suppose If You’re Investing in the Company
• You compare ₹4,757 (what it should be worth) with the actual
price in the market.

• This helps you decide if the company is overvalued or undervalued.

MARKET VALUE YOU ESTIMATED DECISION

₹6,000 ₹4,757 Too expensive ❌
₹4,000 ₹4,757 Good deal ✅
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Example 2
The following financial information is available for company D, an
unlisted pharmaceutical company, which is being valued.
 EBITDA : Rs. 400 million
 Book value of assets : Rs. 1,000 million
 Sales : Rs. 2,500 million

Based on an evaluation of a number of listed pharmaceutical companies,

A, B, and C have been found to be comparable to company D.

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The financial information for these companies is given below:
A B C
Sales 1600 2000 3200

EBITDA 280 360 480

Book value of assets 800 1000 1400

Enterprise value (EV) 2000 3500 4200

Calculate the EV (Enterprise Valuation)

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 Calculate EV/EBITDA for Each Company

1. EV/EBITDA

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒​
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡, 𝑇𝑎𝑥𝑒𝑠, 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛, 𝑎𝑛𝑑 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛

2000
Company A: = 7.14 ≈ 7.1
280
3500
Company B: = 9.72 ≈ 9.7
360
4200
Company C: = 8.75 ≈ 8.8
480

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 EV/Book Value

2. EV/Book Value
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒​
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑠𝑠𝑒𝑡𝑠 𝑜𝑟 𝐸𝑞𝑢𝑖𝑡𝑦

2000
A: = 2.5
800
3500
B: = 3.5
1000
4200
C: = 3.0
1400

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 EV/Sales

3. EV/Sales
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒​
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

2000
A: = 1.25
1600
3500
B: = 1.75
2000
4200
C: = 1.3125 ≈ 1.31
3200
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Three valuation multiples, as shown below, have been considered

A B C Average
EV-EBITDA 7.1 9.7 8.8 8.5
EV-book value 2.5 3.5 3.0 3.0
EV-sales 1.25 1.75 1.31 1.44

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 Applying the average multiples to the financial numbers of
firm D from the above calculations:

A. EV from EBITDA multiple

𝐸𝑉
𝐸𝑉 = × 𝐸𝐵𝐼𝑇𝐷𝐴 𝑜𝑓 𝐷 = 8.5 × 400 = 3400 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝐸𝐵𝐼𝑇𝐷𝐴 𝑎𝑣𝑒𝑟𝑎𝑔𝑒

B. EV from Book Value multiple

𝐸𝑉
𝐸𝑉 = × 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐷 = 3.0 × 1000 = 3000 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑎𝑣𝑒𝑟𝑎𝑔𝑒

C. EV from Sales multiple

• 𝐸𝑉 =
𝐸𝑉
𝑆𝑎𝑙𝑒𝑠 𝑎𝑣𝑒𝑟𝑎𝑔𝑒
× 𝑆𝑎𝑙𝑒𝑠 𝑜𝑓 𝐷 = 1.44 × 2500 = 3600 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

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EBITDA Basis Book Value Basis Sales Basis
Average EV-EBITDA 8.5 Average EV-book 3.0 Average EV-sales 1.44
value

EBITDA of D Rs. 400 Book Value of D Rs. 1000 Sales of D Rs. 2500
million million million

EV of D Rs. 3400 EV of D Rs. 3000 EV of D Rs. 3600

million million million

[Link]
A simple arithmetic average of the three estimates of EV is:

𝟑𝟒𝟎𝟎 + 𝟑𝟎𝟎𝟎 + 𝟑𝟔𝟎𝟎

= 𝟑𝟑𝟑𝟑 𝒎𝒊𝒍𝒍𝒊𝒐𝒏
𝟑

[Link]
 Example 3

Company Z is an unlisted FMCG company. Its financials are:

• Sales = Rs. 3,500 million

• EBITDA = Rs. 450 million

• Book Value of Assets = Rs. 2,000 million

[Link]
 45

There are 3 comparable listed companies in Stock Exchange : E, F, and G.

Enterprise
EBITDA (₹ Book Value (₹
Company Sales (₹ million) Value (EV) (₹
million) million)
million)
E 2,000 300 1,200 2,500

F 4,000 500 1,800 4,800

G 3,500 400 1,500 4,000

[Link]
 46

Questions
[Link] the following multiples for each comparable company:
a) EV/EBITDA
b) EV/Book Value
c) EV/Sales
[Link] the average multiples for EV/EBITDA, EV/Book Value, and EV/Sales.

[Link] the average multiples, estimate the Enterprise Value (EV) of Company Z based on its
financials.

[Link] the final estimated EV of Company Z by taking the arithmetic average of the three
estimates.

[Link] Price Comparison:

Suppose Company Z is being sold or traded at a market price of Rs. 4,800 million. Compare this
price with your estimated EV and interpret whether the company is overvalued or undervalued.
[Link]
 47

Calculate Multiples

EV/EBITDA

•E = 2500 / 300 = 8.33 ≈ 8.3

•F = 4800 / 500 = 9.6
•G = 4000 / 400 = 10.0

Average EV/EBITDA = (8.3 + 9.6 + 10) / 3 = 9.3

[Link]
 48

EV/Book Value
E = 2500 / 1200 = 2.08 ≈ 2.1

F = 4800 / 1800 = 2.67 ≈ 2.7

G = 4000 / 1500 = 2.67 ≈ 2.7

Average EV/Book Value = (2.1 + 2.7 + 2.7) / 3 = 2.5

[Link]
 49

EV/Sales
E = 2500 / 2000 = 1.25

F = 4800 / 4000 = 1.20

G = 4000 / 3500 = 1.14

Average EV/Sales = (1.25 + 1.20 + 1.14) / 3 ≈ 1.20

[Link]
 50

Apply Average Multiples to Company Z

Estimated EV (₹
Multiple Used Company Z Value
million)
EV/EBITDA 450 9.3 × 450 = 4,185
EV/Book Value 2,000 2.5 × 2,000 = 5,000
EV/Sales 3,500 1.20 × 3,500 = 4,200

[Link]
 51

Final Estimated Enterprise Value

4185+5000+4200​
• 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐸𝑉 =
3

4,462𝑚𝑖𝑙𝑙𝑖𝑜𝑛 (𝑎𝑝𝑝𝑟𝑜𝑥. )

Estimated Enterprise Value of Company Z = Rs. 4,462 million

[Link]
 52

Market Price Comparison

• Given Market Price: Rs. 4,800 million
• Compare with estimated EV = 4,462 million

[Link]
 53

Market Price Comparison

• Given Market Price: Rs. 4,800 million
• Compare with estimated EV = 4,462 million

• Interpretation:
• Market Price > Estimated EV → Overvalued ❌
• Market Price < Estimated EV → Undervalued ✅

[Link]
 54

The following financial information is available for Company

Aluminum, a metal company
EBITDA : 18 crores
Book value of assets : 90 crores
Sales : 125 crores
Based on the evaluation of several metal companies, Brass,
Copper and Bronze have been found to be comparable to
company Aluminum

[Link]
 55

The financial information for these companies is given below.

Brass Copper Bronze
EBITDA 12 15 20
Book value of Assets 75 80 100
Sales 80 100 160
Enterprise Value 150 240 360

Calculate the value of the Aluminum company using the

following multiples : EV-EBITDA, EV-Book value and EV-Sales

[Link]
 56

EV-EBITDA Multiples:
Brass: 150/12 = 12.5x
Copper: 240/15 = 16.0x
Bronze: 360/20 = 18.0x
Average: (12.5 + 16.0 + 18.0)/3 = 15.5x

[Link]
 57

EV-Book Value Multiples:

Brass: 150/75 = 2.0x
Copper: 240/80 = 3.0x
Bronze: 360/100 = 3.6x
Average: (2.0 + 3.0 + 3.6)/3 = 2.87x

[Link]
 58

EV-Sales Multiples:
Brass: 150/80 = 1.875x
Copper: 240/100 = 2.4x
Bronze: 360/160 = 2.25x
Average: (1.875 + 2.4 + 2.25)/3 = 2.175x

[Link]
 59

Now, applying these average multiples to Aluminum's financials:

Using EV-EBITDA Multiple:

Aluminum EBITDA: 18 crores
Value = 18 × 15.5 = 279 crores

[Link]
 60

Using EV-Book Value Multiple:

Aluminum Book Value: 90 crores
Value = 90 × 2.87 = 258.3 crores

[Link]
 61

Using EV-Sales Multiple:

Aluminum Sales: 125 crores
Value = 125 × 2.175 = 271.875 crores

Aluminum’s estimated enterprise value based on comparable

companies is (279 + 258.3 + 271.875)/3 = 270 (Approx)
[Link]
 Ubiquity of Relative Valuation
• "Ubiquity" means that relative valuation is omnipresent in finance—used far more
frequently than intrinsic (DCF) or asset-based methods.

Ubiquity in Following :
• Investment Banks – For deal pricing in mergers & acquisitions (M&A)

• Equity Research – Analysts use multiples to issue “Buy/Sell/Hold” ratings

• Venture Capital & Private Equity – To compare startups or portfolio companies

• Finance Media & Reports – Headlines often show P/E or EV/EBITDA comparisons
[Link]
 63

Ubiquity of Relative Valuation

• Most equity research reports are based on multiples: PE

ratio, EV to EBITDA ratio and price to sales ratio
• DCF techniques are more common in acquisitions and
corporate finance. Almost every acquisition is backed up by
a discounted cash flow valuation with relative valuation
multiples used in the process of valuation.
• Most investment rules of thumb are based on multiples.
Eg: PE ratio

[Link]
 1. Simple and Quick – Easy to calculate using available data
like stock prices and earnings.

