Title: The Multiples Approach — A Practical Guide to Relative Valuation
Key takeaways
– The multiples approach values a company by comparing it to similar firms using standardized ratios (multiples).
– Multiples fall into two broad categories: enterprise-value (EV) multiples and equity (price) multiples.
– Use forward (projected) metrics where possible, select truly comparable peers, and normalize financials to reduce distortions.
– Multiples are quick and useful for cross-checking but can be skewed by market sentiment, accounting differences, and poor peer selection.
Introduction
The multiples approach (aka comparable company analysis or “comps”) is a widely used, pragmatic valuation method that assumes similar companies trade at similar multiples of fundamental metrics (earnings, sales, cash flow). It’s fast, intuitive, and often used as a sanity check alongside intrinsic valuation models (e.g., discounted cash flow).
Understanding the multiples approach
At its core, multiples analysis transforms a company’s financial metric into a valuation by multiplying that metric by a market-derived ratio. For example, if comparable firms trade at an EV/EBITDA of 8x and your target company’s EBITDA is $200 million, an implied enterprise value would be 8 × $200M = $1.6 billion. The approach captures market expectations about growth, risk, and profitability embedded in prices—but it also imports the market’s mistakes and noise.
Types of multiples
– Enterprise-value multiples (applies to the whole firm, independent of capital structure)
– EV/Sales
– EV/EBIT
– EV/EBITDA
– Equity (price) multiples (applies to equity value per share)
– Price / Earnings (P/E)
– Price / Book (P/B)
– Price / Sales (P/S)
– PEG (P/E to growth) — a P/E adjusted for growth
Why choose EV vs. equity multiples
– EV multiples are preferred when comparing firms with different capital structures because enterprise value = market cap + net debt + minority interest + preferred — and therefore isolates operating performance.
– Equity multiples are easy to find in public sources and are common among retail investors but can be distorted by leverage, buybacks, or one-off items.
Common ratios and what they reveal
– P/E = Market price per share / Earnings per share (EPS). Shows how much investors pay for each dollar of earnings.
– EV/EBITDA = Enterprise value / EBITDA. Useful for comparing operating returns while excluding non-cash charges and capital structure.
– EV/EBIT = Enterprise value / EBIT. Captures operating profit after depreciation.
– EV/Sales = Enterprise value / Sales. Useful when profits are negative or volatile.
– P/B = Price per share / Book value per share. Often used for asset-heavy businesses (banks, insurers).
– PEG = (P/E) / (Expected earnings growth rate). Attempts to normalize P/E for growth.
Step-by-step: How to perform a multiples valuation (practical)
1. Define the objective and the metric
– Decide whether you need enterprise value (use EV multiples) or equity value (use price multiples).
– Choose an appropriate denominator (EBITDA, EBIT, EPS, sales, book value).
2. Identify a set of comparable companies
– Industry peers with similar business models, growth prospects, margins, capital intensity, and geographic exposure.
– Use revenue mix, product mix, customer concentration, and business lifecycle to screen peers.
– Exclude outliers with one-time distortions or clearly different risk/scale profiles.
3. Gather current and forward financials
– Collect trailing twelve months (TTM) and forecast figures (consensus analysts’ estimates or your own) for the chosen denominators.
– Prefer forward multiples (next-12-months or FY1/FY2 estimates) because valuation is fundamentally forward-looking.
4. Compute multiples for the comparable set
– For each peer, calculate the relevant multiple(s) using market prices and financials.
– Example: EV/EBITDA_i = EV_i / EBITDA_i.
5. Analyze and summarize the multiples
– Compute median and mean; median is less sensitive to outliers.
– Consider trimming the top/bottom (e.g., 10–20%) if the peer set includes extreme values.
6. Apply the selected multiple(s) to the target company
– Multiply the target’s chosen metric (forward EBITDA, EPS, sales) by the selected multiple (median or range) to get implied EV or equity value.
– If you computed EV, convert to equity value: Equity value = EV − Net debt − Preferred − Minority interest + Cash adjustments as appropriate.
