What is multiples analysis?
The multiples analysis is a valuation technique that determines the different market values for comparable companies. Thus, the assumption is a certain ratio is applicable and can be interpreted across different companies.
Despite being the oldest technique in valuation, the multiples analysis is still used. However, it is now being overshadowed by the discounted cash flow analysis and other market-based methods in valuation.
What are the steps to conduct a multiples analysis?
The first step in conducting a multiples analysis is to identify companies or assets that can be compared with each other. The next step is to determine the market value for each company. This is followed by the creation of valuation multiples through the process of standardization. Under this process, each market value is to be converted into a standardized value that is relative to a key statistic. Finally, the valuation multiple is applied to a key statistic in order to accommodate variation between the group of assets being compared.
What are the multiples used in a multiples analysis?
Multiples used in multiples analysis can be classified as enterprise value multiples or equity multiples. The most common equity multiple is the P/E ratio or the price per earnings ratio while the most common enterprise value multiple is the EV/Sales or the enterprise value per net sales ratio.
Equity multiples are often used in equity valuation. Investors are more familiar with these than the enterprise value multiples. On the other hand, enterprise value multiples are more comprehensive and have more available multiples to be used. These multiples allow analysts to focus on key statistics that minimize differences in accounting policies.
What are the advantages and disadvantages of the multiples analysis?
The simplicity of using multiples in valuation is both an advantage and disadvantage. It is a disadvantage because it simplifies complex information into just a single value or a series of values. This effectively disregards other factors that affect a company’s intrinsic value such as growth or decline. However, this simplicity allows a financial analyst to make quick computations to assess a company’s value.
Meanwhile, using the multiples analysis can also lead to difficulty in comparing companies or assets. This is because companies, even when they seem to have identical business operations, may have different accounting policies. As such, multiples may be easily misinterpreted and comparisons are not as conclusive. They need to be adjusted for different accounting policies.
Multiples analysis also disregards the future point in time – it is static. It only considers the company’s position for a certain time period and fails to include the company’s growth in its business operations. However, there are certain multiples that look at “leading” ratios.
More valuation resources from CFI
We hope this guide to valuation multiples as been a helpful introduction. To keep learning more about valuation methods we’ve compiled several guides that build on what you’ve learned here. To keep learning please see: