Damodaran on Valuation

9.5. CONCLUSION

Enterprise value multiples look at market value of the operating assets of the firm and not just the equity invested in them. Thus, they provide a broader measure of value that is less affected by financial leverage decisions. In this chapter, the various measures of enterprise value were first introduced, with the emphasis on consistency. Cross holdings in other companies, whether classified as majority or minority holdings, can wreak havoc on the unsuspecting analyst when it comes to enterprise value multiples.

The determinants of enterprise value multiples come from looking at a simple discounted cash flow model for the firm. Not surprisingly, the same variables that determine firm value—cost of capital, growth rates, and reinvestment rates—affect enterprise value multiples as well. Each multiple also has one variable that it is most closely linked to; with EV/capital ratios, it is the return on capital, whereas with EV/sales ratios, it is the after-tax operating margin.

In the final section, we looked at potential applications of enterprise value multiples in valuation and presented three ways of controlling for differences across companies—a subjective approach where we look for qualitative reasons for deviations from sector averages, a matrix approach where we graph enterprise value multiples against the key variables determining these multiples, and multiple regressions.