Basic Steps to Using Multiples

Using multiples for relative valuation involves a structured process to ensure a sound and reliable analysis. Here are the basic steps:

Step 1: Understand the Target Company:

• Business Overview: Gain a thorough understanding of the target company's business model, industry, products/services, target market, and competitive landscape.
• Financial Performance: Analyze the company's historical financial performance, including revenue growth, profitability, and cash flow.
• Key Drivers: Identify the key drivers of the company's value and performance.
• Qualitative Factors: Consider qualitative factors such as management quality, brand reputation, and regulatory environment.

Step 2: Select Comparable Companies (or Transactions):

• Identify Comparables: Identify a group of comparable companies that are similar to the target company in terms of:
  • Industry: Operating in the same or similar industry.
  • Business Model: Similar revenue streams, cost structures, and operating characteristics.
  • Size: Similar market capitalization or enterprise value.
  • Growth Prospects: Similar growth rates and growth potential.
  • Risk Profile: Similar financial leverage and operating risk.
• Sources of Comparables:
  • Industry Reports: Market research reports and industry publications.
  • Company Filings: 10-K and proxy statements of the target company and its competitors.
  • Financial Databases: Bloomberg, Reuters, FactSet, etc.
  • Investment Research: Equity research reports from investment banks and brokerage firms.
• Number of Comparables: Aim for a sufficient number of comparables (e.g., 5-10) to provide a reliable benchmark.
• Refine Comparable Set: Remove any companies that are clearly not comparable or are outliers.

Step 3: Calculate Relevant Multiples:

• Choose Appropriate Multiples: Select multiples that are relevant to the target company's industry and business model. Consider using a variety of different multiples (e.g., earnings multiples, revenue multiples, book value multiples, sector-specific multiples).
• Calculate Multiples for Comparables: Calculate the selected multiples for each of the comparable companies.
• Data Consistency: Ensure consistency in the way the multiples are calculated. Use the same definitions and accounting standards for all companies.
• Sources of Data: Obtain data from reliable sources, such as financial statements, company filings, and financial databases.

Step 4: Analyze and Adjust Multiples:

• Calculate Descriptive Statistics: Calculate descriptive statistics for the multiples of the comparable companies, such as the mean, median, high, and low.
• Identify Outliers: Identify any outliers in the data that may be skewing the results.
• Adjust for Differences: Adjust the multiples of the comparable companies to account for any significant differences between them and the target company.
  • Growth Adjustments: Adjust for differences in expected growth rates (e.g., using the PEG ratio).
  • Risk Adjustments: Adjust for differences in risk (e.g., using a risk premium).
  • Accounting Adjustments: Adjust for differences in accounting practices.
• Justify Adjustments: Clearly document and justify all adjustments that are made.

Step 5: Apply Multiples to the Target Company:

• Select a Benchmark Multiple: Choose a benchmark multiple to apply to the target company. This could be the mean, median, or a weighted average of the multiples of the comparable companies, adjusted for any differences between them and the target company.
• Apply the Multiple: Multiply the benchmark multiple by the appropriate financial metric of the target company to arrive at an estimate of its value.
• Consider a Range of Values: Recognize that the valuation is an estimate and consider a range of values based on different multiples and assumptions.
• For example: If benchmark P/E is 12 and expected earnings of the firm is $5, value = 12 * $5 = $60

Step 6: Evaluate and Conclude:

• Cross-Check with Other Valuation Methods: Compare the relative valuation to other valuation methods, such as DCF valuation, to ensure that the valuation is reasonable.
• Consider Qualitative Factors: Consider qualitative factors that may not be fully reflected in the multiples, such as management quality, brand reputation, and competitive advantages.
• Document Your Analysis: Clearly document all steps in the valuation process, including the selection of comparables, the calculation of multiples, the adjustments that were made, and the final valuation conclusion.
• Sensibility Check: Step back and ask: "Does this valuation make sense, given what I know about the company and its industry?"

By following these steps, you can use multiples to perform a sound and reliable relative valuation analysis. Remember that relative valuation is just one tool in the valuation toolkit, and it should be used in conjunction with other methods to arrive at a well-informed valuation conclusion.