Corporate Valuation Using Multiples

Introduction

Corporate Valuation is the process of determining an objective value for a company or business. It is an important element of the financial decision-making process and forms the basis for investments, mergers and acquisitions, liquidations and refinancing options. There are several different methods used for corporate valuation and each one seeks to measure the overall value of a business.

The most common methods used for corporate valuation include discounted cash flow (DCF) analysis, asset-based valuation, and comparable company analysis.

The multiples valuation technique is a variation of the comparable company analysis method which takes the relative market values of publicly-traded companies and applies them to the valuation of private ones. This technique is used to compare businesses of similar size and within the same industry.

Benefits of Valuing a Business Using Multiples

Valuing a business using multiples is one of the most reliable methods used by many experts. It has a number of benefits including accuracy, speed, cost and comparability.

Accuracy

One of the main advantages of using multiples to value a business is accuracy. Multiples provide an indication of the actual market value of a company, as it follows a general market trend. This ensures that the estimated value of the business is realistic and based on current market factors. It also helps to avoid over valuing or undervaluing a business.

Speed

Valuing a business using multiples is much faster than traditional methods of evaluation. With multiples, it is possible to come up with an accurate value of a business within a short space of time. This is because the process is quick and straightforward and requires less data than other methods.

Cost

Valuing a business with multiples is a cost-effective way to estimate the value of a business. This is because it is constantly updated to reflect changes in the market, which means that accurate values can be obtained without having to incur the cost of professional services.

Comparability

Another major benefit of using multiples to value a business is that it can be used to compare different businesses in the same industry. This helps to give an indication of the performance of a particular business in comparison to its competitors. It also helps investors to identify the best businesses to invest in. By comparing different multiples, it is possible to identify the most attractive investment opportunities.

Disadvantages of Valuing a Business Using Multiples

The practice of valuing a business using multiples, such as transactional comparables, industry averages, or past performance can have its drawbacks. Understanding the risks and pitfalls is an important part of the analysis.

Difficulty of Selecting the Appropriate Multiple

Selecting an appropriate multiple that accurately values a business can be difficult. Multiples may be different, not just between industries, but also within the same industry for different businesses. Variations in such factors as size, market or geography, product or service type, and most importantly, profitability and perceived risk can all significantly affect the multiples used in the valuations.

Risk of Using Non-Comparable Multiples

Often, the easiest approach to valuation is to use similar or comparable companies as benchmarks by employing public or private transaction multiples. However, to be reliable, these multiples must accurately reflect the similarities between the businesses. If the comparison companies are not truly comparable, the results of the valuation could be vastly different than when using more reliable connectors.

Use of Outdated Multiples

The worlds of finance and business change rapidly and multiples used in valuations may quickly become outdated. Companies can be significantly affected by a variety of often difficult to predict external factors, such as macro-economic changes, competitors entering the market, technology leaps, and regulatory changes.

Investors and business owners must constantly assess the potential impacts that changes to their own and other businesses have on the multiples they use in their valuations.

Types of Multiples Used for Valuation

Valuation multiples are commonly used to value businesses. The most common valuation multiples used in the corporate finance world include Price-to-Earnings (P/E), Enterprise Value to EBITDA (EV/EBITDA), Return on Investment (ROI), Price to Earnings to Growth (PEG), and Price to Revenue (P/R).

Price-to-Earnings (P/E)

The Price/Earnings (P/E) ratio is a widely used measure of value. It is computed by dividing a company's market capitalization by its earnings per share. The P/E ratio can give investors an indication of the company's expected growth in the future as well as gauge the company’s valuation relative to its industry peers. A high P/E ratio implies that a company's stock is overvalued, while a low P/E ratio implies that the stock is undervalued.

Enterprise Value to EBITDA (EV/EBITDA)

The Enterprise Value to EBITDA (EV/EBITDA) ratio measures a company’s enterprise value divided by its earnings before interest, taxes, depreciation, and amortization. This ratio can give investors a sense of how efficiently a company is being managed and how much cash it is generating in comparison to its debt and equity capitalization. A higher ratio typically indicates a more efficiently run business.

Return on Investment (ROI)

The Return on Investment (ROI) is a measure of the rate of return on a company's investments. It is calculated by dividing a company's net income (or profits) by its total assets. The higher the ROI, the higher the return that a company is earning on its investments. The ROI is a popular measure of performance and is often used to compare the performance of one company to another.

Price to Earnings to Growth (PEG)

The Price to Earnings to Growth (PEG) ratio is a measure of a company's fundamentals in comparison to its stock price. It is calculated by dividing a company's PE ratio by its expected growth rate. This ratio gives investors a way to compare the true value of a company's stock relative to its peers. A PEG ratio of 1 indicates that the stock is trading at fair value, and a ratio higher or lower than 1 implies that the stock is overvalued or undervalued, respectively.

Price to Revenue (P/R)

The Price to Revenue (P/R) ratio is a measure of a company’s stock price relative to its total revenues. It is computed by dividing a company's market valuation by its total sales. This ratio can give investors an indication of the company’s expected sales growth in the future, as well as gauge the company’s valuation relative to its competitors. A higher P/R ratio indicates a more expensive stock, while a lower P/R ratio indicates a cheaper stock.

