Valuation of companies by multiples

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

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

This method of valuation of 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 perform this method of valuation of companies by multiples, it is necessary:

  • Find a universe of comparable companies (either in the industry 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 such thing as an equal company, which is why we talk about, since 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, we move on to the second phase where an analysis of all the metrics that may make sense when valuing a company is performed, such as:

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

Metrics that vary and have to be analyzed personally in each valuation.

Once all these multiples have been calculated, a statistical analysis is carried out to find out which variables really influence the valuation of the company. We seek to find which variables significantly affect this group of companies in the valuation. This analysis is crucial to understand which are the metrics that truly affect the valuation of these comparable companies, since sometimes "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 the companies and the various financial statements of the comparable companies, can be obtained both from financial information, which must be published periodically by the listed companies, and from data on previous transactions.

Results of the valuation of companies by multiples

Once the hypotheses have been checked and the metrics that work in the sector have been discovered, the average and median of these multiples are calculated.

Normally, the median of these multiples tends to be more interesting, to avoid the effects of those leading or worst valued companies, finding a more realistic valuation. However, one should not disregard the average of the multiples, as they can be used to understand the polarization of the sectors and 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 aim of better specifying the valuation, i.e., it serves as a complement to achieve a more accurate valuation and also serves as a sanity test, avoiding errors in the assumptions used for the projection.

Limitations of the valuation of companies by multiples

Even so, the multiples method has certain limitations:

valoracion de empresas por multiplos
  • The difficulty of finding the companies that can best reflect the value of the company we want to analyze: this problem can be very relevant, since there are in 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 market in order to carry out this valuation, which entails the need for a customized study by a team with extensive experience in the sector that know how the sector is and which companies can behave in a similar way, in addition to having knowledge of relevant previous 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 demonstrated that this method creates a dispersion at the time of the 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 through the valuation by multiples must be analyzed in context in order to obtain relevant conclusions.
  • The choice of the different company-sensitive metrics 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 valuation experts are needed to provide a sound understanding of the current market conditions, all of which is necessary to achieve a valuation that really brings accuracy to the basic discounted cash flow methodology.
The M&A Professionals



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