What are Valuation Multiples?

Valuation multiples are financial measurement tools that evaluate one

financial metric as a ratio of another, in order to make different
companies more comparable. Multiples are the proportion of one
financial metric (i.e. Share Price) to another financial metric (i.e.
Earnings per Share). It is an easy way to compute a company’s value
and compare it with other businesses.  Let’s examine the various types
of multiples used in business valuation.
 

 
Types of Valuation Multiples
There are two main types of valuation multiples:
1. Equity Multiples
2. Enterprise Value Multiples
 
There are two main methods of performing analysis using multiples:
1. Comparable Company Analysis (“Comps”)
2. Precedent Transaction Analysis (“Precedents”)
 
Advantages and Disadvantages of Valuation Multiples
Using multiples in valuation analysis helps analysts make sound
estimates when valuing companies. This is especially true when
multiples are used appropriately because they provide valuable
information about a company’s financial status. Furthermore, multiples
are relevant because they involve key statistics related to investment
decisions. Finally, the simplicity of multiples makes them easy to use for
most analysts.
However, this simplicity can also be considered a disadvantage because
of the fact that it simplifies complex information into just a single value.
This simplification can lead to misinterpretation and makes it
challenging to break down the effects of various factors.
Next, multiples portrait a snapshot of a company’s status rather than its
potential. As such, they do show how a company grows or progresses.
Therefore, multiples reflect short-term rather than long-term values.
 

 
The image above is an example of Comparable Company Valuation
Multiples from CFI’s Business Valuation Course.
 
1. Equity Multiples
Investment decisions make use of equity multiples especially when
investors look to acquire minor positions in companies. The list below
shows some common equity multiples used in valuation analyses.
 P/E Ratio – the most commonly used equity multiple; input data
is easily accessible; computed as the proportion of Share Price
to Earnings Per Share (EPS)
  Price/Book Ratio – useful if assets primarily drive earnings;
computed as the proportion of Share Price to Book Value Per
Share
 Dividend Yield – used for comparisons between cash returns and
investment types; computed as the proportion of Dividend Per
Share to Share Price
 Price/Sales – used for firms that make losses; used for quick
estimates; computed as the proportion of Share Price to Sales
(Revenue) Per Share
However, a financial analyst must take into account that companies
have varying levels of debt that ultimately influence equity multiples.
 
2. Enterprise Value (EV) Multiples
When an assessment is needed on a merger and acquisition, enterprise
value multiples are the more appropriate multiples to use, as they
eliminate the effect of debt financing. The list below shows some
common enterprise value multiples used in valuation analyses.
 EV/Revenue – slightly affected by differences in accounting;
computed as the proportion of Enterprise Value to Sales or
Revenue.
 EV/EBITDAR – most used in industries in the hotel and transport
sectors; computed as the proportion of Enterprise Value to
Earnings before Interest, Tax, Depreciation & Amortization, and
Rental Costs
 EV/EBITDA – EBITDA can be used as a substitute of free cash
flows; is the most used enterprise value multiple; computed as
Enterprise Value / Earnings before Interest, Tax, Depreciation &
Amortization
 EV/Invested Capital – used for capital-intensive industries;
computed as the proportion of Enterprise Value to Invested
Capital
There are many more equity and enterprise value multiples used in
company valuation, this article only presented the most common ones.
A thorough understanding of each multiple and related concepts can
help analysts better apply multiples in making financial analyses.
 
Compare equity value and enterprise value.
 
Methods of Using Multiples
All of the above, are utilized within the two common approaches to
valuation multiples:
 Comparable Company Analysis – This method analyzes public
companies that are similar to the company being valued. An
analyst will gather share prices, market capitalization, capital
structure, revenue, EBITDA, and earnings for each company.
Learn more about performing comparable company analysis.
 
 Precedent M&A Transactions – This method analyzes past
mergers and acquisitions (M&A) for companies in the same
industry, which can be used as a reference point for the company
that is being valued. Learn all about performing precedent
transaction analysis.
 

What is EV/EBITDA?
EV/EBITDA is a ratio that compares a company’s Enterprise Value (EV) to
its Earnings Before Interest, Taxes, Depreciation & Amortization
(EBITDA).  The EV/EBITDA ratio is commonly used as a valuation metric
to compare the relative value of different businesses.
In this guide, we will break down the EV/EBTIDA multiple into its various
components and walk you through how to calculate it step by step.
Learn more in CFI’s Business Valuation Techniques course.
 
