Valuation Metrics

This is the densest section in the unit. Every metric below feeds the comparable-company, precedent-transaction, DCF, and accretion/dilution analyses bankers build for every deal.

What Is Deal Math and Per-Share Effects?

The starting layer is the per-share and equity-level figures most stock screens display.

• Accretion / dilution: Whether a transaction (typically a merger) raises or lowers the acquirer's EPS post-deal
• Price per share: Market price of one common share
• EPS (revisited): Net income divided by weighted average diluted shares outstanding
• Equity value: Market capitalization, computed as price per share times fully diluted shares outstanding
• Market cap: Total equity market value of common stock
• Sum-of-the-parts analysis: Value each business segment separately, then aggregate to get total firm value (useful for conglomerates and holding companies)

Think of it this way: Equity value is what the market is willing to pay for the common stock. It ignores debt entirely. The next layer of metrics fixes that gap.

What Are Enterprise Value and EV Multiples?

Enterprise value (EV) captures the full capital structure, not just common equity. It is the standard reference value for M&A purchase prices and for comparing companies with different debt loads.

Why each addition and subtraction:

• Add debt because a buyer of the whole business assumes the debt
• Add preferred stock because preferred holders have a senior claim on assets
• Add minority interest because EV captures the value of consolidated subsidiaries, even the portion not owned by the parent
• Subtract cash because a buyer would use the cash to pay down debt at close (cash net offsets debt)

Exam Tip: Gotchas

• EV vs equity value. EV adds debt, preferred, and minority interest and subtracts cash because EV represents the value of the whole capital structure. M&A purchase prices are typically quoted as EV. Public offering proceeds and market caps are equity value.
• EV subtracts cash; net debt also subtracts cash. When you see "EV = market cap + net debt + preferred + minority interest," that's the same formula just rearranged. Net debt has the cash subtraction baked in.

What Are the Equity Multiples?

Equity multiples compare market price (per share) to a per-share fundamental measure.

Exam Tip: Gotchas

• Stated vs tangible book value (P/B). Stated book includes goodwill and intangibles; tangible book strips them out. For acquirers that pay big premiums (lots of goodwill on the books), tangible P/B is the tougher number.
• Last twelve months (LTM) vs forward multiples. LTM is historical and certain. Forward P/E and forward EV/EBITDA depend on projections; different consensus estimates produce different multiples on the same stock at the same price.

What Are the Yield and Payout Metrics?

The yield bucket compares per-share return to per-share price.

• Dividend yield: Annual dividend / price per share
• Dividend payout ratio: Dividends / net income (the percentage of earnings paid out)
• Earnings yield: EPS / price per share (the inverse of P/E)

Earnings yield is useful for comparing a stock's return to a bond yield: a 5% earnings yield is roughly comparable to a 5% bond yield, with the stock holder taking equity risk in exchange for growth potential.

What Growth and Period Conventions Appear on the Exam?

Three conventions appear in every comp table and DCF model.

• CAGR (compound annual growth rate): The geometric, period-over-period growth rate; smooths out year-to-year noise. CAGR = (ending value / beginning value)^(1 / number of years) − 1
• LTM (last twelve months or trailing twelve months): Rolling actual results that may not match a calendar or fiscal year
• Normalized (operating) earnings: Earnings adjusted to remove non-recurring effects; reflects steady-state run rate

LTM is the standard for trading comps because it uses the most recent actual results, regardless of fiscal-year-end timing.

How Does Discounted Cash-Flow Valuation Work?

The DCF family of metrics computes intrinsic value from projected future cash flows.

• DCF (discounted cash flow): Intrinsic value equals the present value of projected free cash flows discounted at the weighted average cost of capital (WACC), plus a terminal value capturing all cash flows after the projection period
• DDM (dividend discount model): Equity value equals the present value of expected future dividends
• NPV (net present value): Present value of cash inflows minus present value of cash outflows; accept a project if NPV is greater than zero
• IRR (internal rate of return): The discount rate that sets NPV to zero; accept a project if IRR exceeds the hurdle rate or WACC
• Economic profit: Net operating profit after tax (NOPAT) minus (invested capital times WACC); a positive number means the company is earning above its cost of capital
• Cost of capital: The blended required return demanded by capital providers

The WACC formula:

Where:

• $E/V$ = equity weight in the capital structure (equity divided by total equity plus debt)
• $D/V$ = debt weight in the capital structure
• $R_e$ = cost of equity (the return equity investors require)
• $R_d$ = cost of debt (the yield to maturity on the company's debt)
• $T$ = corporate tax rate
• $(1 - T)$ = the tax shield adjustment; interest is tax-deductible, so the after-tax cost of debt is what matters

Terminal value methods in a DCF:

Terminal value is a large part of total DCF value, so the choice of method materially affects the answer.

Exam Tip: Gotchas

• The tax shield reduces the cost of debt, not the cost of equity. Interest is tax-deductible; dividends are not. That's why the WACC formula multiplies the debt component by (1 minus tax rate) and leaves the equity component alone.
• IRR is the discount rate that sets NPV to zero. The accept/reject signal is: accept if IRR is greater than the hurdle rate (or WACC); reject if it's lower.
• DDM only works for dividend-paying companies. A high-growth company that retains all earnings can't be valued with a dividend discount model. Use a DCF on free cash flows instead.

What Are the Risk Inputs?

The risk inputs that feed cost of equity (and therefore WACC) are tested by name.

• Stock volatility: Standard deviation of price returns; the dispersion of return outcomes
• Beta: Systematic risk relative to the broad market; the slope of the stock's return regressed against the market return

Beta is the input that connects a company's risk profile to its cost of equity through the capital asset pricing model (CAPM).

How Does Accretion/Dilution Math Work?

Accretion/dilution analysis tells the acquirer whether a transaction raises or lowers pro forma EPS.

Stock-funded acquisition: Accretive if the target's earnings yield exceeds the acquirer's cost of using its own stock. As a quick rule of thumb: in an all-stock deal, the transaction is accretive if the target's P/E is lower than the acquirer's P/E.

Cash-funded acquisition: Accretive if the target's after-tax earnings exceed the after-tax interest cost of the debt used to fund the deal.

Think of it this way: The acquirer is "buying earnings." If the cost of the currency used to pay (stock or debt) is cheaper than the earnings being bought, EPS goes up. If it's more expensive, EPS goes down.

Exam Tip: Gotchas

• Accretion/dilution direction. A stock-funded deal is accretive when target P/E is LOWER than acquirer P/E (the acquirer is paying with relatively expensive currency to buy relatively cheap earnings). A cash-funded deal is accretive when the target's after-tax earnings yield exceeds the after-tax cost of debt.

What Should You Check on Exam Day?

• Compute Enterprise Value: market cap plus total debt, preferred stock, and minority interest, minus cash.
• Distinguish stated book value (includes goodwill and intangibles) from tangible book value (strips them out).
• Recall accretion/dilution direction: stock-funded deals are accretive when target P/E is lower than acquirer P/E; cash-funded deals are accretive when after-tax target earnings exceed the after-tax cost of the acquisition debt.
• Remember WACC applies the (1 minus tax rate) shield only to the cost of debt, never to the cost of equity.
• Confirm terminal value is a large share of total DCF value, so the terminal-value method drives the result.