Multiples Valuation Analysis is a relative valuation method using financial ratios such as the P/E ratio or the EV/EBITDA ratio. This approach values a company based on specific operating metrics, such as earnings or cash flow. It is also referred to as the market-based approach, as it suggests that similar companies should have comparable valuations based on underlying assets.

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What is Multiples Valuation?

The Multiples Valuation method is one of the simpler ways to value a business based on using financial metrics. The purpose is to evaluate the metrics of a business and compare them with similar businesses to determine whether they are overvalued or undervalued.

The simpler it is, the better I like it.

Peter Lynch

Multiples are calculated by dividing a value by a value driver. To learn more about multiples, you can visit ➡️ Investment Ratios.

Valuing a business using multiples is a common practice for determining its value. Although it is one of the oldest valuation methods, it has been replaced by more detailed modelling techniques such as the Discounted Cash Flow Model. Nevertheless, Multiples Valuation is still an effective way to determine the value of a business.

I typically use Multiples in three approaches which I will go through further down.

1. Comparable Companies Analysis (Market-Based Approach).
2. Comparing the current multiple of a company against its historical multiples.
3. Forecasting certain line items to place a future multiple on a business.

I also use the multiple to estimate my Expected Yearly Returns which is why it is important to know how Multiple Expansion and Contraction can impact stock prices.

Whether it is the comparable companies’ approach or forecasting a financial line item such as revenue or earnings and then using the output to determine a future trading price, multiples can help shed light on the current valuation of a business and understand its potential future valuation.

I find multiples to be a simpler way to value a business. Although it is still based on assumptions, comparing a company to other businesses can be useful as it uses real-time data. This can help in determining the current value of a business whether it is expensive or not.

Understanding the Value and Value Drivers.

When calculating multiples, a value is divided by a value driver. It’s important for the numerator to align with the denominator.

There are two types of Equity Value: equity multiples (Market Capitalisation) and enterprise value multiples (Total Value of the Company). These make up the value component of the numerator, which is the measure of value.

The denominator is the value driver, which is a financial or operating metric such as Sales and Earnings.

The main Value Drivers used are Revenue, EBIT, EBITDA and Net Income (or Earnings Per Share, EPS).

The key difference is that equity multiples are impacted by changes in the capital structure, even if the enterprise value remains consistent.

Equity Multiples

Equity Value is the value that is assigned to the owners of the business (Shareholders). This is impacted by a company’s capital structure. Equity Value is more commonly used for shareholders and analysts because you are looking to invest in shares (the equity component) and not buy the whole business.

Multiple	Measure
Price-to-Earnings	Compares price per share to earnings per share. This is the most popular equity multiple because of data available and the simplicity of it.
Price-to-Sales	Price per share compared to the revenue per share. This is the preferred ratio for loss making companies, early stage, hyper-growth and pre earnings.
Price-to-Book	Compares the share price to the book value per share. Good for valuing companies with a lot of assets and heavy balance sheets.
PEG Ratio	This compares the share price to the expected growth rate. Good for hyper-growth companies and if you have reliable growth data.
Dividend Yield	The ratio of dividend price to share price. Companies that pay their shareholders dividends, consider alongside the Payout Ratio.

📖 Learn More: Investment Ratios

Enterprise Value Multiples

Enterprise Value is an important metric as it takes into account a company’s debt. This makes it more accurate than Equity Multiples which can be distorted by accounting practices of individual companies. Even if two companies look similar on the surface, differences in their capital structures, debt, EBITDA and other financial techniques can make them vastly different. It is important to look beyond the surface level and consider these underlying factors to truly understand the value of a business.

Multiple	Measure
EV-to-Sales	Can be used for all types companies and is very useful for companies with depressed earnings or companies that are loss making (early-stage) and pre FCF and profit.
EV-to-EBIT	Compares EV to the EBIT of a company. This is a similar multiple to the EV/EBITDA however excludes depreciation and amortization.
EV-to-EBITDA	Compares EV to earnings before interest, tax, depreciation and amortization. This is the most popular EV multiple. It considers a company’s debt, cash and profitability.
EV-to-FCF	This multiple focus on cash generation (free cash flow). This multiple works only for mature firms with stable positive cash flows.

📖 Learn More: Enterprise Value

The Business Growth cycle and Multiples Valuation.

Before applying the Multiples Valuation method, it’s important to take into account certain key considerations, regardless of what you are trying to value. Firstly, you need to know what business stage the target company is in. Is it an early-stage business? Does the company have earnings or is it a loss maker? Is it a mature or declining company? Is the business on the verge of achieving operating leverage and so will start spitting out free cash flow?

