Multiples

Multiples aren’t necessarily a valuation method. They are standardized financial ratios used when applying the Comparable Company Analysis or a Precedent Transactions Analysis valuation methods.

Both of these methods fall under market approach or relative valuation. This valuation strategy determines value by comparing companies to each other using standardized metrics or "multiples". That’s in contrast to absolute valuation methods that attempt to find a company's intrinsic value by examining its fundamentals, like cash flows, in isolation, such as Discounted Cash Flow (DCF) analysis.
 

Why Are Valuation Multiples Important?

Valuation multiples are needed when comparing companies because absolute financial figures like revenue or profit can be misleading. They don’t account for differences in company size, profitability margins, growth prospects, risk profiles, and industry-specific characteristics. 

Valuation multiples solve this problem with standardization. That happens by dividing a company’s total worth, either the market capitalization or the enterprise value, by common financial metrics like sales, earnings, and book value.

The result is a ratio or multiple that makes direct and meaningful comparisons possible. For example, instead of comparing a $1 billion market cap company with $100 million in profit to a $100 million market cap company with $10 million in profit (absolute figures), we can compare their Price-to-Earnings (P/E) ratios:

• Company 1: P/E = $1 billion / $100 million = 10x (10 times its earnings)
• Company 2: P/E = $100 million / $10 million = 10x (10 times its earnings)

Even though their absolute sizes and profit figures are different, the P/E ratio shows they are valued similarly by the market relative to their earnings. 
 

What Are Common Valuation Multiples 

The popular valuation multiples are grouped into two main categories: 

Equity Value Multiples 

These multiples divide the company's market capitalization or stock price, by a financial metric that pertains to equity holders, such as earnings, sales, and book value. Equity multiples can be affected by changes in capital structure even if the enterprise value remains the same. However, they are easy to calculate and are available through most financial newspapers and websites.

1. Price-to-Earnings (P/E) Ratio

The P/E ratio shows how much investors are willing to pay for each dollar of a company's earnings. A higher P/E ratio might suggest that investors have high growth expectations for the company or that the stock is overvalued compared to its earnings. 

P/E Ratio = Price Per Share ÷ Earnings Per Share (EPS)

For example: If Company A's stock trades at $50 and its EPS is $5, its P/E ratio is 10x. This means investors are willing to pay $10 for every $1 of current earnings.

The next step is to compare this 10x P/E ratio to the P/E ratios of similar companies, its own historical P/E, or industry averages to determine if Company A is relatively overvalued, undervalued, or fairly valued.

2. Price-to-Book (P/B) Ratio

Book Value is the net asset value of a company (total assets minus total liabilities). Thus, the multiple compares a company's market value to its book value, or the value of its net assets according to its balance sheet. 

P/B Ratio = Share Price ÷ Book Value Per Share

P/B works best for:

• Financial institutions like banks and insurance companies
• Asset-heavy businesses like manufacturing, real estate
• Companies with significant tangible assets

However, P/B becomes less relevant for companies with substantial intangible assets, like brands, patents, or intellectual property. A lower P/B ratio might suggest undervaluation or that the market has concerns about the company's assets

3. Price-to-Sales (P/S) Ratio

The P/S ratio is similar to EV/Revenue but uses market capitalization instead of enterprise value. It indicates how much investors are willing to pay for each dollar of the company's revenue.

P/S Ratio = Market Capitalization ÷ Annual Revenue

or for per-share values:

P/S Ratio = Share Price ÷ Sales Per Share (Total Revenue divided by the number of outstanding shares)

4. PEG Ratio (Price/Earnings to Growth)

The Price/Earnings to Growth (PEG) Ratio is another common valuation multiple that builds upon the P/E ratio by factoring in a company's expected earnings growth rate.

PEG Ratio = P/E Ratio ÷ EPS Growth Rate (%)

A PEG of 1.0 might indicate a fair valuation relative to growth. Below 1.0 might suggest undervaluation, while above 1.0 might indicate overvaluation.

Enterprise Value Multiples

These multiples divide the company's enterprise value (market capitalization + net debt) with a financial metric that represents the value available to all capital providers, both debt and equity holders. They are less impacted by accounting differences, and allow for direct comparisons among various companies regardless of capital structures. 

1. Enterprise Value-to-Revenue (EV/Revenue)

This multiple compares the total value of the company (equity and debt) to its total sales. It's useful for companies that may not be profitable yet or have cyclical earnings, as revenue is generally more stable.

EV/Revenue = Enterprise Value (Market Capitalization + Total Debt - Cash & Cash Equivalents) /Revenue

2. Enterprise Value-to-Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA)

This multiple looks at the total company value relative to its operating profitability before non-cash expenses and financing costs. EBITDA, Earnings Before Interest, Taxes, Depreciation, and Amortization, is often used as a proxy for cash flow. This multiple is popular because it helps to normalize for differences in capital structure (debt), tax rates, and accounting methods (depreciation and amortization).

EV = Market Capitalization + Total Debt - Cash and Cash Equivalents

EV/EBITDA = Enterprise Value ÷ EBITDA

For example, if Company C has an EV of $1 billion and EBITDA of $200 million, its EV/EBITDA is 5x.

