There are five requirements for making useful analyses of comparable multiples:
- value multibusiness companies as a sum of their parts,
- use forward estimates of earnings,
- use the right multiple,
- adjust the multiple for nonoperating items, and,
- use the right peer group.
1. Value Multibusinesses companies as a sum of their parts
Multibusiness companies' various lines of business typically have very different growth and ROIC expectations.
These firms should be valued as a sum of their parts.
2, All Multples should use forward estimates of earnings
All multiples should be forward-looking rather than based on historical data, as valuation of firms is based on expectations of future cash flow generation.
3. Use the Right Multiples
(a) Value-to-EBITA & P/E Multiples
The right multiple is often the value-to-EBITA ratio.
This measure is superior to the price-to-earnings (P/E) ratio because:
- capital structure affects P/E and
- nonoperating gains and losses affect earnings.
(b) Alternative Multiples
Alternatives to the value-to-EBITA and P/E multiples include
- the value-to-EBIT ratio,
- the value-to-EBITDA ratio,
- the value-to-revenue ratio,
- the price-to-earnings-growth (PEG) ratio,
- multiples of invested capital, and
- multiples of operating metrics.
All of these ratios should be adjusted for the effects of nonoperating items.
5. Use the right Peer Group
The peer group is important.
The peer group should consist of companies whose underlying characteristics (such as production methodology, distribution channels, and R&D) lead to similar growth and ROIC characteristics.