12. Market-Based Valuation with Multiples

Overview

In this lesson, we use a variety of market multiples to find a valuation range for MarkerCo. The multiples calculate both enterprise value and equity value.

Summary

  1. Lesson Goal (00:04)

    The goal of this lesson is to calculate the value of MarkerCo using a variety of market multiples.

  2. Valuing MarkerCo Using Multiples (00:20)

    There are numerous different multiples that can be used to value a company. This lesson demonstrates five popular ones: Enterprise Value / EBITDA, Enterprise Value / Revenue, Price / Earnings, Price / Revenue, and Price / Book. We can find values for these multiples by analyzing the accounts of competitors who are publicly listed, and calculating the value of these multiples for those competitors.

    Once we’ve identified values for the multiples, we use them to calculate the equity value of the company. For example, to value the company using the Price / Revenue multiple, we multiply revenue for the last year of actual accounts by the value of the multiple. This gives us the price, or equity value, for the company. When using the enterprise value multiples, we need to add cash and subtract debt from the enterprise value to get the equity value.

    Here is an explanation of some of the terms used in these multiples:

    • Price: Price is equivalent to the equity value. In this context, it means price per share.
    • Earnings: Earnings refers to the net profit in the Income Statement.
    • Book: Book refers to the total equity in the Balance Sheet.
  3. Analyzing the Valuations (02:37)

    The valuations produced by using multiples can differ from the valuations produced by the discounted cashflow method. For example, in our case, all the market multiples produce a lower valuation that the discounted cashflow method. There are several possible explanations for this:

    1. The market undervalues the business. This could occur if competitor companies don’t have the same growth prospects as our company.
    2. We overvalue the business. This can happen if our growth assumptions are too aggressive and not realistic.
    3. We have selected the wrong market multiple. This can happen if we select the wrong competitor companies to compare our company with.

    Understanding why valuation discrepancies occur is a key ability of a strong analyst.

  4. Resource: Understanding the Multiples Used in This Lesson (03:40)

    EV / EBITDA (Enterprise Value / EBITDA)

    • Pro: Can be used to compare companies with different debt levels
    • Pro: Removes the impact of amortisation and depreciation, which can be manipulated
    • Con: Does not include capital expenditure which can hide a big cash drain

    EV / Revenue (Enterprise Value / Revenue)

    • Pro: Can be used to compare companies with different debt levels
    • Pro: Can be used to value companies that have yet to turn a profit (e.g. startups)
    • Con: Does not address profitability

    Price / Earnings (Equity Value / Net Profit)

    • Pro: Earnings is a measure of what is generated for shareholders
    • Pro: Widely used by convention across industry
    • Con: Earnings are prone to manipulation
    • Con: Different accounting policies (e.g. on depreciation) can lead to difficulty finding comparable companies

    Price / Revenue (Equity Value / Revenue)

    • Pro: Less susceptible to accounting manipulation
    • Pro: Can be used to value companies that have yet to turn a profit (e.g. startups)
    • Con: Does not address profitability

    Price / Book (Equity Value / Shareholders' Equity)

    • Pro: Can be used when company is not profitable
    • Pro: Less volatile than Price / Earnings
    • Con: Different accounting methods can lead to complications when comparing book values
    • Con: Does not take intangibles such as brand value into account

Transcript

In the previous lesson, we calculated the equity value using a discounted cash flow method from MarkerCo. This gave us an implied equity value for the business. In this lesson, we're going to compare the discounted cash flow method with some mark up multiples. MarkerCo is a privately held company, however a couple of its competitors are publicly listed. Which enables us to find some comparable multiples to use. There are many different multiples used to value companies. But I've selected probably the 5 most popular for this lesson. Two of which relate to enterprise value and three of which relate to equity value otherwise referred to as price, which means the price per share. From MarkerCo's publicly traded competitors, I've found multiple values for the company. So let's calculate these quickly. The first multiple is enterprise value all over EBITDA. I want to calculate the equity value for all of my multiples, so when I'm calculating the enterprise value, I'm going to first need to add cash and cash equivalents. And then I'll take the multiple and multiply by EBITDA to find the enterprise value. And I can find EBITDA for 2015 right here.

And this gives me my equity valuation. I'll prefer a similar calculation for the enterprise value divided by revenue. So again, I'll take cash add it to the multiple, multiplied by revenue which, of course, I find in the Income Statement.

Here we go.

Now I'll move on to the multiplies that allow me to calculate equity value directly. Price earnings takes the multiple and multiplies it by net profit.

Here we have net profit.

Price revenue, again takes the multiple and multiplies it by revenue. Again, in the Income Statement which I find by scrolling up.

And price to book, which you may not have seen before, takes the multiple and multiplies it by the shareholder's equity that is currently on the Balance Sheet.

And here it is.

Comparing our public multiples against the discounted cash flow we performed earlier, there's clearly a disconnect between what we think the company is worth and what the market does. This can mean a number of things. One, the comparable companies do not show the same growth prospects as MarkerCo and the public comparable undervalued the business. Two, our growth assumptions are too aggressive for MarkerCo and we have overvalued the business. And the three, we have not picked the correct comparable companies. In general, we should be able to account for point three. Points one and two however, distinguish between good and bad analysts. If you have the ability to identify value where the market does not, you can create a huge amount of wealth for yourself and your employer. However, getting a valuation wrong can destroy value very quickly. In the next lesson, I'm going to show you how to use these valuations to calculate the internal rate of return and net present value for an investor interested in buying MarkerCo.

Financial Modeling Essentials
Performing Your First Company Valuation