Multiples Analysis

What is Multiples Analysis?

Multiples analysis is a relative valuation method that values an asset based on how similar assets trade. To do so, the valuer establishes several ratios. These ratios are usually expressed as multiples rather than percentages and compare a value with a value driver.

Multiple = Value / Value Driver

A company’s value is driven by its ability to generate profits. It is very important that this value number is consistent with the value driver (profit) used.

When using ratio analysis, it is also very important to compare similar companies. Valuation multiples for mature companies (i.e. supermarkets) are likely to be vastly different to high growth sectors such as technology.

Understanding Multiples

Multiples are calculated by dividing a value by a value driver. It is important that the value (numerator) is consistent with the value driver (denominator).

Value

There are two types of value number, Enterprise value (EV) and equity value. Enterprise value is the value of the core business before any financial assets and the deduction of debt. In other words, it is unaffected by a company’s capital structure.

The equity value is the value attributable to the owners or shareholders of the business. This is after adding any financial assets and after deducting debt. In other words, it is affected by a company’s capital structure.

Value Driver

This number represents the driver of value. Common value drivers include the following:

• Revenue
• EBIT
• EBITDA
• Net Income (or Earnings Per Share, EPS)

Revenue, EBIT and EBITDA are all unaffected by a company’s capital structure and are therefore drivers of EV.

Net Income is impacted by a company’s capital structure and is therefore a driver of Equity value.

Multiples Grid

Below is an example of how multiples are calculated. The left-hand side starts with enterprise value and crosses the bridge all the way down to the implied share price.

The right-hand side shows the income statement, and starts at EBIT, which is the profit generated by the operations, adds the return on financial assets, deducts the cost of financial liabilities, tax expense and any dividends attributable to preference shareholders. This provides the residual earnings or net income.

The calculation highlights the importance of selecting a consistent value and value driver number. Enterprise value is independent of capital structure and must be compared to a suitable profit number. EBIT is before any returns on financial assets and costs related to financial liabilities. The EV/EBIT multiple in this example is 10.0 x. Value and value driver are consistent.

The P/E ratio compares the share price to the income attributable to common shareholders on a per share basis. This is after the impact of capital structure and equals 13.3 x. Both value and value driver are impacted by capital structure and the ratio is consistent.

Other Multiples:

There is a broad range of multiples used in multiples analysis, some of which tend to be better suited to certain sectors or industries. Here are some examples:

EV/Revenues:

Can be used for all companies but is particularly useful for companies with depressed earnings or companies that are loss making.

EV/(EBITDA-CapEx):

This multiple is commonly used for capital intensive companies.

EV/Free Cash Flow:

This multiple is getting used increasingly as it focuses on cash generation. Note, this multiple works only for mature firms with stable cash flows.

Price/Book Value:

This multiple is useful for balance sheet driven companies, e.g. companies in real estate, banking, and insurance sectors. It is also useful for businesses like oil & gas companies where the value of the business is highly driven by the assets they own, i.e. their book value.

EV/Rooms:

This multiple is used for comparing companies in the hotel industry.

EV/Subscribers:

This multiple is used for publishers and cable companies.