Why Relative 2. Market-Based – Reflects what investors are currently

willing to pay for similar companies.
Valuation is 3. Widely Accepted – Commonly used by analysts, investors,
popular? and media.
4. Flexible – Works across sectors, especially when future cash
flows are hard to predict (like in startups or banks).

[Link]
Potential Pitfalls of Relative Valuation

1. Selecting the Right Comparable Companies: Finding truly

comparable firms is tough. Differences in business
models, geographies, growth potential, or risk
profiles make peer groups imperfect.

• Example:
Comparing Netflix (subscription-driven) with YouTube (ad-
based) both are tech/media firms, but their revenue
models and cost structures are entirely different.

[Link]
2. Over-Reliance on Historical Data: Multiples are often calculated
using past earnings, which don’t always reflect a company’s future
potential.

Example:
Tesla (2010s to Now)
Then: Loss-Making Company (2010–2019)
 Tesla was not profitable for many years.
 It invested heavily in R&D, new factories (Gigafactories), and
launching new models.
 Analysts using trailing P/E (based on past earnings)
saw negative or sky-high P/E ratios — making Tesla
look overvalued.

[Link]
3. Market Sentiment Distortions: Sometimes, the
stock market gets emotional — everyone becomes
too excited (boom) or too scared (crash). Not
because the company's performance improved or
declined, or because of any major deal or news —
but simply because investor mood changed.

Example:
• During the 2021 tech boom, Despite being loss-
making, Paytm’s ₹18,300 crore IPO in 2021 was
valued at ~₹1.4 lakh crore (40× P/S) due to
bullish investor sentiment — but as mood
shifted, the stock crashed 70%, exposing
sentiment-driven overvaluation.
[Link]
4. Overemphasis on a Single Multiple: Focusing
only on one ratio (e.g., P/E) gives a limited view of
the company’s value. It may miss key risks or
strengths.

Example:
Vodafone Idea might appear "cheap" on P/E or P/B,
but it has massive debt.
If you only look at P/E, you miss this financial risk.
So even look at EBITDA, which includes debt.

[Link]
5. Ignoring Qualitative Factors: Relative valuation is
quantitative — but intangibles matter too such as
brand value , innovations.

Example:
Apple vs. Xiaomi

In some years, Xiaomi may have comparable revenues

and margins to Apple.
But Apple trades at a much higher valuation. Why?
Strong brand, customer loyalty, global pricing power,
and tight ecosystem.
[Link]
 70

Potential pitfalls
• Relative valuation can result in inconsistent estimates of
value where key variables such as risk, growth and cash
flow potential are ignored.
• Depending on the market conditions, the relative valuation
might estimate the value of an asset can result in values
that are too high when the market is overvaluing
comparable firms or too low when it is undervaluing there
forms.
• Lack of transparency in the underlying assumptions of
Relative valuation can lead to manipulation of figures.

[Link]
Equity Valuation Multiple

Fundamental Determinants of the P/E Multiple

The Fundamental P/E Multiple is the theoretical price-to-
earnings ratio a company should have, based on its internal
financial performance and investor expectations.

It answers the question:

• "What should investors be willing to pay for ₹1 of earnings,
based on profitability, growth, and risk?"

[Link]
 Equity Valuation Multiples 72

Price-Earnings Ratio
= Market price per share/Earnings per share

It is the relationship between current market price and

expected EPS of the current year or the Expected EPS of the
following year. So price earning multiple can be expressed
as:
P0/E1

[Link]
 Fundamental Determinants of the P/E Multiple
Formula:
1−𝑏
𝑃/𝐸 =
𝑟 − (𝑅𝑂𝐸 × 𝑏)
Where:
b Plough back ratio (Retention how much of profit is reinvested
ratio)
1-b Dividend Payout Ratio how much of profit is paid to
shareholders
r Cost of Equity The return investors expect, given the
risk of the stock
ROE Return on Equity how efficiently the company makes profit
using shareholders' capital

g = ROE × b Sustainable Growth Rate the return expected by investors for

taking risk

[Link]
Fundamental Determinants of the P/E Multiple

In simple terms:

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑎𝑦𝑜𝑢𝑡 𝑅𝑎𝑡𝑖𝑜

P/E =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 – 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒

[Link]
 75

Alpha Company’s ROE is 18 percent and its cost of equity is 15

percent. Alpha’s dividend payout ratio is 0.4 and its plough
back ratio is 0.6. Calculate PE ratio of Alpha.

