Intro to Finance: Valuation - Multiples Valuation, PE PB EV/EBITDA Comparable Company Analysis

What This Is

Multiples valuation is a method used to estimate a company's intrinsic value by comparing its stock price to its financial metrics, such as earnings, book value, or enterprise value. This approach is useful for investors and analysts who want to quickly assess a company's valuation without performing a detailed discounted cash flow (DCF) analysis. For example, let's say Apple's stock price is $150 and its earnings per share (EPS) is $10. Using the price-to-earnings (P/E) multiple, we can estimate Apple's intrinsic value as $1,500 (P/E multiple x EPS).

Key Formulas & Symbols

• P/E = Market Price per Share / Earnings per Share where P/E = price-to-earnings multiple, Market Price per Share = current stock price, Earnings per Share = net income / number of shares outstanding.
• P/B = Market Price per Share / Book Value per Share where P/B = price-to-book multiple, Market Price per Share = current stock price, Book Value per Share = total equity / number of shares outstanding.
• EV/EBITDA = Enterprise Value / Earnings Before Interest, Taxes, Depreciation, and Amortization where EV/EBITDA = enterprise value-to-EBITDA multiple, Enterprise Value = market capitalization + debt - cash, EBITDA = earnings before interest, taxes, depreciation, and amortization.
• Comparable Company Analysis (CCA) = Average P/E of Peer Companies x Earnings per Share where CCA = comparable company analysis estimate, Average P/E of Peer Companies = average P/E multiple of peer companies, Earnings per Share = net income / number of shares outstanding.
• Enterprise Value (EV) = Market Capitalization + Debt - Cash where EV = enterprise value, Market Capitalization = number of shares outstanding x current stock price, Debt = total debt, Cash = total cash and cash equivalents.
• Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) = Net Income + Interest Expense + Taxes + Depreciation + Amortization where EBITDA = earnings before interest, taxes, depreciation, and amortization, Net Income = net income, Interest Expense = interest expense, Taxes = taxes, Depreciation = depreciation, Amortization = amortization.

Step-by-Step Calculation

1. Gather the necessary data: market price per share, earnings per share, book value per share, enterprise value, EBITDA, and the average P/E multiple of peer companies.
2. Calculate the P/E multiple by dividing the market price per share by the earnings per share.
3. Calculate the P/B multiple by dividing the market price per share by the book value per share.
4. Calculate the EV/EBITDA multiple by dividing the enterprise value by the EBITDA.
5. Calculate the CCA estimate by multiplying the average P/E multiple of peer companies by the earnings per share.

Common Mistakes

• Mistake: Using the book value of equity instead of the market value of equity to calculate the P/B multiple.
• Correction: Use the market value of equity, which is the current stock price x number of shares outstanding, to calculate the P/B multiple.
• Mistake: Failing to adjust the EBITDA for non-operating items, such as interest expense and taxes.
• Correction: Adjust the EBITDA for non-operating items to get a more accurate estimate of the company's operating performance.
• Mistake: Using the average P/E multiple of peer companies without considering the company's growth prospects and risk profile.
• Correction: Consider the company's growth prospects and risk profile when selecting peer companies and estimating the CCA.

Exam / CFA Tips

• Tip: Be prepared to calculate the P/E multiple and P/B multiple for a given company and explain the implications of each multiple.
• Tip: Understand the differences between the P/E multiple and the P/B multiple and how they are used in valuation.
• Tip: Be prepared to explain the limitations of the EV/EBITDA multiple and how it is used in valuation.

Quick Practice Problem

Apple's stock price is $150 and its earnings per share is $10. What is the P/E multiple?

Answer: 15 (P/E multiple = Market Price per Share / Earnings per Share = $150 / $10) Explanation: The P/E multiple is a useful metric for estimating a company's intrinsic value by comparing its stock price to its earnings per share.

Last-Minute Cram Sheet

• The P/E multiple is sensitive to changes in earnings per share.
• The P/B multiple is useful for companies with low or negative earnings.
• EV/EBITDA is a useful multiple for companies with high levels of debt.
• CCA is a useful method for estimating a company's intrinsic value when there are few comparable companies.
• The P/E multiple is not a good indicator of a company's growth prospects.
• The P/B multiple is not a good indicator of a company's risk profile.
• EV/EBITDA is not a good multiple for companies with high levels of cash and cash equivalents.
• CCA is not a good method for estimating a company's intrinsic value when there are many comparable companies.