What are the steps for choosing the appropriate multiples for a multiples valuation?

Appropriate valuation multiples depend on industry norms, company size, growth rate, profitability, and risk profile. Common multiples include P/E, EV/EBITDA, and P/S. They simplify complex financial data, offering a quick, relative assessment of a company's value. Multiples are crucial in comparing companies, reflecting market perceptions and aiding in relative valuation. They are valuable for investors seeking quick, informed decisions based on industry benchmarks and peer comparisons.

Why to use multiples? When the firm under consideration is privately held or non-public, then application of DCF is lengthy, cumbersome and expensive. So the multiplier approach works very well. The only careful exercise is to select appropriate multiples.

Selecting multiples requires a nuanced approach. Consider industry norms, company characteristics (size, growth, profitability), and the purpose of valuation. Use multiples from comparable company analyses, ensuring data consistency and investor relevance. Align chosen multiples with prevailing market conditions and financial metrics. Maintain consistency, benchmark against industry standards, and assess the unique aspects of the target company. This comprehensive approach ensures the selected multiples are relevant, reliable, and aligned with the specific context of the valuation.

There are two broad categories of multiples: Earning multiple and Enterprise value multiple. First category includes P/E, Book value, Asset value, Sales, Profit, Cash flows, and so on. The second one includes EBITDA, EBIT, BV, and so on. Selection of a few measures from both the categories can suffice. Though such a selection should be judicious, rational and focussed. For instance, if the firm under consideration is a manufacturing one, then fixed assets, book value, installed capacity, and carpet area can be appropriate multiples. In case of an FMCG firm, number of brands, sales revenue, EBITDA, and P/E can do the job.

The valuation objective is to determine the intrinsic worth of an asset, business, or investment. This process involves assessing and quantifying its economic value for various purposes such as financial reporting, mergers and acquisitions, investment decisions, taxation, or legal proceedings. Identifying the specific objective is crucial, as it guides the selection of appropriate valuation methods and factors considered in the analysis. Each valuation context, whether it's determining a fair market value for a sale or assessing the impact on financial statements, requires a tailored approach to achieve accurate and relevant results.

When selecting comparable companies or assets for valuation, ensure alignment with the target in terms of industry, size, geographic scope, and business model. Consider financial metrics, stage of development, operational factors, and overall financial health. Additionally, account for market conditions and recent comparable transactions. This meticulous selection process ensures relevant and accurate benchmarks for a more reliable valuation analysis.

First and foremost, gather the market price information of all the comparables. Do not hesitate to remove outliers. So the comparable firms having abnormally high or low values should be excluded. If the calculation is based on enterprise value multiples, then do not forget to apply correct expression, namely total market capitalisation plus total long-term debts minus cash. There shouldn't be any anomaly in applying the correct formula. In the absence of data, don't hesitate to remove the comparable firm.

To calculate multiples, select comparable firms, gather financial data, and compute metrics like P/E, EV/EBITDA, and P/S. Average multiples from comparables and apply them to the target's metrics for an estimated valuation. Conduct sensitivity analysis and adjust for differences. Cross-check results for consistency. This systematic approach provides a comparative valuation, offering insights into the target's potential value based on industry benchmarks.

To analyze and compare multiples, scrutinize the calculated metrics (P/E, EV/EBITDA, P/S) of the target against industry averages or peer benchmarks. Assess deviations and identify reasons for differences. Consider qualitative factors impacting valuation, such as growth prospects, market share, and competitive advantages. Evaluate the robustness of the multiples by examining their sensitivity to changes in assumptions. A thorough comparison provides a nuanced understanding of the target's valuation relative to its peers, aiding informed decision-making.

Apply the calculated multiples to the corresponding financial metrics of the target company to estimate its valuation. Adjust the multiples, if necessary, to account for any unique characteristics or differences between the target and comparable companies. Consider factors such as growth prospects, risk profile, and operational nuances. This adjustment ensures a more tailored and accurate reflection of the target's value, enhancing the reliability of the valuation analysis.