What is the EV/EBITDA Multiple Used For?
The ratio of EV/EBITDA is used to compare the entire value of a
business with the amount of EBITDA it earns on an annual basis.  This
ratio tells investors how many times EBITDA they have to pay, were
they to acquire the entire business.
The most common uses of EV/EBITDA are:
 To determine what multiple a company is currently trading at (I.e
8x)
 To compare the valuation of multiple companies (i.e. 6x, 7.5x, 8,
and 5.5x across a group)
 To calculate the terminal value in a Discounted Cash Flow DCF
model
 In negotiations for the acquisition of a private business (i.e. the
acquirer offers 4x EBITDA)
 In calculating a target price for a company in an equity research
report
 
To learn more about how to use EV/EBITDA multiples, check out
our business valuation fundamentals course.
 
What is EV?
EV stands for Enterprise Value and is the numerator in the EV/EBITDA
ratio.  A firm’s EV is equal to its equity value (or market capitalization)
plus its debt (or financial commitments) less any cash (debt less cash is
referred to as net debt).
 
To learn more, see our guide to Enterprise Value vs Equity Value.
 
What is EBITDA?
EBITDA stands for Earnings Before Interest Taxes Depreciation
and Amortization.  It often used in valuation as a proxy for cash flow,
although for many industries it is not a useful metric.
 
 
To learn more, read our Ultimate Cash Flow Guide.
 
EV/EBITDA in a Comps Table
The most common way to see the EV/EBITDA multiple displayed is in
a comparable company analysis (referred to as Comps for short).
Below is an example of the EV/EBITDA ratios for each of the 5
companies in the beverage industry.  As you will see by the red lines
highlighting the relevant information, by taking the EV column and
dividing it by the EBITDA column, one arrives at the EV/EBITDA column.
 
 
An analyst looking at this table may make several conclusions,
depending on other information they have about the company.  For
example, Monster Beverage has the highest EV/EBITDA multiple which
could be because it has the highest growth rate, is considered the
lowest risk, has the best management team, and so on.
 
Pros and Cons of EV/EBITDA
There are many pros and cons to using this ratio.  As with most things,
whether or not it is considered a “good” metric depends on the specific
situation.
Pros include:
 Easy to calculate with publicly available information
 Widely used and referenced in the financial community
 Works well for valuing stable, mature businesses with low capital
expenditures
 Good for comparing relative values of different businesses
Cons include:
 May not be a good proxy for cash flow
 Does not take into account capital expenditures
 Hard to adjust for different growth rates
 Hard to justify observed “premiums” and “discounts” (mostly
subjective)
To learn more about valuation multiples, check out our business
valuation fundamentals course.
 
How to Learn to Calculate EV/EBITDA
The best way to learn is by doing.  If you want to calculate Enterprise
Value to EBITDA ratios for a group of companies, follow these steps and
try on your own.
10 steps to calculate EV/EBITDA and value a company:
1. Pick an industry (i.e. the beverage industry, as in our example)
2. Find 5-10 companies that you believe are similar enough to
compare
 3. Research each company and narrow your list by eliminating any
companies that are too different to be comparable (i.e. too
big/small, different product mix, different geographic focus, etc.)
4. Gather 3 years of historical financial information for each
company (i.e. revenue, gross profit, EBITDA, and EPS)
5. Gather current market data for each company (i.e. share price,
number of shares outstanding, and net debt)
6. Calculate the current EV for each company (i.e. market
capitalization plus net debt)
7. Divide EV by EBITDA for each of the historical years of financial
data you gathered
8. Compare the EV/EBITDA multiples for each of the companies
9. Determine why companies have a premium or discounted
EV/EBITDA ratio
10. Make a conclusion about what EV/EBITDA multiple is
appropriate for the company you’re trying to value
To learn more about how to use valuation multiples, check out
our business valuation fundamentals course.
 
EV/EBITDA Calculator
Download CFI’s free EV to EBITDA Excel Template to calculate the ratio
and play with some examples on your own.
 
 
What is the Enterprise Value to Revenue Multiple?
The Enterprise Value to Revenue Multiple is a valuation metric used to
value a business by dividing its enterprise value (equity plus debt minus
cash) by its annual revenue. The EV to revenue multiple is commonly
used for early-stage or high-growth businesses that don’t have positive
earnings yet.
 
