Comparable Company Multiples

Question 1

Two types of Comparable methods

Answer 1

1) Public Company Multiples - An analysis of multiples based on the publicly traded equity prices for securities (typically common shares) of a public company lusted on a given stock exchange.
2) Precedent Transaction Multiples - Multiples based on open market transactions (that are not based on stock exchanges trading prices), whether public or private.

Question 2

What are the 5 most common multiples used in valuation practice?

Answer 2

1) EBITDA to find EV/EBITDA
Benefits:
- Analyzes the effects of profitability and return.
- eliminates the effects of financial leverage.
- not impacted by differing capital structures

Challenges:
- accounting practices could impair results, if some companies are expenses certain items while others are capitalizing them.

Assumes:

• that CapEx are proportionately similar amongst all companies in the industry.
• that what gets depreciated is fairly uniform across the industry.

2) EBIT to find EV/EBIT
- same as above, but can be relatively better measure than EBITDA for capital intensive companies, because they directly consider depreciation.

3) Revenue to find EV/Rev
Benefits:
- available for companies that are not profitable.
- fast growth companies that are prioritizing growth over profitability.

4) Net Book Value to find Price-to-book Ratio
Benefit:
- used in industries where tangible assets are important component of value.
- because ratio requires data for a specific date rather than a period of time, this approach is typically used as a means of assessing a value conclusion from other valuation approaches.

Challenges:
- not useful in non-capital intensive businesses where there are limited tangible assets on the balance sheet and where can also be significantly impacted by accounting policies.

Formula:

     Market Capitalization ------------------------------------------------- book value of shareholders equity

5) Net Earnings to find Price-to-earnings ratio
Benefits:
- useful where investments and debt are more closely related to operations than to pure financing activities (financial institutions for example).
- also used where P/E ratios are relied on or when companies have materially different income tax rates or tax positions.

Challenges:

• identically performing companies will receive differing valuation results due to differing capital structures. When valuating, the valuator must make notional adjustments to debt and/or interest expense for all of the comparables and the subject company in order to have consistent assumptions related to its financial structures.
• this process is typically complex and the use of net earnings ratio as a valuation multiple is limited to the industries noted above.

Question 3

Adjustments to be made to Publicly traded multiples

Answer 3

1) Adjustment for Liquidity
- Public multiples, especially those that have large trading volumes, should be adjusted down when being compared to a private company, which doesn’t have a readily available liquid market.

2) Adjustment for Minority Discount
- Public multiples inherently have a minority discount banked into the price. This should be adjusted out of the multiple, or offset against the adjustment for liquidity when comparing to a private company.