The valuation approach using multiples depends on using the right multiple to value the right business. It’s also important to understand the industry. For a high-growth pre-earnings company, you may use a Price-to-Sales ratio as there are no earnings to evaluate. A mature company with a lot of earnings and data, you may choose to use EV/EBITDA to compare it against other stable companies.

For the value to mean anything, the company, the underlying operations, the sector, and the industry must all be researched and understood. By understanding the fundamental drivers, industry trends, and competition, you can ensure that you are valuing the business using the right value and value driver.

It’s important to compare like for like. A SaaS business cannot be compared to a manufacturing company. The key is to use the ratios as a comparison point. You are not trying to compare line item for line item, for example, sales and EBITDA, against your target company. Looking at the industry average of similar companies simply helps you to establish a foundation of likely price points.

What to do with the Multiples?

Valuing a business with multiples is the first step. Once this is done, there are several ways to use it.

How does it compare to its Peer Group?

Comparing companies to similar companies is known as Company Comparable Analysis. For instance, comparing Coca-Cola to Pepsi can help understand the valuation of the target company against similar priced ones. The key is “like-for-like” otherwise it won’t be an accurate outcome to value a company against something that is entirely different.

Compare the Company to What it could be.

When valuing a smaller company that is entering hyper-growth, we can compare multiples to potential companies it could compete with. New entrants offering similar products or services to a company with a bigger market share can be considered. If this business serves the same clientele, we can compare the multiples to “what it could be”.

Where does it sit in comparison to the Industry?

Comparing the multiples of the company valuation to the industry as a whole provides insights into whether it trades in line with the industry or higher or lower. If it is lower, we try to understand why the market values it cheaper. If it is higher, we ask why it is valued higher and whether it warrants the higher multiples.

Compare to the Market Average.

Comparing the valuation multiple to the Market Average helps see where the company is valued in comparison to the market. This is an efficient way to immediately see if a company is overvalued or undervalued.

Compare against its Historical Multiples.

Comparing the current trading multiples to the historical multiples of the business can help see how it is currently trading in line with its average. For example, if a company trades historically on average at a P/E 20x and it is currently trading at 25x, this tells us it is overvalued in comparison to its average. If the outlook is brighter, it may warrant it. If the fundamentals have not changed, it means the market is placing a higher value on the same assumptions.

Use a multiple to estimate future Stock Prices.

We can look at how the multiple will evolve over the life cycle of a company. If we begin to forecast certain line items such as revenue and earnings, we can place a multiple on these extrapolated results to look give us a rough guide to future stock prices. While not perfect it can be helpful.

Comparable Company Analysis using Multiples.

Comparable Company Analysis is also known as “comps”. It is a peer group that consists of a group of companies or assets that are chosen to be comparable to the company or assets being valued. This selection is usually based on the similarity of the companies or assets in terms of industry or characteristics such as earnings growth and return on investment.

The Comparable Company Analysis (Market-Based Approach) employs a peer group that is similar to the target company. The group can include direct competitors or companies within the same industry, with similar fundamentals. However, it is important to understand that no two companies are the same. They may differ in their capital structures, accounting practices, growth outlooks, and return on capital.

The peer group should serve as a guide rather than an absolute measure for valuation. The most important factor is selecting the right peer universe for comparison. To do this, it is essential to understand the value drivers and the business model of each of the businesses. Once the appropriate peer universe has been identified, the right multiple for the business should be used.

An example using Comparable Company Analysis.

To illustrate how this works, let’s run through an example. We are looking at investing in a Business and want to value the business based on multiples. We have two other companies the business competes with which we will use as our Peer group.

The first and most important step in “comps” analysis is to determine the Equity Value and the Enterprise Value to help us work out the value drivers. So let’s begin there.

	Target Company	Peer A	Peer B
Current Share Price:	$7.50	$12.25	$9.30
Shares Outstanding:	250m	178m	312m
Market Capitalisation:	$1.87b	$2.18b	$2.90b
(-) Cash:	$27.5m	$41m	$78.5m
(+) Total Debt:	$248m	$312m	$189m
Enterprise Value:	$2.09b	$2.45b	$3.01b

The next step is to determine the Financial data for each of the companies and then lay it out side by side (in our case top to bottom).

