Valuation of companies by multiples

The business valuation multiples is a method used in company valuation that helps to calculate the target value of a company.

Through this company valuation method This method of valuing companies by multiples does not calculate the absolute or intrinsic value of the company, but rather a range of values relative to other similar companies. It is used to better delimit the range previously obtained using the discounted cash flow method. It is a necessary complement for a good analysis.

Method by multiples

To do this multiples method of valuing companiesis necessary:

• Find a universe of comparable companies (either in the sector or companies that share similar characteristics).
• Operating in similar markets

Of all these companies that may share characteristics, those that are most closely related and comparable should be chosen.

There really is no other company like it, which is why we talk about relative valuationas this method does not calculate the true value of the company. However, because there are companies that behave similarly in the market, this valuation method can serve as a "proxy" when valuing a realistic range.

Once the selection of these companies has been made, the second phase is followed by an analysis of all the metrics that may make sense when valuing a company, such as the following:

• enterprise value divided by EBITDA
• the value of the company divided by the number of services offered

Metrics that vary and need to be analysed personally for each assessment.

Once all these multiples have been calculated, a statistical analysis is carried out to find which variables really influence the valuation of the company. The aim is to find which variables significantly affect the valuation of this group of companies. This analysis is crucial to understand which are the metrics that really affect the valuation of these comparable companies, as sometimes the "typical" variables such as EBITDA or sales are not the factors that most affect the valuation.

The data used for the metrics, both the valuation of companies and the various financial statements of comparable companies, can be obtained both from financial information, which must be published periodically by listed companies, and from data on past transactions.

Results of the multiples method of valuing companies

Once the hypotheses have been tested and the metrics that work in the sector have been discovered, we move on to the calculation of the mean and median of these multiples. Normally, the median of these multiples is of more interest, to avoid the effects of those companies that are at the top or that are less highly valued, and to find a more realistic valuation. However, the median of the multiples should not be ignored, as they can be used to understand the polarisation of sectors and to distinguish strata of comparable companies.

Thanks to these metrics, a valuation range is obtained, which is then applied in a complementary way to the discounted cash flow method, with the objective of making the valuation more precise, i.e. it serves as a complement to achieve a more accurate valuation as well as serving as a sanity check, avoiding errors in the assumptions used for the projection.

Limitations of the multiples method of business valuation

Even so, the method by multiples has certain limitations:

• The difficulty in finding companies that can best reflect the company's value we want to analyse: this problem can be very relevant, as there are sectors in which there are few companies and it is necessary to find companies in complementary sectors that have similar cycles or that can share the market in order to carry out this valuation, which implies the need for a personalised study by a team with extensive experience in the sector that knows how the sector is doing and which companies can behave in a similar way, as well as having knowledge of previous relevant transactions.

• The conviction of the results of this method. It is important to remember that valuation by multiples gives a range of relative values. Empirically it has been shown that this method creates a dispersion at the time of final valuation of around 30%, which has a significant impact on the final valuation. This is the reason why it is used as a complement to the discounted cash flow method and not as an absolute valuation method. The results obtained by valuation multiples have to be analysed in context in order to draw relevant conclusions.

• The choice of the different sensitive metrics This can be a challenge, as it requires a good selection of comparable companies, in order to be able to statistically verify the relationship between the chosen metrics and the final valuation of the companies. This is why experts are needed in business valuation that bring reasonableness and closeness to current market conditions, all of which are necessary to achieve a valuation that truly brings accuracy to the discounted cash flow methodology.