[Link]
 76

Given
Parameter Value
ROE 18% = 0.18
Cost of equity (r) 15% = 0.15
Dividend payout ratio 0.4
Plough back ratio (b) 0.6

[Link]
 77

1−𝑏
𝑃/𝐸 =
𝑟 − (𝑅𝑂𝐸 × 𝑏)

1− 0.6
𝑃/𝐸 =
0.15−(0.18×0.6)
0.4
=
0.15−(.108)

0.4
=
0.042

𝑃/𝐸 = 9.5238

[Link]
Fundamental Determinants of the P/E
Multiple

Example
NovaTech Ltd. has a Return on Equity of 17% ,
and its cost of equity (r) is 13 %. NovaTech’s
dividend payout ratio is 0.4, and its ploughback
ratio is 0.6.

Calculate P/E multiple from Fundamental point

of view

[Link]
 79

Given
Parameter Value
ROE 17% = 0.17
Cost of equity (r) 13% = 0.13
Dividend payout ratio 0.4
Plough back ratio (b) 0.6

[Link]
Fundamental Determinants of the
P/E Multiple

1−𝑏
𝑃/𝐸 =
𝑟 − (𝑅𝑂𝐸 × 𝑏)

0.4
𝑃/𝐸 = = 𝟏𝟒. 𝟐𝟗
0.13 − (0.17 × 0.6)

[Link]
 81

• Calculate the P/E muitple from a fundamental point of view for

Zenith FinCorp has a Return on Equity of 22 %, and its cost of equity
is 16 %. Zenith’s dividend payout ratio is 0.3, and its ploughback
ratio is 0.7.

[Link]
 82

Given

Parameter Value
ROE 22% = 0.22
Cost of equity (r) 16% = 0.16
Dividend payout ratio 0.3
Plough back ratio (b) 0.7

[Link]
 83

0.3
• 𝑃/𝐸 = = 50
0.16−(0.22×0.7)

Interpretation:
• Zenith has a very high ROE and high ploughback, leading to strong
growth. Since investors require a moderate return (r = 16%), the
stock justifies a high P/E of 50, meaning investors may be willing to
pay ₹50 for every ₹1 of earnings.

[Link]
 84

Reasons for using P/E multiple

• Earning power is a major driver of investment value and
hence EPS is extensively used in security valuation.

• Empirical research suggest that low P/E stocks tend to

outperform the market.

[Link]
 85

Price to Book value ratio

= Market price per share/book value per share

It is the relationship between current market price and

book value per share.

So price to book value multiple can be expressed as:

P0/B0

[Link]
 Fundamental Determinants of the P/B Multiple 86

The Fundamental P/B Multiple is the theoretical value of a company’s market price
relative to its book value, based on how efficiently it uses equity capital and the
risk-return tradeoff.

𝑅𝑂𝐸 (1 − 𝑏)
𝑃/𝐵 =
𝑟−𝑔
Where:
ROE = Return on Equity
b = Ploughback ratio (retention ratio)
1−b = Dividend payout ratio
r = Rate of return (cost of equity)
g= ROE × b = growth rate
[Link]
 87

Magna corporation’s ROE is 20 percent and its r is 16 percent.

Magna’s dividend payout ratio is 0.4 and its g is 12 percent.
Calculate price to book value ratio.

[Link]
 88

0.20 (0.4)
𝑃/𝐵 =
0.16 − 0.12

𝑃/𝐵 = 2.00

[Link]
 89

Phoenix Ltd. has the following financials:

• Return on Equity (ROE) = 18%
• Required Rate of Return (r) = 14%
• Dividend Payout Ratio = 0.35
• Expected Growth Rate (g) = 10%

• Calculate the Price-to-Book (P/B) ratio

[Link]
 90

𝑅𝑂𝐸 (1 − 𝑏)
𝑃/𝐵 =
𝑟−𝑔

[Link]
 91

0.18 × 0.35
𝑃/𝐵 =
0.14 − 0.10

0.063
𝑃/𝐵 =
0.04

Price-to-Book Ratio = 1.575

[Link]
 92

Reasons for using P/B multiple

Book value is a stock figure and it is generally positive, even
when EPS is negative.

Compared to EPS, book value per share is more stable. When

EPS is unusually high or low or highly volatile, P/B multiple
may be more meaningful than the P/E multiple.

[Link]
 93

Price to Sales ratio

= Market price per share/Sales Revenue value per share

It is the relationship between company’s current stock price and

revenue per share for the most recent twelve months.

So price to sales multiple can be expressed as:

P0/S0

[Link]
 94

Fundamental Determinants of the P/S Multiple

Formula
𝑁𝑃𝑀(1 + 𝑔)(1 − 𝑏)
𝑃/𝑆 =
𝑟−𝑔
Where:
Net Profit Margin = Net Income / Sales
(1 – b) = Dividend payout ratio
g = ROE × b = Growth rate
r = Rate of return (cost of equity)
[Link]
 95

Black limited has a NPM of 8 percent and a growth rate 12

percent. Black’s dividend payout ratio (1-b) is 0.3 and its
cost of equity is 0.16. Calculate Price to sales ratio.