	Target Company	Peer A	Peer B
Market Data
Current Share Price:	$7.50	$12.25	$9.30
Market Capitalisation:	$1.87b	$2.18b	$2.90b
Enterprise Value:	$2.09b	$2.45b	$3.01b
Financial Data
Revenue (LTM)	$1.2b	$3.85b	$4.2b
EBITDA (LTM)	$487m	$633m	$965m
EBIT (LTM)	$280m	$320m	$544m
Earnings (LTM)	$107m	$198m	$228m
EPS Growth Rate	12%	8%	11%
Earnings Per Share	$0.428	$1.11	$0.70
Equity Value Multiples
Price-to-Sales	1.55x	0.56x	0.69x
Price-to-Earnings	17.52x	11.03x	13.28x
PEG Ratio	1.46x	1.37x	1.20x
EV Multiples
EV/EBITDA	4.29x	3.87x	3.11x
EV/EBIT	7.46x	7.65x	5.53x
EV/Revenues	1.74x	0.63x	0.71x

In this example, we have laid down the valuation multiples of our potential investment against two comparison companies.

On the outlook, our target company seems to be valued higher than Peer A and Peer B. The P/E ratio as well as the EV/EBITDA are signs it is trading higher than the other two companies. We must look at why. Understand the outlook of the business and see if it is warranted.

When comparing companies we are analysing all the line items as well. Our target company has healthy margins. All though the company is smaller it looks like it is more efficient which is why it may be valued higher.

We have used trailing multiples (past data and current data) for this example as opposed to forward looking Multiples Valuation which considers the forecasted financial metrics. For example you may see “10x NTM Earnings” which means the company is valued at ten times its forward earnings estimate.

What to do after comparing the Target Company?

After the first stage you should look at the average multiples of all the businesses to help compare value. Once you have done this, you can start to look at the forward estimates and determine valuation based on these numbers.

Although these are estimates, they can be very helpful when valuing stable and consistent companies. Let me explain with an example. Assuming we forecast the Earnings Per Share based on the EPS growth rate in the prior example, we can estimate forward-looking stock prices using this data.

For instance, using Peer B, we can estimate next year’s Earnings Per Share at 0.77 cents (current year’s EPS plus our expected growth rate). The average of the P/E ratios is 13.94x, so we can apply this to our forward EPS targets. To determine the estimated stock price, we simply multiply the forward EPS by the average P/E estimated for the forecasted year (if the multiple does not change). Therefore, Peer B would be $0.77 x 13.94 = $10.83.

Modelling using Multiples is a bit more in-depth than this, but the concept is simple to understand. Using the Multiples Valuation approach in comparable company analysis using current data is a better way to see how a company trades today, as opposed to where it may trade in the future.

Using Multiples Valuation with financial modelling.

This section on using multiples to analyse projected metrics can be challenging. However, I find it to be a useful approach although based on assumptions and the unknown future. I rely on my model to forecast the projected sales by taking into account past growth rates and revenue. I spend a significant amount of time analysing the revenue of companies, especially small caps that have considerable growth potential.

By examining the operating margins of a company and other metrics, we can reverse engineer some of the line items such as EBITDA and NPAT. This information can help us to place a multiple on a business based on the projected line items. Focusing on understanding the business model can help us to look at a Revenue Build-up or a P x Q (Price x Quantity) model. This is the first stage.

The next step is to estimate the revenue and apply the margins to determine the line items. For instance, if the operating margins historically sit at 20% or Net profit sits at 10%, we can determine each forecasted year’s NPAT or EBITDA. It’s essential to note that this is not a perfect application since forecasting is not always accurate. I rely on this approach more so to see how big a business can grow, even if it is just an entertaining exercise.

The application is like a DCF model however does not use Free Cash Flow. You can discount the results to today’s value at the end as well.

An example using Multiples Valuation.

Sounds confusing? Let’s run through an example.

We are looking at a small-cap growth business and want to see how it can evolve over the next 10 years. By taking the current sales and the historical revenue growth rate we can place a forward-looking growth of revenue at 20% for the first 5 years then taper it off every year after as it grows into its market share.

We look at some similar companies that we believe the company can compete with and grow into. These businesses are much bigger, and our small cap is going after the same addressable market.

We will use the average Price-to-Sales ratio and Price-to-earnings ratio of the comparable companies and our exit multiple at year 10. What we are looking to do is determine in Year 10 if we were to exit, what “COULD” the potential share price be based on our modelled line items.

Let’s start with some known assumptions:

• Current Share Price: $7.50
• Market Cap: $1.87B
• Shares Outstanding: 250M
• TTM Revenue: $1.2B
• Revenue Growth Rate: 20% for the first 5 Years then 10% for 5 Years.
• EBITDA Margin from Revenue: 25%
• NPAT Margin from Revenue: 15%
• Exit Year P/S Based on Comparable Companies: 2.5x
• Exit Year P/E Based on Comparable Companies: 17x

Estimating the future Implied Value using the Multiples.

By modelling this all out and placing an exit multiple value on the forecasted Year 10 Revenue and Year 10 Earnings per share we have a rough valuation guide.

Using the forecasted revenue if we look at the 10th year estimated revenue it is $4.8 billion. This gives us a Sales Per Share price of $19.24. That is the value driver we will use.

