Comparative Analysis of Same Sized IT Companies Based On Their Business Valuation

Comparative Analysis of same sized IT companies based on their business valuation
Introduction:
Equity Research is the area which deals with the live economy. Equity Research is a field that has evolved and transformed the Financial Sector over the Past few decades. Equity Research helps the investor to know about the value, risk &volatility of the covered security, and thus assist investors to decide whether to buy, hold, sell, sell short, or simply avoid the security in question. In the process of research, analysts require high level of real time as well as historical data, so as to evaluate and analyze different aspects of the covered security. With Technology, the availability of data is no matter today but there are tools and models needed to analyze the data.
Equity Research provides unique perspectives supported by industry-based intelligence and thorough study of fundamental vis a vis technical tools. Equity Research is aimed at identifying the opportunities for wealth creation and arriving at the right investment decisions.
An equity analyst tries to identify undervalued or overvalued stocks through both his/ her expertise and by use of available research tools. Broadly there are 2 methods to analyze stock (i) Fundamental analysis and (ii) Technical analysis
Fundamental Analysis involves evaluating companies value by evaluating companies business model, the sales and profit growth, return on equity, growth in earnings per share etc., value so arrived at is then compared with the ongoing market prices. If it is found that the market price is significantly lower than that, then it is advisable to buy the shares of that Company expecting that market will revalue the shares in future thereby offering capital appreciation in the value of the shares. Technical Analysis on the other hand focuses on the market price movement of the share in the past mainly through graphs or price and traded volumes in order to judge further performance.
Following segments would be included in equity research (Fundamentals): Valuation Techniques- Interpreting Financial Statements such as Income Statement, Balance Sheet, Cash flow Statement, Ratio Analysis, would be covered here. Also the participants would be able to understand the Forecasting and growth rate assumptions, the company analysis, the forecasting exercises and the growth rate assumptions are studied taking the practical case studies. Valuation Approaches-Dividend Discount Models such as Gordon Constant Growth Model, Two-Stage growth model, Multi-Stage growth model, Free Cash Flow Models, Free Cash Flow to Firm, Free Cash Flow to Equity holders. Capital Market Theory-Capital Asset Pricing Model, Cost of Equity, Cost of Preference Shares, Cost of Debt, WACC (Weighted Average Cost of Capital)
Valuation
Valuation is the art/science of determining what a security or asset is worth. Sometimes we can observe a market value for a security and we are interested in assessing whether it is over or under valued. Sometimes there is no market value and we are trying to construct one for argaining or transaction purposes. The value of a security or asset is going to depend crucially on the asset pricing model we choose. The most common kind of valuation problem is equity valuation. Business valuation refers to estimation of business value. Valuation is just to estimate What (cash flow) + When (time period) + How (risk), we receive in future out of a subject property.
The value of Business enterprise containing more than one stream is generally more than just a sum total of values of every such stream. So, the business value is affected by tangible as well as non-tangible factors. The purpose for conducting valuations will determine informational needs. Each purpose adds or deletes bits of information that may be important to the overall valuation project. Information must be collected, analyzed, and included. A companys historical financial statements generally provide the most reliable information for estimating future performance and risk assessment. Audited financial statements are preferred. In other cases, the analyst may have to rely on income tax returns or internally generated financial statements, the quality of which may be suspect for purposes of proper financial statement analysis. If the historical information is unreliable, the special care should be taken to disclose the facts and degree of responsibility assumed based on financial statements.
The process Financial statement adjustments to normalize financial position and performance Common size balance sheets and income statements Ratio analysis: asset management, leverage, liquidity, and profitability Comparison to industry financial data Analysis of trends and unusual items The research into valuation models and metrics in finance is surprisingly spotty, with some aspects of valuation being deeply analyzed and others, such as how best to estimate cash flows and reconciling different versions of models, not receiving the attention that they deserve.
In broadest possible terms, there are three approaches to value any asset, business or Business interest: 1. The asset approach 2. The income approach 3. The market approach (Relative valuation approach)
1. THE ASSET APPROACH

The Asset-based Approach involves methods of determining a companys value by analyzing the value of a companys assets. This valuation approach often serves as a valuation floor since most companies have greater value as a going concern than they would if liquidated, i.e., the present value of future cash flows generated by the assets usually far exceed the liquidation value of those assets. This difference between the asset value and going concern value is commonly referred to as goodwill.
2. THE INCOME APPROACH

The concept is to value a business or asset based on its earning capacity. Earnings is a final crux of the business activity. Earnings are linked with all other fundamentals of the business like growth, capital requirements, risk involvement or uncertainty, etc. and so, valuation of business based on its earning capacity can be a better proxy. The Income Approach derives an estimation of value based on the sum of the present value of expected economic benefits associated with the asset or business
3.THE MARKET APPROACH (RELATIVE VALUATION APPROACH)

Market value is also known as extrinsic value. The basis of market value is the assumption that if comparable Asset (or property) has fetched a certain price, then the subject asset (or property) will realize a price something near to it.
Commonly used Multiples

Business can be valued based on the multiples like - Earning multiples- (PAT, EBITDA, EBIT etc) - Book value (or replacement value) multiple - Revenue Multiples - Business specific Multiple
Price to Earnings (P/E) Multiple

When it comes to valuing equity or ownership, the price/earnings ratio is one of the oldest and most frequently used metrics. P/E Ratio = Market Value (OR Price) / Earnings
Price to Book value (OR replacement value) multiple

This is also a widely used multiple to compare the equity value of the value of firm. The market capitalization is divided by the book value of capital to determine a multiple. P/BV Ratio = Market Value / Book Value of Capital or Owners fund
Price to Revenue multiple

Both earnings and book value are accounting measures and are determined by accounting rules and principles. An alternative approach, which is far less affected by accounting choices, is to use the ratio of the value of a business to the revenues it generates
P/R Ratio = Market Value / Revenue
Business Specific Multiple

While earnings, book value and revenue multiples are multiples that can be computed for firms in any sector and across the entire market, there are some multiples that are specific to a sector. Like, valuing a call centre based on per seat criteria or a steel manufacturing business on the basis of per ton production. Steps to determine a value under market approach 1. Selection of similar public companies and transactions 2. Financial analysis and comparison 3. Selection and calculation of valuation multiples 4. Application to the company being valued 5. Final adjustments
Objective of the study

The objective is to do complete valuation of the three same sized IT companies. Based on the past data estimate the future position of the companies & also do the comparative analysis of the companies that would help investor as well as the brokers to take the decision of investing in which company.
Methodology
I had started with the compilation of literatures and materials available on valuation. Valuation of business requires major consideration for financial and economic theories and of course, the business characteristics and valuation fundaments are indifferent to the region differentiation. In order to do valuation of the companies, Financials Statements (Balance Sheet, Profit & Loss A/C, and Cash flow Statement) are required so these data can be collected from Annual reports of these Companies. Apart from this to collect quarterly data of the companies that can be collected from the quarterly reports as well as from the press release of the companies.
Schedule
Date From 15 feb to 22 feb From 23 feb to 25 feb Particulars Deciding the company & collecting the data Making the valuation model in excel & as per data doing valuation of the companies

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Comparative Analysis of same sized IT companies based on their business valuation

1. THE ASSET APPROACH

2. THE INCOME APPROACH

3.THE MARKET APPROACH (RELATIVE VALUATION APPROACH)

Commonly used Multiples

Price to Earnings (P/E) Multiple

Price to Book value (OR replacement value) multiple

Price to Revenue multiple

P/R Ratio = Market Value / Revenue

Business Specific Multiple

Objective of the study

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