Valuation using multiples

Valuation using multiples

Valuation using multiples is a method for determining the current value of a company by examining and comparing the financial ratios of relevant peer groups, also often described as comparable company analysis (or comps). The most widely used multiple is the price-earnings ratio (P/E ratio or PER) of stocks in a similar industry. Using the average of multiple PERs improves reliability but it can still be necessary to correct the PER for current market conditions.

P/E multiples are popular in part due to their wide availability. The value of a business should, however, be reflected in multiples based on enterprise value (EV/EBITDA, EV/EBIT, EV/NOPAT) of a company. These multiples reveal the rating of a business independently of its capital structure, and are the most commonly used in transactions on private companies.

Contents

Mathematics

ForMultiples.gif

Condition: Peer company is profitable.

Rf = discount rate during the last forecast year tf = last year of the forecast period. C = correction factor P = current stock Price NPP = net profit peer company S = number of shares NPO = net profit of target company after forecast period

Process Data Diagram

The following diagram shows an overview of the process of company valuation using multiples. All activities in this model are explained in more detail in section 3: Using the Multiples method.

MultiplesPDD.gif

Using the Multiples Method

Determine Forecast Period

Determine the year after which the company value is to be known.

Example:

‘VirusControl’ is an ICT startup that has just finished their business plan. Their goal is to provide professionals with software for simulating virus outbreaks. Their only investor is required to wait for 5 years before making an exit. Therefore VirusControl is using a forecast period of 5 years.

Identifying peer companies

Search the (stock)market for companies most comparable to the target company. From the investor perspective, a peer universe can also contain companies that are not only direct product competitors but are subject to similar cycles, suppliers and other external factors (e.g. a door and a window manufacturer may be considered peers as well).

Important characteristics include: operating margin, company size, products, customer segmentation, growth rate, cash flow, number of employees, etc.

Example:

VirusControl has identified 4 other companies similar to itself.

  • Medical Sim
  • Global Plan
  • Virus Solutions
  • PM Software

Determining correct Price Earning Ratio (P/E)

The price earnings ratio (P/E) of each identified peer company can be calculated as long as they are profitable. The P/E is calculated as:

P/E = Current Stock Price / (Net Profit / Number of shares)

Particular attention is paid to companies with P/E ratios substantially higher or lower than the peer group. A P/E far below the average can mean (among other reasons) that the true value of a company has not been identified by the market, that the business model is flawed, or that the most recent profits include, for example, substantial one-off items. Companies with P/E ratios substantially different from the peers (the outliers) can be removed or other corrective measures used to avoid this problem.

Example:

P/E ratio of companies similar to VirusControl:


 

Current Stock Price

Net profit

Number of Shares

P/E

Medical Sim

€16.32

€1.000.000

1.100.000

17.95

Global Plan

€19.50

€1.800.000

2.000.000

21.7

Virus Solutions

€6.23

€3.000.000

10.000.000

20.8

PM Software

€12.97

€4.000.000

2.000.000

6.5

One company, PM Software, has substantially lower P/E ratio than the others. Further market research shows that PM Software has recently acquired a government contract to supply the military with simulating software for the next three years. Therefore VirusControl decides to discard this PER and only use the values of 17.95, 21.7 and 20.8.

Determining future company value

The value of the target company after the forecast period can be calculated by:

Average corrected PER * net profit at the end of the forecast period.

Example:

VirusControl is expecting a net profit at the end of the fifth year of about € 2.2 million. They use the following calculation to determine their future value:

((17.95 + 21.7 + 20.8) / 3) * 2.200.000 = € 44.3 million

Determining discount rate / factor

Determine the appropriate discount rate and factor for the last year of the forecast period based on the risk level associated with the target company

Example:

VirusControl has chosen their discount rate very high as their company is potentially very profitable but also very risky. They calculate their discount factor based on five years.


Risk Rate

50%

Discount Rate

50%

Discount Factor

0.1316

Determining current company value

Calculate the current value of the future company value by multiplying the future business value with the discount factor. This is known as the time value of money.

Example:

VirusControl multiplies their future company value with the discount factor:

44,300,000 * 0.1316 = 5,829,880 The company or equity value of VirusControl : € 5.83 million



Wikimedia Foundation. 2010.

Игры ⚽ Нужно решить контрольную?

Look at other dictionaries:

  • Valuation (finance) — Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · Chart of accounts  …   Wikipedia

  • Business valuation — is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to consummate a sale of a… …   Wikipedia

  • Terminal value (finance) — This article is about finance concept. For other uses, see Terminal value (disambiguation). In finance, the terminal value (continuing value or horizon value) of a security is the present value at a future point in time of all future cash flows… …   Wikipedia

  • Prime number — Prime redirects here. For other uses, see Prime (disambiguation). A prime number (or a prime) is a natural number greater than 1 that has no positive divisors other than 1 and itself. A natural number greater than 1 that is not a prime number is… …   Wikipedia

  • Stock selection criteria — is a strategy in which an analyst or investor uses a systematic form of analysis to determine if a particular stock constitutes a good investment which should be added to their portfolio. The objective of stock selection criteria is maximizing… …   Wikipedia

  • Economic Affairs — ▪ 2006 Introduction In 2005 rising U.S. deficits, tight monetary policies, and higher oil prices triggered by hurricane damage in the Gulf of Mexico were moderating influences on the world economy and on U.S. stock markets, but some other… …   Universalium

  • Dodd–Frank Wall Street Reform and Consumer Protection Act — Full title An Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end too big to fail , to protect the American taxpayer by ending bailouts, to protect consumers… …   Wikipedia

  • Real estate bubble — This article is about the general phenomenon of housing bubbles. For housing bubbles in various countries, see below. A real estate bubble or property bubble (or housing bubble for residential markets) is a type of economic bubble that occurs… …   Wikipedia

  • Stock market bottom — A stock market bottom is a trend reversal that marks the end of a market downturn and the beginning of an upward moving trend. A bottom may occur because of the presence of a cycle, or because of panic selling as a reaction to an adverse… …   Wikipedia

  • Parity of zero — Zero objects, divided into two equal groups Zero is an even number. In other words, its parity the quality of an integer being even or odd is even. Zero fits the definition of even number : it is an integer multiple of 2, namely 0 × 2. As a… …   Wikipedia

Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”