This article examines the different kinds of multiples that may be used in business valuation.
Two major forms of valuation multiples exist:
- Multiples of Equity
- Multiples of Enterprise Value
There are two primary techniques of carrying out analysis using multiples:
- Comparable Study of Companies (“Comps”)
- Precedent Study of Transactions (“Precedents”)
Advantages and disadvantages of valuation multiples
For investors and corporations, using multiples as part of valuation analysis helps them make informed choices . This is particularly true as multiples can be used to provide information on the financial position of an organisation. In addition, multiples are important because they consider crucial investment judgement decisions. Lastly, for most analysts, the simplicity of multiples makes them convenient to use.
However, because of the way multiples simplify complex knowledge into only a single value, this simplicity can often be considered a disadvantage. This simplification may lead to misinterpretation and makes it almost impossible to break down the impact of different variables on the multiple.
Multiples reflect a single instance of the state of a business, rather than giving any description of what happens over a given time frame. As a result, they cannot easily show how a business develops or advances. In addition, multiples represent short-term rather than long-term data. The resulting values therefore may only be appropriate for use in the short‑term and not in the longer future.
#1 Equity multiples
Investment decisions use multiples of equity, particularly when investor(s) want noncontrolling (i.e. minority) positions in companies. The following list details some common equity multiples used as part of company valuations:
- P/E Ratio: the most widely used equity multiple; data is easily accessible and measured as a proportion of share price to earnings per share.
- Price/Book Ratio: this multiple is helpful if assets primarily drive profits; it is measured as the share price to book value per share proportion.
- Dividend Yield: this multiple can be used for to compare cash returns versus investment types and is measured as the proportion of dividend per share to share price.
- Price/Sales: this type of multiple is employed for businesses that are trading at a loss and can be used for quick estimates of company value. This is measured as the proportion of share price to sales (revenue) per share
It is important to note that financial analyst(s) must keep in mind that businesses can have differing amounts of debt and this may influence equity multiples.
#2 Enterprise Value (EV) multiples?
Multiples of enterprise value are appropriate multiples to consider when making decisions on mergers and/or acquisitions. The following list highlights some common multiples of enterprise value used in company valuations:
- EV/Revenue: slightly influenced by accounting differences; measured as the enterprise value to sales or revenue proportion.
- EV/EBITDAR: frequently used in in the hotel and transport industry; measured as enterprise value to EBITAR and Rental Costs proportions.
- EV/EBITDA: most commonly used multiple of enterprise value, EBITDA can be used in place of free cash flows; measured as the proportion of enterprise value to enterprise value or EBITDA.
- EV/Invested Capital: this multiple is used for capital-intensive industries; measured as the enterprise value to invested capital proportion.
Obviously, other multiples of equity and enterprise value exist. Here, we are only including the most commonly used ones. A more thorough understanding of these and other multiples can help analysts when making financial analyses.
Methods of using multiples
It is possible to analyse all of the above metrics using two common approaches to company valuation multiples:
- Comparable Business Analysis – this approach analyses public businesses that are similar to the one being valued. For each business, an analyst will compile share values, market capitalization, capital structure, sales, EBITDA and profits.
- Previous M&A Transactions – This approach analyses previous past mergers and acquisitions (M&A) for businesses in the same market that can be used as a point of comparison for the business being valued.
Contact us if you would like to know more about the valuation multiples that apply to your business.