[Link]
 96

0.08(1 + 0.12)(0.3)
𝑃/𝑆 =
0.16 − 0.12

𝑃/𝑆 = 0.67

[Link]
 97

Trinity Healthcare Ltd. has a Net Profit Margin of 15%,

a Return on Equity of 20%, and a cost of equity of 13%.
Trinity’s ploughback ratio is 0.4, and its dividend payout
ratio is 0.6. So, from a fundamental point of view,
Trinity’s P/S multiple is:

[Link]
 98

First all the values are given except g so calculate growth rate where

g=ROE×b

=0.20×0.4

=0.08

[Link]
 99

𝑃 0.15 1 + 0.08 1 − 0.4

=
𝑆 0.13 − 0.08
0.15 × 1.08 × 0.6
=
0.05
= 1.944
Trinity Healthcare Ltd.’s Fundamental P/S Multiple = 1.94

Interpretation:
Investors should be willing to pay ₹1.94 for every ₹1 of revenue
[Link]
 100

Reasons for using Price to Sales Multiple

• Compared to EPS and book value, sales are generally less
amenable to manipulation.
• Since Sales is always positive, P/S ratio can be used when
EPS is negative.
• Generally, sales are more stable than EPS, P/S multiple is
more stable compared to P/E multiple.

[Link]
 101

Modified Multiples – often used by industry practitioners

• P/E to growth multiple - known as PEG = (P/E)/g

• P/B to ROE multiples - known as Value ratio = (P/B)/ROE

• P/S to NPM multiple – known as PSM = (P/S)/NPM

Among these modified multiples, PEG is a favourite multiple of

financial analysts. PEG multiple of less than 1 suggests that the
stock is undervalued and a PEG multiple of more than 1 suggests
that the stock is overvalued.
[Link]
 102

The following information is available for Gamma Company.

• ROE = 20 percent
• Cost of Equity = 15 percent
• Dividend payout ratio = 50 percent
• Net profit margin = 10 percent.
• growth rate = 8 percent
Calculate the following for Gamma Company.
(a)P0/E1 (d) PEG
(b)P0/B0 (e) Value ratio
(c)P0/S0
[Link]
 103

Given Data
ROE = 20% = 0.20
Cost of Equity = 15% = 0.15
Dividend Payout Ratio = 50% → Retention Ratio b=0.5
Net Profit Margin (NPM) = 10% = 0.10
Growth rate g=8%=0.08

[Link]
 104

1−0.5
𝑃/𝐸 = = 10
0.15−(0.2×0.5)

[Link]
 105

0.20 (1−0.5)
𝑃/𝐵 = = 1.428
0.15−0.08

[Link]
 106

0.10(1+0.08)(1−0.5)
𝑃/𝑆 = = 0.771
0.15−0.08

[Link]
 107

10
𝑃𝐸𝐺 = = 125
0.08

[Link]
 108

1.428
Value Ratio = = 7.14
0.20

[Link]
 109

Answers: PE ratio =10 PEG = 125

Value ratio = 7.14 PB ratio = 1.428
PS ratio = 0.77

[Link]
 110

Numericals on Equity valuation multiples

Vidyut Company’s ROE is 20 percent and its r is 16 percent.
Vidyut’s dividend payout ratio is 0.3. What is Vidyut’s P/E
multiple from a fundamental point of view?

[Link]
 111

Given Data
Parameter Value
ROE 20% = 0.20
Cost of equity (r) 16% = 0.16
Dividend payout ratio 0.3 → so b = 1 - 0.3 = 0.7

[Link]
 112

[Link]
 113

White ltd as a NPM of 7 percent and a growth rate of 11

percent. White’s dividend payout ratio is 0.4 and its r is 0.15.
From a fundamental point of view what is White’s PS
multiple?

[Link]
 114

[Link]
 115

Delta Corporation’s ROE is 16 percent and its r is 14 percent.

Delta’s dividend payout multiple is 0.25 and its g is 12
percent. What is Delta’s P/B multiple from a fundamental
point of view?

[Link]
 116

[Link]
 117

Avinash limited’s ROE is 24 percent and its r is 18 percent.

Avinash’s dividend payout ratio is 0.3, growth rate is 8
percent. What is Avinash’s PEG multiple?

[Link]
 118

[Link]
 119

Cheran Corporation’s ROE is 15 percent and its r is 16 percent.

Cheran’s dividend payout ratio is 0.8 and its g is 3 percent.
What is Cheran’s value ratio?

[Link]
 120

[Link]
 121

MTM ltd has a NPM of 8 percent and a growth rate of 12

percent. MTM’s dividend payout multiple is 0.35 and its r is
16 percent. What is MTM’s PS of NPM multiple?

[Link]
 122

[Link]
 123

Fundamental Determinants of Enterprise Valuation

Enterprise Value (EV) represents the total value of a company

as a whole, considering both equity and debt holders. It is
the value an acquirer would pay to take over the entire
business, including its debt, minus cash.

“What is the total worth of the business from a fundamental

(cash flow and risk-based) perspective, regardless of its
capital structure?”

[Link]
 124

The following are the fundamental enterprise valuation multiple:

• EV/EBITDA multiple
• EV/EBIT multiple
• EV/FCFF multiple
• EV/BV multiple
• EV/Sales multiple

[Link]
 125

Fundamental Determinants of the EV/EBITDA Multiple

The EV/EBITDA multiple tells us how much investors are

willing to pay for each ₹1 of a company's operating cash
profit (before interest, taxes, depreciation, and
amortization).

“Is the business fairly valued based on its ability to generate

operating profits, before financing and accounting
adjustments?”

[Link]
 126

It’s especially useful for comparing companies with different capital structures or when net income is
distorted.

𝑅𝑂𝐼𝐶 − 𝑔
𝐸𝑉/𝐸𝐵𝐼𝐷𝑇𝐴 = × (1 − 𝐷𝐴)(1 − 𝑡)
𝑅𝑂𝐼𝐶 × 𝑊𝐴𝐶𝐶 − 𝑔
Where:
ROIC Return on Invested Capital = NOPAT (Net operating profit after tax) / Capital Invested
g Growth rate
WACC Weighted Average Cost of Capital
DA Depreciation & Amortisation as % of EBITDA
t Corporate Tax Rate

[Link]
 127

Example:

Delta Cement Ltd. has the following financial data:

• Return on Invested Capital (ROIC): 16%
• Weighted Average Cost of Capital (WACC): 11%
• Expected Growth Rate: 4%
• Depreciation and Amortization as a % of EBITDA (DA): 20%
• Corporate Tax Rate: 30%
What is Delta Cement Ltd.’s fundamental EV/EBITDA multiple?

[Link]
 128

0.16 − 0.04
𝐸𝑉/𝐸𝐵𝐼𝐷𝑇𝐴 = × (1 − 0.20)(1 − 0.30)
0.16 × 0.11 − 0.04

0.12
𝐸𝑉/𝐸𝐵𝐼𝐷𝑇𝐴 = × 0.8 × 0.7
0.16 × 0.07

0.12
𝐸𝑉/𝐸𝐵𝐼𝐷𝑇𝐴 = × 0.8 × 0.7
0.16 × 0.07

𝐸𝑉/𝐸𝐵𝐼𝐷𝑇𝐴 = 5.99

Delta Cement Ltd.’s Fundamental EV/EBITDA = 6.00

Interpretation:
Investors should be willing to pay 6 times EBITDA to buy the entire firm (debt + equity)
[Link]
 129

Fundamental Determinants of the EV/Sales Multiple

The EV/EBIT multiple tells us how much value the market
assigns to a company’s core operating profit before
interest and tax. It removes the effects of capital structure,
taxation strategies, and non-cash charges.

It Says:
“How much should investors pay for ₹1 of pre-interest, pre-
tax operating earnings, based on how much of it is
retained, returned, and how risky the business is?”

[Link]
 130

(1 − 𝑡)(1 − 𝑅𝑒𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒)

𝐸𝑉/𝐸𝐵𝐼𝑇 =
𝑊𝐴𝐶𝐶 − 𝑔
Where:
Symbol Meaning
t Tax rate
Reinvestment Rate Portion of NOPAT reinvested to sustain growth
WACC Weighted Average Cost of Capital
g Long-term sustainable growth rate
Note: EBIT × (1 – t) = NOPAT (Net operating profit after tax)
So this formula is derived from Enterprise DCF using NOPAT. [Link]
 131

Aster Mining Ltd. has the following business fundamentals:

• Corporate Tax Rate: 25%
• Reinvestment Rate: 50%
• Weighted Average Cost of Capital (WACC): 10%
• Long-term Growth Rate: 4%
What is the fundamental EV/EBIT multiple for Aster Mining
Ltd.?
[Link]
 132

(1 − 0.25)(1 − 0.50)
𝐸𝑉/𝐸𝐵𝐼𝑇 =
0.1 − 0.04

𝐸𝑉 0.375
= = 6.25
𝐸𝐵𝐼𝐷𝑇𝐴 0.06

Aster Mining Ltd.’s fundamental EV/EBIT multiple = 6.25

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 133

Fundamental Determinants of the EV/FCFF Multiple

The EV/FCFF multiple tells us how much the entire firm
(equity + debt holders) is worth relative to the free cash
flow it generates for all investors — i.e., the cash
available before interest and after tax and reinvestments.

It Says:
“How many rupees is the market paying for every ₹1 of true,
free cash generated by the business after taxes and
reinvestment?”

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𝐸𝑉 1
=
𝐹𝐶𝐹𝐹 𝑊𝐴𝐶𝐶 − 𝑔

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 135

Zentara Pharma Ltd. has stable operating performance and

reports say that their WACC is 9 percent and growth rate is 4
percent Based on this data, calculate Fundamental EV/FCFF
multiple.