Advantages of EV/EBITDA multiple: 

• Accounts for debt unlike P/E
• Less affected by accounting differences in depreciation
• Easier to compare companies with different tax situations

3. EV/EBIT 

EV/EBIT is similar to EV/EBITDA but accounts for the capital intensity of the business by including depreciation. It shows the relationship between the total value of the company and its operating profitability. It tells you how many dollars an investor would need to pay for each dollar of the company's operating earnings.

• EBIT: Earnings Before Interest and Taxes, also called operating profit.
• Enterprise Value (EV): The total value of the company, including its market capitalization (equity value), debt, and preferred stock, minus cash and cash equivalents. It's the theoretical cost to acquire the entire business.

EV/EBIT= Enterprise Value (EV) / Earnings Before Interest and Taxes (EBIT)
 

Common Valuation Multiples Interview Questions 

1. Why might investors prefer EBIT multiples over EBITDA multiples?

The primary concern with EBITDA is that it might present an overly optimistic view of profitability by treating capital expenditures as if they were somehow optional or free. However, in reality they are necessary ongoing costs for many businesses.

So, some investors, including notable value investors like Warren Buffet, prefer EBIT multiples because:

1. EBITDA can potentially mask capital expenditure requirements by removing depreciation.
2. Depreciation is a real economic cost for businesses with physical assets.
3. EBIT provides a clearer connection to capital expenditures through depreciation expenses.
4. Companies with high depreciation expenses typically require ongoing capital expenditures to maintain operations.
5. The gap between EBIT and EBITDA becomes particularly significant in capital-intensive industries.

2. What are the key differences between P/E, EV/EBIT, and EV/EBITDA multiples, and when is each most appropriate?

These three financial ratios all measure a company's profitability, but they serve different purposes.

P/E (Price-to-Earnings) Ratio is calculated using net income, which includes the impact of interest payments. It’s affected by a company's capital structure, debt-to-equity ratio, and it’s most suitable for financial companies (banks, insurance firms) where interest expenses are fundamental to their business model. 

EV/EBIT (Enterprise Value-to-Earnings Before Interest and Taxes) is capital structure-neutral, making it useful for comparing companies with different debt levels. It includes depreciation and amortization costs and provides a more realistic picture of operational profitability in industries with significant fixed assets. It’s preferred for manufacturing businesses and other capital-intensive industries where equipment depreciation reflects a real economic cost.

EV/EBITDA (Enterprise Value-to-Earnings Before Interest, Taxes, Depreciation, and Amortization) is also capital structure-neutral but excludes depreciation and amortization. It’s better suited for technology companies and service businesses with fewer physical assets. 

3. What industry-specific valuation multiples are used beyond traditional metrics?

Different industries require specialized valuation multiples that better reflect their unique business models:

Technology/Internet Companies:

• EV/Unique Visitors
• EV/Pageviews

Retail and Airlines:

• EV/EBITDAR (adds back rental expense)
• Used to normalize companies that own versus rent their facilities

Energy Companies:

• EV/EBITDAX (adds back exploration expenses)
• EV/Daily Production
• EV/Proved Reserves

Real Estate Investment Trusts (REITs):

• Price/FFO (Funds From Operations)
• Price/AFFO (Adjusted Funds From Operations)

4. Why do we add debt and subtract cash when calculating Enterprise Value?

Debt is added because the acquirer assumes the company’s debt, and cash is subtracted because it can be used to pay down debt, reflecting the net cost to acquire the company. 

5. How do you determine the appropriate multiple to use when valuing a company? 

The choice depends on several factors, particularly the company’s profitability, growth stage, and industry. Young, high-growth firms without stable earnings are often valued using revenue-based multiples like the price-to-sales (P/S) ratio.

Established companies with reliable earnings are better suited for metrics like EV/EBIT or EV/EBITDA. Industry-specific characteristics also play a role – for example, real estate and energy companies often require specialized multiples.

It’s also important to ensure there is enough comparable market data to interpret the multiple meaningfully.

👉 In our Case Library, you can practice the most important finance concepts. We've picked out two valuation cases for you:

Key Takeaways

Multiples are a fundamental tool in company valuation, enabling comparisons between businesses using standardized financial metrics. Unlike absolute figures such as revenue or profit, multiples place a company’s value in a relative context. Common examples include the price-to-earnings ratio (P/E), which compares market capitalization to net income, and the enterprise value to EBITDA ratio.

There are two main categories of multiples. Equity value multiples focus on the shareholder perspective, while enterprise value multiples reflect the entire capital structure. Choosing the right multiple depends on factors such as the industry, profitability, growth stage, and the availability of comparable data. For instance, P/E and PEG ratios are often used for mature, profitable companies, whereas EV/Revenue or price-to-sales (P/S) ratios are more suitable for younger, high-growth firms.

Multiples are also a frequent topic in finance interviews. Candidates are often asked to explain their application, differences, and relevance. A solid understanding of how the main multiples work and when each one is most appropriate can significantly boost your confidence during interviews.