Multiples: First Principles |
In relative valuation, the objective is to value assets,
based upon how similar assets are currently priced in
the market. While multiples are easy to use and
intuitive, they are also easy to misuse. Consequently, a
series of tests were developed that can be used to
ensure that multiples are correctly used. There are two
components to relative valuation. The first is that, to
value assets on a relative basis, prices have to be
standardized, usually by converting prices into
multiples of earnings, book values or sales. The second
is to find similar firms, which is difficult to do since
no two firms are identical and firms in the same
business can still differ on risk, growth potential and
cash flows. The question of how to control for these
differences, when comparing a multiple across several
firms, becomes a key one.
This article covers reasons for popularity, potential
pitfalls, standardized values and multiples, basic steps
for using multiples. pdf |