Why Use the EV to Revenue Multiple?
If a company doesn’t have positive Earnings Before Interest Taxes
Depreciation & Amortization (EBITDA) or positive Net Income, it’s not
possible to use EV/EBITDA or P/E ratios to value the business. In this
case, a financial analyst will have to move further up the income
statement to either gross profit or all the way up to revenue.
If EBITDA is negative, then having a negative EV/EBITDA multiple is not
useful. Similarly, a company with a barely positive EBITDA (almost zero)
will result in a massive multiple, which isn’t very useful either.
For these reasons, early-stage companies (often operating at a loss)
and high growth companies (often operating at breakeven) require an
EV/Revenue multiple for valuation.
 
EV to Revenue Multiple Formula
The formula for calculating the multiple is:
= EV / Revenue
 
Where:
 EV (Enterprise Value) = Equity Value + All Debt + Preferred
Shares – Cash and Equivalents
 Revenue = Total Annual Revenue
 
Below is a screenshot of the calculation in Excel:
 

What are the Pros and Cons of the EV to Revenue Multiple?

As with any valuation method, there are advantages and disadvantages,
which are outlined below:
Pros:
 Useful for companies with negative earnings
 Useful for businesses with negative or near zero EBITDA
 Easy to find revenue figures for most businesses
 Easy to calculate the ratio
Cons:
 Does not take into account the company’s capital structure
  Ignores profitability and cash flow generation
 Hard to compare across different industries and different growth
stages of companies (early vs. mature)

P/E Multiple

What is the Price Earnings Ratio?

The Price Earnings Ratio (P/E Ratio) is the relationship between a
company’s stock price and earnings per share (EPS). It is a popular ratio
that gives investors a better sense of the value of the company. The P/E
ratio shows the expectations of the market and is the price you must
pay per unit of current earnings (or future earnings, as the case may
be).
Earnings are important when valuing a company’s stock because
investors want to know how profitable a company is and
how profitable it will be in the future. Furthermore, if the company
doesn’t grow and the current level of earnings remains constant, the
P/E can be interpreted as the number of years it will take for the
company to pay back the amount paid for each share.
 
Image: CFI’s  Financial Analysis Courses.
 
P/E Ratio in Use
Looking at the P/E of a stock tells you very little about it if it’s not
compared to the company’s historical P/E or the competitor’s P/E from
the same industry. It’s not easy to conclude whether a stock with a P/E
of 10x is a bargain or a P/E of 50x is expensive without performing any
comparisons.
The beauty of the P/E ratio is that it standardizes stocks of different
prices and earnings levels.
The P/E is also called an earnings multiple. There are two types of P/E:
trailing and forward. The former is based on previous periods of
earnings per share, while a leading or forward P/E ratio is when EPS
calculations are based on future estimates, which predicted numbers
(often provided by management or equity research analysts).
 
Price Earnings Ratio Formula
P/E = Stock Price Per Share / Earnings Per Share
or
P/E = Market Capitalization / Total Net Earnings
or
Justified P/E = Dividend Payout Ratio / R – G
where;
R = Required Rate of Return
G = Sustainable Growth Rate
 
P/E Ratio Formula Explanation
The basic P/E formula takes the current stock price and EPS to find the
current P/E. EPS is found by taking earnings from the last twelve
months divided by the weighted average shares outstanding. Earnings
can be normalized for unusual or one-off items that can
impact earnings abnormally. Learn more about normalized EPS.
The justified P/E ratio is used to find the P/E ratio that an
investor should be paying for, based on the companies dividend
and retention policy, growth rate, and the investor’s required rate of
return. Comparing justified P/E to basic P/E is a common
stock valuation method.
 
Why Use the Price Earnings Ratio?
Investors want to buy financially sound companies that offer a
good return on investment (ROI). Among the many ratios, the P/E is
part of the research process for selecting stocks because we can figure
out whether we are paying a fair price.
Similar companies within the same industry are grouped together for
comparison, regardless of the varying stock prices. Moreover, it’s quick
and easy to use when we’re trying to value a company using earnings.
When a high or a low P/E is found, we can quickly assess what kind of
stock or company we are dealing with.
 
 
High P/E
Companies with a high Price Earnings Ratio are often considered to be
growth stocks. This indicates a positive future performance, and
investors have higher expectations for future earnings growth and are
willing to pay more for them.
The downside to this is that growth stocks are often higher in volatility,
and this puts a lot of pressure on companies to do more to justify their
higher valuation. For this reason, investing in growth stocks will more
likely be seen as a risky investment. Stocks with high P/E ratios can also
be considered overvalued.
 
