Damodaran on Valuation

8.4. APPLICATIONS OF EQUITY MULTIPLES

Now that we have looked at the determinants of equity multiples and how the multiples change as the fundamental variables change, we can turn our attention to the proverbial bottom line. In this section, we begin by looking at the conventional use of multiples in sectors to make valuation judgments and then extend our discussion to entire markets. We also consider how to compare multiples across time and across markets.

8.4.1. Comparing Equity Multiples across Firms in a Sector

The most common approach using equity multiples is to choose a group of firms in the same sector as the firm that we are trying to value, to calculate the average value for the multiple for this group, and to subjectively adjust this average for differences between the firm being valued and the comparable firms. While doing this, analysts implicitly assume that firms in the same sector are equally risky and that controlling for risk is therefore not necessary. Even if we accept this heroic assumption as reasonable, relative valuations range across the spectrum. Some relative valuations do not control for any of the other variables that we argued affect the multiples that firms trade at, whereas others do control at least partially for some of the differences.

Reviewing the determinants of equity multiples from earlier in the chapter, we outline all of the variables that affect each multiple in Table 8.12. Note that the companion variable for each multiple is italicized ...