– Convert equity value to per-share price by dividing by diluted shares outstanding.
7. Cross-check and stress-test
– Use multiple metrics (EV/EBITDA and P/E) and ranges (low/median/high) to create a valuation band.
– Reconcile with DCF or precedent transaction multiples where possible.
Illustrative numeric example
– Peer median EV/EBITDA = 8.0x (forward)
– Target company forward EBITDA = $200 million
– Implied Enterprise Value = 8.0 × $200M = $1,600M
– Target net debt = $300M
– Implied equity value = $1,600M − $300M = $1,300M
– Diluted shares outstanding = 100M
– Implied price per share = $1,300M / 100M = $13.00
Limitations and common pitfalls
– Market sentiment and timing: Multiples reflect market prices, which can be over- or undervalued due to sentiment, liquidity or macro shocks.
– Poor peer selection: No two companies are exactly alike. Incorrectly chosen comparables produce misleading implied values.
– Accounting differences: Diverse revenue recognition, depreciation, lease accounting, or one-off items can distort denominators.
– Capital structure effects: Using equity multiples without adjusting for leverage differences can mislead.
– Oversimplification: Multiples reduce a firm’s complexity to one number and can miss qualitative advantages (brand, IP, management quality).
Advantages and disadvantages
Advantages
– Fast and straightforward; useful for screening and cross-checking.
– Based on observable market data; reflects real-time investor pricing.
– Good for sector-level benchmarking and producing valuation ranges.
Disadvantages
– Relies on comparables that may not exist or be truly comparable.
– Inherits market mispricings and short-term noise.
– Can mask company-specific fundamentals or accounting quirks.
Practical tips to improve reliability
– Use forward (consensus) metrics rather than trailing numbers.
– Prefer median of multiples and report a range (e.g., 25th–75th percentile).
– Normalize financials: remove non-recurring items, adjust for different fiscal year-ends, and convert to common accounting standards where possible.
– Adjust multiples for growth and profitability differences (e.g., use PEG, or regression-based adjustments).
– Complement with DCF, precedent transactions, and qualitative assessment.
Important financial ratios to evaluate a company (quick reference)
– P/E (Price-to-Earnings)
– EV/EBITDA
– EV/EBIT
– EV/Sales
– P/B (Price-to-Book)
– D/E (Debt-to-Equity)
– ROE (Return on Equity)
– ROIC (Return on Invested Capital)
– Profit margin (Net, Operating, Gross)
What is EV/EBITDA (deeper dive)
– Definition: EV/EBITDA = (Market capitalization + net debt + minority interest + preferred) / EBITDA.
– Interpretation: A lower EV/EBITDA can imply a cheaper company relative to peers, all else equal. Because EBITDA excludes interest, taxes, depreciation, and amortization, it isolates operating cash-generation potential.
– Use cases: Common for capital-intensive industries, private company valuations, and M&A screenings.
– Caveats: EBITDA omits capital expenditures and working capital needs, so EV/EBITDA can overstate cash available to investors, especially for firms with high capex or rapid working-capital build.
When to use multiples vs. other methods
– Multiples: Best for quick comparisons, sector screens, and sanity checks.
– DCF/Intrinsic valuation: Better when you can reasonably forecast cash flows and want to model firm-specific drivers.
– Precedent transactions: Useful for M&A context because transaction multiples capture takeover premiums.
Bottom line
The multiples approach is a pragmatic, market-based way to value companies by comparison. Its strengths are speed, simplicity, and reliance on observable market prices; its weaknesses stem from peer selection, accounting/structural differences, and market noise. Use multiples as one tool among several—apply careful peer selection, forward-looking metrics, normalization adjustments, and always present a valuation range rather than a single point estimate.
Source
– Investopedia, “Multiples Approach,” Crea Taylor. https://www.investopedia.com/terms/m/multiplesapproach.asp
If you’d like, I can:
– Build a step-by-step spreadsheet template for multiples analysis you can reuse.
– Prepare a worked example with real public-company data for a specific industry.
– Suggest criteria and filters to pick comparables for a chosen sector. Which would help you most?