Value Drivers
What is a Value Driver?
Value drivers are factors that drive a company’s performance, growth and hence its value. An appropriate value driver should be used in order to best understand the business and its valuation.
A value number is often compared to a relevant value driver to build a range of multiples. An analyst will use these multiples to produce a range of valuations.
Multiple = Value / Value Driver
The value driver sits as the denominator in the multiple equation. It is usually an earnings number which drives the company’s value. It is very important that this value number is consistent with the value driver used.
Value drivers can also be “non-financial” items if very specific to the industry in question.
Key Learning Points
- A value driver is a factor that drives a company’s performance, growth and value
- A value number is compared to a value driver to produce multiples. These multiples value a company (asset) based on how similar companies trade.
- Revenue, EBITDA, EBIT and EPS are the most common drivers of value
- When calculating multiples, a like for like comparison is always appropriate – the value driver must match the valuation and all comparables in the set should be calculated on the same basis
Common Value Drivers:
It is important to select a suitable value driver when trying to understand and value a business.
Revenues
Revenues is a good value driver for startups or companies with depressed earnings or companies that are loss making. These companies are in a high growth stage and are reinvesting a significant proportion of their earnings back into the business. Revenues is therefore used when EBIT or other profit numbers cannot be used. As revenue is unaffected by a company’s capital structure it is a driver of enterprise value.
EBITDA
EBITDA is the recurring operating profits before the impact of depreciation and amortization. Companies within a similar industry can make different judgements about the lives of fixed assets and intangibles, resulting in differences in depreciation and amortization expenses. There is no difference in the economic cost incurred by the business, but they will report a different expense figure for the reporting year based on their chosen accounting policy. EBITDA is useful for comparing companies with large asset bases and focuses on the earnings generated by the core business. As EBITDA is unaffected by a company’s capital structure it is a driver of enterprise value.
EBIT
Earnings Before Interest and Taxes (EBIT) is the recurring operating profit. It is based on the operational profitability and a driver of enterprise value.
Earnings Per Share (EPS):
Earnings per share (EPS) is the profit attributable to common shareholders on a per share basis. It is post capital structure meaning all expenses related to providers of capital (and government in the form of taxes) are included. It is a driver of equity value and expressed on a per share basis as the P/E multiple.
Impact of Capital Structure
Capital structure affects the process of matching a value with a value driver. Enterprise value is the value of the core business before any financial assets and the deduction of debt. Therefore, EV is compared with an operational value driver such as EBIT as it is before all debt, equity, and tax expenses. Interest is a financing expense and is not associated to the operations of a business. However, equity value should be compared with a driver like EPS, which is post capital structure. EPS is the residual value attributable to the shareholders after all expense are deducted from the operational income.
Sector Specific Value Drivers
Value drivers can also be non-financial depending on the sector. Access lines, fiber miles or subscriber numbers might be used in telecommunications or square footage for retail and real estate. EBITDAR (earnings before interest, taxes, depreciation, amortization and rent expense) is used for casinos and restaurants while EBITDA (earnings before interest, taxes, depreciation, amortization and exploration expense) is used for oil and gas businesses.