Selecting the Appropriate Multiple

Selection of the most appropriate multiple is a critical step in corporate valuation using multiples. However, it is an area which requires considerable research, evaluation and analysis; some of the key elements of this process include:

Identification of Key Elements of the Business Model

The success or failure of a corporate valuation using multiples depends heavily on the quality and accuracy of the underlying assumptions that inform the multiples. As such, it is essential to identify the key elements of the business model in order to ensure that the assumptions that underlie the multiples are accurate and reasonable.

Comparison with Publicly Traded Companies

Once the key elements of the business model have been identified, it is then important to use them to compare the target company to public companies of similar size, nature and industry. This comparison is intended to allow for a rough estimate of the market-implied valuations of the target company based upon the price of the public company.

Evaluation of the Economic Environment

In addition to comparing the target company to public companies of similar size, nature and industry, it is also important to consider the prevailing economic environment when selecting the appropriate multiple. This is because the impact of overall economic conditions on the value of corporate assets and liabilities will ultimately affect the outcome of the corporate valuation.

Consideration of the Size of the Upscaling Opportunity

Another key element that must be taken into account when selecting the appropriate multiple is the size of the upscaling opportunity available to the target company. The larger the upscaling opportunity available to the company, the higher the multiple can potentially be. As such, this should be taken into consideration when selecting the appropriate multiple.

Validation of the Assumptions of the Multiples

Finally, it is important to validate the assumptions of the multiples used in the corporate valuation process. This is to ensure that the assumptions used in the multiples are reasonable and in line with the data used to inform the valuation. This can be done by performing a sensitivity analysis on the assumptions and testing their accuracy against the market data.

Estimating the Value Using Multiples

Using multiples to estimate the value of a company is a relatively straightforward process that provides a reliable valuation for investors or analysts. A multiple is a suitable method of valuation when observing the financial position and condition of the company across many years is not feasible, or the volatility of the company's share price, attributed to the market and broader trade environment, is too great.

Calculation of the Basic Multiple

The basic multiple serves as the foundation of the estimated value. The most common method of calculating the multiple is Price/Earnings to Price/Book. It is also common to make use of Price/Sales, Price/Cashflow, and other calculations as aspects of the multiple. A Price/Earnings to Price/Book calculation is typically the most reliable, as it looks at the tangible assets of the company, added to the market expectation in terms of the return on investment.

Adjustment of the Basic Multiple

Having calculated the basic multiple, the value of this is then adjusted accordingly. This is based on factors such as the competition, the industry profitability, and expectations of the economic climate. In some cases, the competitive advantage of the company may need to be factored into the adjusted value, along with any other considerations that are likely to have a long-term impact on the performance of the company.

Application of the Adjusted Multiple

Once the multiple has been adjusted to reflect the value of the company, the adjusted multiple can then be applied to calculate the estimated value. This calculation should include the total adjusted market capitalization, including any outstanding debt, as well as any investments that the company has made. Care should be taken not to overestimate the value of any particular asset, as this could lead to a distorted estimation of value.

Calculation of the Final Estimated Value

The calculation of the final estimated value should always be done using the latest available data. A selection of multiple valuations should be used in order to consider any uncertainties, and any limitations due to the method of valuation. Comparing the estimated value to the current market capitalization should be used as an initial point of reference, before reviewing any changes to the market capitalization to arrive at the estimated value.

Conclusion

In conclusion, corporate valuation using multiples is one of the most popular methods to quickly and accurately evaluate companies. This type of valuation utilizes a range of metrics to compare a company's performance against similar businesses or industry averages. The selected multiple is then applied to the target company in order to predict its estimated value.

Summary of Corporate Valuation using Multiples

Multiples are used to compare a company's performance to other similar businesses or to industry averages. This type of valuation uses multiple metrics, including P/E ratio, EBIT and EV/EBITDA, before applying the most suitable multiple to the target company in order to predict its estimated value.

Overview of the Advantages and Disadvantages

One of the advantages of using multiples for corporate valuation is that they are easy to understand and use, allowing investors or interested parties to quickly get a general feel for the worth of a business. Additionally, multiples are unbiased and can be customized to the specific industry. However, the main disadvantage of multiples is their tendency to over or underestimate the value of a company depending on which multiple is used.

Definition of the Types of Multiples

• Price-to-Earnings (P/E) Ratio: This ratio is used to evaluate the performance of a company by comparing its share prices to its earnings.
• Enterprise Value-to-Revenue (EV/Revenue): This ratio measures the overall worth of a company by comparing its enterprise value to its total revenue.
• Enterprise Value-to-Earnings Before Interest and Taxes (EV/EBIT): This ratio assigns a value to a company by looking at its enterprise value in relation to its pre-tax profits.
• Enterprise Value-to-Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA): This ratio is used to measure the total value of a company’s operations by looking at its enterprise value in relation to its EBITDA.

Overview of the Process of Selecting and Applying the Multiple

In order to select and apply the most suitable multiple, it is important to analyze the financial performance of a company and compare it to other similar businesses in the industry. Once a multiple has been carefully selected, the estimated value of the company can then be calculated using the formula of the chosen multiple. This process requires the consideration of a diverse range of metrics, ensuring an accurate and comprehensive valuation.