VALUATION MULTIPLES FROM FIRST PRINCIPLES
• There is a lot of misunderstanding & misapplication of valuation multiples, both among retail and institutional investors
• Get clarity on this by revisiting the 1st principles here
Prerequisites:
• Finance 101 knowledge
THREAD 👇
KEY CONCEPT: VALUE STAKEHOLDERS
"Beauty is in the eye of the beholder"
"Value is in the rights of the user"
So it is important to ask, "VALUE TO WHOM?"
There are 2 main types of stakeholders in a company:
1. Equity holders
2. Lenders
KEY CONCEPTS: MCAP and EV
Value to equity holders is represented by the Market Capitalization (MCAP).
Value to equity AND lenders is represented by Enterprise Value (EV):
Notice how you can convert between Enterprise Value to Market Capitalization easily
KEY CONCEPT: FCFF
Free cash flow to the firm (FCFF) = Cash flows available for distribution to both equity holders AND lenders
Related:
Free cash flow to equity (FCFE) = Cash flows available for distribution to ONLY the equity holders
We will focus on EV & FCFF in the examples
KEY CONCEPT: FUNDAMENTAL VALUE OF A COMPANY
The fundamental/intrinsic value of a company is equal to the present value of the cash flows it would generate in future.
The growing perpetuity expression of value is shown below:
