Standardized Values and Multiples (brief overview)

Earnings Multiples, Book Value Multiples, Revenue Multiples, and Sector-specific Multiples.

This topic provides a brief overview of standardized values and commonly used multiples in relative valuation, categorized by the financial metric they use. 1. Standardized Values (Multiples):

• Definition: A ratio of a company's market value (or enterprise value) to a financial metric. Multiples are used to standardize values, allowing for comparisons across different companies, regardless of their size.
• Purpose: To create a common metric that can be used to assess the relative valuation of different companies.
• Types: Multiples can be broadly classified based on the financial metric used in the denominator:
  • Earnings Multiples
  • Book Value Multiples
  • Revenue Multiples
  • Sector-Specific Multiples
• Choice of Numerator:
  • Equity Value (Market Capitalization): Used for multiples that reflect the value available to equity holders (e.g., P/E ratio, P/B ratio).
  • Enterprise Value (EV): Used for multiples that reflect the value of the entire company (both debt and equity) (e.g., EV/EBITDA, EV/Revenue). Enterprise value is calculated as Market Capitalization + Total Debt - Cash and Cash Equivalents.

2. Earnings Multiples:

• Concept: Relate a company's market value to its earnings. Earnings represent the profitability of the company.
• Common Earnings Multiples:
  • Price-to-Earnings Ratio (P/E): Market Capitalization / Net Income. The most widely used multiple. Reflects how much investors are willing to pay for each dollar of earnings.
    • Trailing P/E: Uses historical earnings (typically the past 12 months).
    • Forward P/E: Uses expected future earnings (typically the next 12 months).
  • PEG Ratio: P/E Ratio / Earnings Growth Rate. Adjusts the P/E ratio for the company's expected earnings growth rate.
  • EV/EBITDA: Enterprise Value / Earnings Before Interest, Taxes, Depreciation, and Amortization. A popular multiple for valuing companies with significant capital expenditures and depreciation.
  • EV/EBIT: Enterprise Value / Earnings Before Interest and Taxes. Similar to EV/EBITDA, but excludes depreciation and amortization.
• Advantages: Earnings are a key driver of value.
• Limitations: Can be distorted by accounting practices, cyclicality, and negative earnings.

3. Book Value Multiples:

• Concept: Relate a company's market value to its book value of equity or assets. Book value represents the historical cost of the company's assets.
• Common Book Value Multiples:
  • Price-to-Book Ratio (P/B): Market Capitalization / Book Value of Equity. Reflects how much investors are willing to pay for each dollar of book value.
  • EV/Book Value of Capital: Enterprise Value / (Book Value of Equity + Book Value of Debt - Cash).
  • Tobin's Q: Market Value of Assets / Replacement Cost of Assets. (Approximated as (Market Value of Equity + Debt)/Book Value of Assets.)
• Advantages: Book value is more stable than earnings. Useful for valuing companies with significant tangible assets.
• Limitations: Book value is based on historical cost, which may not reflect current market values. Can be distorted by accounting practices.

4. Revenue Multiples:

• Concept: Relate a company's market value to its revenue (sales). Revenue represents the top-line growth of the company.
• Common Revenue Multiples:
  • Price-to-Sales Ratio (P/S): Market Capitalization / Revenue. Reflects how much investors are willing to pay for each dollar of revenue.
  • EV/Revenue: Enterprise Value / Revenue. Useful for valuing companies with negative earnings or volatile earnings.
• Advantages: Revenue is less susceptible to accounting manipulation than earnings or book value. Useful for valuing companies with negative earnings.
• Limitations: Revenue does not reflect profitability. Companies with high revenue but low profit margins may be overvalued.

5. Sector-Specific Multiples:

• Concept: Use financial metrics that are specific to a particular industry.
• Examples:
  • Retail: Price-to-Sales, Revenue per Square Foot
  • Technology: Price-to-Subscribers, EV/Page Views
  • Real Estate: Price/Funds From Operations (FFO)
  • Oil & Gas: EV/Proven Reserves, EV/Daily Production
• Advantages: Provide more relevant comparisons within a specific industry.
• Limitations: May not be applicable to companies outside the specific industry.

In summary, the choice of which multiple to use depends on the specific characteristics of the company being valued, the availability of data, and the industry in which the company operates. It's generally recommended to use a variety of different multiples to get a more comprehensive view of the company's relative valuation.