Exit Share Price in Year 10 based on P/S of 2.5x = $48.09

Exit Share Price in Year 10 based on P/E of 17x against Year 10 EPS = $49.05

We can also estimate present day value by applying our discount rate to the sum of the Sales and Earnings. *I have included Terminal Value also in this column as it is sometimes used as the Terminal Value in a DCF model so it is all connected.

This can be a helpful approach to looking at companies and the future implied share prices. It is not about discounting these prices back to a present value, or trying to determine intrinsic value. It is about if we enter at the current price, and all things being equal this company continues to grow, based on the multiple my “assumed” exit share price will be $x. Is this worth it? What is the likelihood of it?

Why do I look at companies like this? It is hard to value smaller companies in hyper growth that have 5-10 years of above average growth ahead. So instead, I am looking at the future revenues and an exit multiple on the implied share price to see how much “potential upside” there is. If my entry price is $7.50 and I hold long-term then I estimate my exit price to be roughly $48 a share. That is about 6.5x my capital.

The easiest way to use the multiples…

One of the simplest ways to assess the value range of a company is to compare it against its own trading history. This can help determine if the business is overvalued or undervalued. However, this approach does not provide insight into why the company’s trading history may differ from its current value. Investors should think critically and investigate the reasons behind any discrepancies.

For example, if we lay out the historical data and then take the average we can see that a current P/E of 22.5x is not in line with how the company typically trades.

P/E Ratio	2020	2021	2022	2023	Current
Historical P/E	17x	16.2x	15x	15.9x	22.5x

For instance, if a high-quality company is trading below its historical price-to-earnings ratio (P/E), it may present a buying opportunity. It’s important to remember that market sentiment plays a significant role in multiple expansion and contraction. So, if the company’s fundamentals are strong and the multiple is lower than average, it could indicate that the business is undervalued. Conversely, if the multiple is higher than average, it may imply overvaluation due to investors placing a higher multiple on future expectations.

Digging deeper to understand why the multiple is out of sync is crucial. It could be due to deteriorating growth prospects, which would push the value down. Alternatively, it could be higher if the future looks brighter, indicating a higher price.

Valuation is not as straightforward as “low” equals “undervalued” and “high” equals “overvalued.” It requires a thorough understanding of the company’s fundamentals to make an informed assessment of its value.

Multiples Valuation is only valuable if you know the business.

As an investor with a long-term approach, it’s crucial to understand all the drivers of the businesses you want to own. You should be aware of how sales work, what the margins and cash flow are, and the business model, as well as the earnings. Some investors throw multiples around, but they don’t truly understand the companies, which encourages a short-term outlook. Investors and analysts can become fanatical about multiples and forward-looking ratios.

Valuation can be very valuable, but only if investors truly understand the underlying business and how it evolves over time. Companies do not grow linearly, and as a company gets bigger, all the fundamentals change. A leaner start-up may be more efficient, but as it scales, it may have long periods of negative earnings and cash flow. However, beneath the surface, you can see that revenue is rapidly growing, and all earnings are being pumped back into the business to scale.

It’s important to understand the business model and the right multiple in order to grasp the value in context. For instance, a recent high growth business I was valuing had an extremely high P/E ratio that was inconsistent. However, by analysing the business, I discovered that the company is investing heavily in sales, research and development, which will eventually slow down over time. This would then free up a tonne of cash.

So, I knew to use the P/S which would show a more consistent value of the business in comparison to the main economic driver of that business, sales growth.

Therefore, while multiples valuation is helpful, it should still be used with the same philosophy and ideology of sound long-term investing, know what you own.

In Summary…

Although this is not a comprehensive guide to Multiples Valuation, it should give you an idea of how multiples are used to value a business. Like every valuation model, there are advantages and disadvantages to using multiples. The key challenges are understanding which multiple to apply and the value driver to use.

Predicting the multiple is incredibly difficult because it is driven by market sentiment. Even if we use a “back of the envelope” revenue build-up model and extrapolate revenues, the final number is still an assumption largely governed by what investors are willing to pay at that point in time.

Multiples are very helpful for private equity, where enterprise value and EBITDA multiples are commonly used. I have sold companies based on 2.5x EBITDA or 5x NPAT, and each industry has a reasonably accurate idea of valuation.

However, in public markets, there are many more assumptions and variables to consider, and the capital structure is entirely different. The market can swing with wild gyrations that all impact stock prices.

Using multiples in combination with other valuation metrics is the best way to approach valuation. I use a Reverse DCF model with a multiples comparison method as it is fast and effective at providing me with the current state of the company.

Once we have this information, we can begin the rest of the fundamental analysis and research.