Multiples

The (market) multiple valuation methodology determines the value of a company based on comparable companies in the same sector or industry in which the company to be valued is active.

How does the multiple valuation methodology work?

In essence, the multiple methodology is very simple: by multiplying the turnover or (normalized) result of a specific year (for example the operating profit before depreciation, interest and taxes (EBITDA)) by a sector-specific multiple, the enterprise value is determined. For example: the enterprise value is 9 x the operating profit.

Enterprise value versus share value

By subsequently deducting the debt from that enterprise value and adding the excess liquid assets (and any other financial fixed assets), the shareholder value is determined. The result of multiplying the multiple by the financial metric used doestherefore not yield the value of the shares. An additional calculation must be done to determine the equity value.

Public traded multiples vs transaction multiples

But which multiple to use? The multiple to be used in this methodology is based on the market value (based on stock prices) of comparable (listed) companies or on the basis of recent transactions of other companies, listed or not.
If you use stock market multiples to determine a non-listed company, you still have to take into account a discount of approximately 25% for the fact that your company is much smaller, less liquid and riskier than a listed company.

When do you use the multiple methodology?

There are several reasons for using market multiples. First of all, it can be a valuable cross-check on the results of cash flow-based (DCF) methods such as the APV method or the WACC method. If the differences between the two methods are large, it must be possible to explain where the differences lie in the underlying assumptions. For example, is my company growing faster than its peers, or with higher margins? Or is the forecast used perhaps very ambitious?
Because multiples reflect the prices paid for shares of listed companies and in transactions, they can provide a better sense of expected price ranges in transactions.

The biggest advantage of the so-called multiples method is that it is relatively easy to implement. In addition, this method is very often used within the financial sector.

Simple, yet complex? Points of attention with the multiple methodology

Valuation based on multiples also has disadvantages. An important disadvantage of this method is that although the method is essentially simple, it can be difficult to perform a good multiple analysis.
This means that it is sometimes not easy to select good comparable companies (peers). Are there comparable companies that carry out exactly the same activities, have the same growth expectations, achieve comparable margins, are just as capital intensive and are in the same life stage? These are the underlying assumptions that you use when you apply a multiple to the company you are valuing.

Other points of interest are the year of comparison to be used (are you looking back in time, or are you looking forward?), the differences in accounting methodology between your company and its peers, and the detail of the available reports may differ.
Lack of liquidity of the share or the prevailing sentiment on stock markets can also have a major influence on the price of a share, while this price does not necessarily say anything about the real value of the company.
In addition, the peers may have a different risk profile and only if the risk profile of the companies is the same can a good comparison be made.
Transaction multiples may also contain synergy premiums that must be ignored in a stand-alone valuation.

Which multiple to use?

Multiples are preferably applied at EBIT(DA) level, because this comes closest to the free cash flow and is therefore in line with the DCF methodology. In addition, the reported EBIT(DA)s for one-off / non-structural costs must be normalized, so that the normalized EBITDA level can be used as an indication of future expected results.

Why is a 'forward looking multiple' generally lower than a 'backward looking multiple?

A multiple based on future expected results is generally lower than a multiple determined on historical (realized) results. After all, you divide the same company value by a higher number (assuming growth in the company). So pay attention to how the multiple you use is determined and multiply it by the financial metric (turnover, EBIT(DA)) from the same period.

Steps in using the multiple method to calculate shareholder value

In summary, what are the steps to be taken when applying the multiple method:

• Find comparable companies: First it is important to find comparable companies. Find companies that are within the same industry or market, and ideally at the same stage of life, with similar growth and margin expectations. Look at listed companies, but also see if you can find information about recent transactions. In the Valid Value model, multiples per sector are available as support data.
• Determining the multiples: If you do not have access to databases that provide multiples, determine the multiple of the peers.  
  • Calculate the market capitalization (market value of equity) per peer by multiplying the number of shares by the stock price
  • Calculate the enterprise value by adding the net debt position (debt -/- cash and other financial fixed assets) to the market value of the equity.
  • Determine the financial key figure for the multiple: for example, last year's turnover over the (normalized) EBITDA.
  • Divide the enterprise value by the financial metric.
  • Determine the mean and median of all calculated multiples.
  • Make an indicative correction of e.g. 25% to these stock market multiples to determine the multiple of a smaller, non-listed company
• Applying the multiples: Now it's time to apply the multiples to the company you want to value. Multiply the company's financial metric by the multiple.
• Comparison: Compare the results with another valuation method (for example the DCF method). You can do this by comparing the valuations (in euros or the applied currency) of both methods, or by determining the so-called 'implied multiple'. This is equal to the enterprise value of, for example, the DCF method divided by the financial metric. How does this implicit multiple compare to the peer multiple? Are these in the same range or are there major differences? What are the underlying assumptions that can explain these differences?

This valuation method is one of the 6 valuation methods in the Valid Value model.