Build a comparable companies table and write a two-page memo that pulls together your work from modules 6 to 9.
Open your model, add a new tab and name it Comps. Before you fill it in, have three things ready: your model and valuation tab, your reading log from lesson 6.8, Build an annual report reading log for one company, and the peer list and classification from lessons 9.3, Choose a peer group that is really comparable, and 9.7, Classify a stock before you judge its multiple. If your peer data is ready, the whole exercise takes about forty-five minutes.
The tab supports an investment memo, a document that tells a reader what you think, why, and what would change your mind. Fund analysts write one before a position goes into a portfolio. Your one-page valuation note from lesson 8.8, Value your modelled company with a DCF, tells you what one method says. The memo goes further and uses every tool from modules 6 to 9. You build the comps tab first and write the memo after it.
A comps tab compares your company with at least five peers on multiples, growth, margin and classification, and ends with a median row. Give your company one row and each peer one row. The columns are: date and source of prices, market value, net debt, enterprise value, P/E, EV/EBITDA, P/B, free cash flow yield, five-year revenue growth, operating margin, and the three classification labels from lesson 9.7.
Every figure must be on the same basis. That means the same kind of earnings, leases treated the same way, and financial years calendarised where they differ, as shown in lesson 9.3. Below the peers, add a median row. Below that, add a row with your company's own figures so you can compare the two directly.
Marcus is an analyst working on Larkspur Precision, a company with a parts business and a coatings business that it bought. His peer medians, in made-up figures, come out at a P/E of 13 times earnings, EV/EBITDA of 7.5 times, P/B of 1.9 times book, a free cash flow yield of 5.0%, growth of 9% a year and an operating margin of 13%. Larkspur's own row shows a P/E of 11.4, EV/EBITDA of 6.25, P/B of 1.7, a free cash flow yield of 5.8%, growth of about 7.5% a year and a margin of 14%.
Apply each median multiple to your company's own figures and work back to a value per share. For enterprise value multiples such as EV/EBITDA, subtract net debt from enterprise value before you divide by the share count.
For Larkspur, 13 times underlying earnings of 14 cents gives about S$1.82 a share. On EV/EBITDA, 7.5 times EBITDA of S$80 million gives an enterprise value of S$600 million; less net debt of S$20 million, that is about S$1.93 a share. On P/B, 1.9 times book equity of S$285 million gives about S$1.81 a share. On free cash flow, a 5.0% yield on free cash flow of S$28 million makes the equity worth S$560 million, about S$1.87 a share. The comps range is about S$1.81 to S$1.93.
Put the comps values in one block beside your DCF results: the central DCF range, the bear and bull scenarios, the implied growth from your reverse DCF, and today's price. Marcus's block reads: comps S$1.81 to S$1.93; DCF central range S$1.58 to S$2.08; bear S$1.05; bull S$2.40; price S$1.60; reverse DCF implied growth about 1%, against 7.5% in the past.
Check the block before you write anything. If comps and DCF disagree by more than about a third, one of them is probably wrong, so go back over your peers and your terminal value. In Marcus's case the methods agree that the price sits at the low end of reasonable values. They also agree that a downturn would take value well below the price.
Valuation tells you what a business is worth if your forecast holds. The quality section tells the reader how much to trust that forecast. It covers three things: the moat from lesson 9.4, Competitive position: Five Forces and moats, tested against the numbers; capital allocation from lesson 9.5, Capital allocation: dividends, buybacks, acquisitions and reinvestment; and management incentives and ownership from lesson 6.5, Management incentives, ownership and related-party deals.
Marcus finds Larkspur's moat real but narrow. Return on capital was 15.6% in FY5 against a 9% cost of capital, and about 11% in the FY4 downturn, still above the cost of capital. The parts business earns about 19% and coatings earns almost nothing. Reinvestment has created value, but the coatings purchase lost about S$18 million of value even in its best year. Management pay rewards revenue and EBITDA, which would not stop another deal like that one. The family owns 55% and the chief executive owns 2%, so they feel the share price. There is one related-party lease, and it is small.
The memo is no more than two pages, under plain headings, in this order:
The view: your value range, today's price, and one sentence on what the price assumes. The business in two sentences, taken from your reading log. Valuation, with DCF and comps side by side. Quality: moat, capital allocation, incentives. Risks, ranked by how much value each would destroy. What would prove you wrong.
Portfolio managers read the last section first, and it is what makes a memo useful. Each item there must be an observable wrong-sign: something a future results announcement, filing or price could show, with a threshold. Write at least three. A vague statement that things get worse is a bad example because nobody can check it. "The top two customers fall below 50% of revenue with no new customer replacing them" is a good one.
Marcus's memo opens with the price of S$1.60, a DCF value of about S$1.60 to S$2.10 and peer medians of about S$1.81 to S$1.93. The price assumes about 1% growth against 7.5% over the last cycle, so the market is pricing either a downturn or the loss of customer volume. Quality is decent: a narrow moat in parts, one poor acquisition, and incentives that reward size. In the bear case, a downturn starting next year, Larkspur is worth about S$1.05, so there is no margin of safety against that outcome. He would be wrong if the top two customers fall below 50% of revenue with no replacement, if operating margin falls below 12% in a year when revenue held up, or if the board spends its growing cash on another acquisition outside the parts business.
The memo does not say buy, sell or hold. How much of a portfolio a holding deserves is a sizing question, and module 11 answers it with written rules.
When you finish, you should have a Comps tab with at least five peers on four multiples plus growth and margin, with sources and dates, a median row, and implied values beside the DCF range. You should also have a memo of no more than two pages with a value range, what the price implies, a quality section covering moat, capital allocation and incentives, ranked risks, and at least three observable wrong-signs.
Now build the tab and write the memo for your own company.
Build the comps tab. Then write a two-page memo that gives your value range, compares it with today's price and says what evidence would show you are wrong.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).