𝐸𝑉 1
= = 20
𝐹𝐶𝐹𝐹 0.09 − 0.04

EV/FCFF = 20.00

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 136

Fundamental Determinants of the EV/BV Multiple

EV/BV (Enterprise Value to Book Value) compares a

company’s total market value (debt + equity) to its accounting
book value of total capital invested.
It tells you how much investors are willing to pay for each ₹1 of
book value deployed in the business.

It Says:
“How many rupees is the market paying for every ₹1 invested in
the assets of the business (net of depreciation)?”

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𝐸𝑉 𝑅𝑂𝐼𝐶 − 𝑔
=
𝐵𝑉 𝑊𝐴𝐶𝐶 − 𝑔

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 138

Aegis Motors Ltd. has a Return on Invested Capital (ROIC)

of 14%, a Weighted Average Cost of Capital (WACC) of 10%,
and expects its NOPAT to grow at a long-term rate of 4%.
Based on this information, calculate the fundamental
EV/BV (Enterprise Value to Book Value) multiple for Aegis
Motors Ltd.

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 139

𝐸𝑉 0.14 − 0.04
= = 1.67
𝐵𝑉 0.10 − 0.04

Aegis Motors Ltd.’s fundamental EV/BV multiple is 1.67.

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Fundamental Determinants of EV/Sales Multiple

The EV/Sales multiple shows how much investors are willing

to pay for each ₹1 of total revenue, based on the
firm’s profitability, growth, reinvestment needs, and cost of
capital.

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 141

Formula

𝐸𝑉 𝐴𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑜𝑝𝑒𝑟𝑡𝑎𝑡𝑖𝑛𝑔 𝑚𝑎𝑟𝑔𝑖𝑛 1 + 𝑔 (1 − 𝑅𝑒𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒)

=
𝑆𝑎𝑙𝑒𝑠 𝑊𝐴𝐶𝐶 − 𝑔

Where:

After-Tax Operating Margin EBIT × (1 – Tax Rate) ÷ Sales

g Sustainable growth rate

Reinvestment Rate Portion of NOPAT reinvested to support g

WACC Weighted Average Cost of Capital

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 142

Zylon Electronics Ltd. reports an after-tax operating margin

of 9%. The company’s long-term growth rate is 4%, and it
reinvests 45% of its after-tax operating income back into
the business. Its Weighted Average Cost of Capital (WACC)
is 10%. Based on this data, calculate the fundamental
EV/Sales multiple for Zylon Electronics Ltd.

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𝐸𝑉 0.09 1 + 0.04 × (1 − 0.45)

= = 0.858
𝑆𝑎𝑙𝑒𝑠 0.10 − 0.04

Zylon Electronics Ltd.’s fundamental EV/Sales multiple is

0.86 (rounded).

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 Exercise: Relative Valuation – Banking Sector 144

Estimate the fair value of Indus Bank using the relative valuation
approach. Use the following listed Indian banks as comparables:

Market Cap (₹ Net Profit (₹ Book Value of Sales / Total

Bank
million) million) Equity (₹ million) Income (₹ million)

HDFC Bank 12,00,000 60,000 2,20,000 3,00,000

ICICI Bank 8,50,000 45,000 1,80,000 2,50,000

Axis Bank 4,50,000 25,000 1,20,000 1,80,000

Kotak Mahindra 7,00,000 30,000 1,50,000 2,00,000

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 Exercise: Relative Valuation – Banking Sector 145

Indus Bank Financial Data

Metric Value (₹ million)

Net Profit 8,000
Book Value of Equity 35,000
Sales / Total Income 50,000

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 146

Question:
1. Compute P/E, P/B, and P/S multiples for each comparable
bank.
2. Calculate the average multiples of P/E, P/B, and P/S across
comparable banks.
3. Estimate the intrinsic value of Indus Bank using the
average multiples.
4. Compare the estimated intrinsic value with the market
price of ₹55,000 million and determine if Indus Bank is
overvalued or undervalued.

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Solution: Relative Valuation – Indus Bank

Step 1: Valuation Multiples of Comparable Banks

𝑀𝑎𝑟𝑘𝑒𝑡𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
𝑃/𝐸 =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
𝑃/𝐵 =
𝐵𝑜𝑜𝑘𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
𝑃/𝑆 =
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑆𝑎𝑙𝑒𝑠
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 148