Low P/E
Companies with a low Price Earnings Ratio are often considered to be
value stocks. It means they are undervalued because their stock prices
trade lower relative to their fundamentals. This mispricing will be a
great bargain and will prompt investors to buy the stock before the
market corrects it. And when it does, investors make a profit as a result
of a higher stock price. Examples of low P/E stocks can be found in
mature industries that pay a steady rate of dividends. 
 
P/E Ratio Example
If Stock A is trading at $30 and Stock B at $20, Stock A is not necessarily
more expensive. The P/E ratio can help us determine, from a valuation
perspective, which of the two is cheaper. 
If the sector’s average P/E is 15, Stock A has a P/E = 15 and Stock B has a
P/E = 30, stock A is cheaper despite having a higher absolute price than
Stock B because you pay less for every $1 of current earnings. However,
Stock B has a higher ratio than both its competitor and the sector. This
might mean that investors will expect higher earnings growth in the
future relative to the market.
The P/E ratio is just one of the many valuation measures and financial
analysis tools that we use to guide us in our investment decision, and it
shouldn’t be the only one.
 
Forward Multiple

he Forward Price-to-Earnings or Forward P/E Ratio

The forward P/E ratio (or forward price-to-earnings ratio) divides the
current share price of a company by the estimated future
(“forward”) earnings per share (EPS) of that company.  For valuation
purposes, a forward P/E ratio is typically considered more relevant than
a historical P/E ratio.

 
What is the Formula for the Forward P/E Ratio?
The formula to calculate the forward P/E ratio is the same as
the regular P/E ratio formula, however, estimated (or forecasted)
earnings per share are used instead of historical figures.
Forward P/E formula:
= Current Share Price / Estimated Future Earnings per Share
 
For example, if a company has a current share price of $20, and next
year’s EPS is expected to be $2.00, then the company has a forward P/E
ratio of 10.0x.
 
Where to get the Estimated EPS
The most challenging part of calculating the ratio is determining what
the estimated future EPS of the company should be.  The most
common places to find estimates are:
 Equity research reports
 Bloomberg
 Capital IQ
 Google Finance
 Yahoo Finance
 Create your own estimate
 
For valuation purposes, analyst consensus is the preferred method of
determining future EPS.  Analyst consensus represents the average (or
“consensus”) of all the equity research analysts that cover a stock and
submit their estimates to IBES on Bloomberg or another data set.
If you don’t have access to that information, you can typically find
estimates for large-cap stocks on sites like Google Finance and Yahoo
Finance.
 
Forward-looking Stock Market
Since the stock market is forward-looking (as opposed to backward), it
places more emphasis on what is expected to happen in the future,
rather than what happened in the past.
For this reason, more emphasis is typically placed on forward valuation
multiples, rather than historical multiples.
 
Download the Forward P/E Template
Download our forward P/E ratio template to use your own numbers in
Excel and perform a forward-looking valuation of companies.  After
downloading the template, input their current share prices and two
years of futures EPS estimates, and the P/E ratios will automatically be
calculated.
 

What is the Trailing P/E Ratio?

The trailing price to earnings ratio – trailing P/E ratio – is the most
commonly used of the P/E variations (trailing versus forward). The
trailing P/E ratio accounts for a company’s actual earnings instead of its
projected earnings. It is considered one of the most accurate ways of
determining how valuable a company (or its stock) actually is; it offers –
in a perfect market – a fair valuation of a stock.
 
Formula for Trailing P/E Ratio
The trailing P/E ratio is calculated as follows:
 

 
Importance of Price to Earnings
Determining price to earnings is important specifically to investors
because it shows what is actually being paid per dollar that a company
logs in its bottom line. There is a clear bargain to be obtained if an
investor can tap into profits for a fairly low price. If the cost is high in
relation to earnings, an investor needs to ask the reason behind it.
As discussed above, the trailing P/E ratio provides the clearest insight
into the actual value of a company and its stock because it uses
historical earnings per share.
 
What is the Forward P/E Ratio?
The forward P/E ratio is different and somewhat less popular. The
forward P/E ratio divides a stock’s current share price by future
earnings. The formula is sometimes referred to as estimated price to
earnings.
The forward P/E ratio offers a few benefits. It helps compare a
company’s current earnings to those that it is on track to make in the
future. Still, the future earnings guidance is often updated or changed
as new figures come in, meaning investors need to pay close attention
when using the forward-looking indicator.
The major downside to the forward P/E ratio is that companies often try
to beat the system. They may initially claim higher earnings, then adjust
the figure as they head into the next announcement of earnings. Or,
they may claim a lower earnings figure in one quarter so that the next
quarter beats the estimate.