Valuation for Mergers, Buyouts, and Restructuring, Second Edition

Chapter 4

Metrics and Multiples

4.1 THE USE OF MULTIPLES IN VALUATION

In Chapter 2, a company was valued in relation to the pricing of fixed-income securities and a market portfolio of equities by discounting free cash flows at WACC. A more direct approach often used in practice relies on valuation multiples such as price-to-earnings, price-to-book, enterprise value to earnings before interest, taxes, depreciation, and amortization (EBITDA), and enterprise value to revenues. These multiples are calculated as the ratio of value to some normalizing metric such as net income, EBITDA, or revenues. For example, the EBITDA multiple is obtained dividing the value of the enterprise by EBITDA and it expresses enterprise value-per-dollar of EBITDA.

Although valuation based upon multiples is only indicative and not a substitute for a careful projection and valuation of free cash flows, it has a role as a complement and check of discounted cash flow (DCF) valuation. Empirical research on the forecasting performance of the DCF approach and valuation multiples derived from comparable companies suggests that each contains useful information and that relying on both approaches in combination is likely to produce more accurate estimates of value than the use of each in isolation.¹

Multiples are estimated from the prices of other companies with characteristics comparable to the company being valued. Usually, these comparables are companies in the same industry. Since the ultimate purpose of a valuation ...