P/E Ratios
Formula
Bank Market Cap (₹ mn) Net Profit (₹ mn) P/E
Substitution

HDFC Bank 12,00,000 60,000 12,00,000 ÷ 60,000 20

ICICI Bank 8,50,000 45,000 8,50,000 ÷ 45,000 18.89 ≈ 18.9

Axis Bank 4,50,000 25,000 4,50,000 ÷ 25,000 18

Kotak Mahindra 7,00,000 30,000 7,00,000 ÷ 30,000 23.33 ≈ 23.3

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 149

P/B Ratios
Market Cap (₹ Book Value (₹ Formula
Bank P/B
mn) mn) Substitution

12,00,000 ÷
HDFC Bank 12,00,000 2,20,000 5.45
2,20,000

8,50,000 ÷
ICICI Bank 8,50,000 1,80,000 4.72
1,80,000

4,50,000 ÷
Axis Bank 4,50,000 1,20,000 3.75
1,20,000

7,00,000 ÷
Kotak Mahindra 7,00,000 1,50,000 4.67
1,50,000

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 150

P/S Ratios
Market Cap (₹ Formula
Bank Sales (₹ mn) P/S
mn) Substitution

12,00,000 ÷
HDFC Bank 12,00,000 3,00,000 4.0
3,00,000

8,50,000 ÷
ICICI Bank 8,50,000 2,50,000 3.4
2,50,000

4,50,000 ÷
Axis Bank 4,50,000 1,80,000 2.5
1,80,000

7,00,000 ÷
Kotak Mahindra 7,00,000 2,00,000 3.5
2,00,000

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 151

Bank P/E Ratio P/B Ratio P/S Ratio

HDFC Bank 22.5 5.45 4.0

ICICI Bank 18.9 4.72 3.4

Axis Bank 11.8 3.75 2.5

Kotak Mahindra 17.2 4.67 3.5

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 152

Average Multiples of Comparable Banks

420 + 18.9 + 18 + 23.3

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃/𝐸 = = 480.2​= 20.05 ≈ 20
4

5.45 + 4.72 + 3.75 + 4.67

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃/𝐵 = = 418.59​= 4.65
4

4.0 + 3.4 + 2.5 + 3.5

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃/𝑆 = = 413.4​= 3.35
4

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Intrinsic Value of Indus Bank

Given Financials for Indus Bank

• Net Profit = ₹8,000 million

• Book Value = ₹35,000 million
• Sales = ₹50,000 million

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 154

Value Using P/E

𝐼𝑛𝑡𝑟𝑖𝑛𝑠𝑖𝑐 𝑉𝑎𝑙𝑢𝑒 (𝑃/𝐸) = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃/𝐸 × 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡

= 20 × 8,000 = ₹1,60,000 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

𝐼𝑛𝑡𝑟𝑖𝑛𝑠𝑖𝑐 𝑉𝑎𝑙𝑢𝑒(𝑃/𝐵) = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑃/𝐵 × 𝐵𝑜𝑜𝑘𝑉𝑎𝑙𝑢𝑒

= 4.65 × 35000 = ₹1,62,750 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

𝐼𝑛𝑡𝑟𝑖𝑛𝑠𝑖𝑐 𝑉𝑎𝑙𝑢𝑒(𝑃/𝑆) = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑃/𝑆 × 𝑆𝑎𝑙𝑒𝑠

= 3.35 × 50000 = ₹1,67,500 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

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1,60,000 + 1,62,750 + 1,67,500​

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑡𝑟𝑖𝑛𝑠𝑖𝑐 𝑉𝑎𝑙𝑢𝑒 =
3

4,90,250
=
3

≈ ₹1,63,417𝑚𝑖𝑙𝑙𝑖𝑜𝑛

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 156

Market Comparison
Estimated intrinsic value with the market price of ₹55,000 million

Market Price of Indus Bank = ₹55,000 million

Estimated Intrinsic Value = ₹1,63,417 million

Indus Bank is significantly undervalued.

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 157

Reconciling relative and discounted cash

flow valuations

Reconciling relative valuation (using multiples) and

discounted cash flow (DCF) valuation is key to becoming a
proficient analyst, as it moves you from simply calculating
numbers to truly understanding the drivers of value.

The core insight is that they are not different models but
different lenses focusing on the same underlying reality:
the value of a company's future cash flows.
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Reconciling the Two Approaches

Often, DCF and Relative Valuation give different results. Why?
Reasons for Differences:
1. Market Mispricing:
Relative valuation reflects current market sentiment.
If peers are overpriced/undervalued, your company’s relative valuation will be
biased.
2. Assumptions in DCF:
DCF depends heavily on forecasts of growth, margins, and discount rates.
Small changes → big differences.
3. Time Horizon:
DCF = long-term fundamentals.
Relative = short-term market perception.
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How to Reconcile
Step 1: Cross-check
If DCF shows much higher value than relative → market may be undervaluing the
sector OR your assumptions may be optimistic.
If DCF is lower → maybe market is over-enthusiastic OR you are too conservative.

Step 2: Use as Complements

DCF tells “what value should be”.
Relative tells “what value is acceptable to the market”.
Together, they form a valuation range.

Step 3: Adjust
Analysts often anchor on DCF but check if relative multiples support it.
If there is a huge gap → revise assumptions or dig into reasons (industry cycle,
regulations, risks).
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