What is the 'Multiples Approach'

The multiples approach is a valuation theory based on the idea that similar assets sell at similar prices. This assumes that a ratio comparing value to some firm-specific variable (operating margins, cash flow, etc.) is the same across similar firms.

The multiples approach is also referred to as the multiples analysis or valuation multiples.

BREAKING DOWN 'Multiples Approach'

Generally, “multiples” is a generic term for a class of many different indicators that can be used to value a stock. A multiple is simply a ratio which is calculated by dividing the market or estimated value of an asset by a specific item on the financial statements or other measure. The multiples approach is a comparables analysis method that seeks to value similar companies using the same financial metrics. An analyst using this valuation approach assumes that a certain ratio is applicable and can be applied to various companies operating within the same line of business or industry. In other words, the idea behind the multiples analysis is that when firms are comparable, the multiples approach can be used to determine the value of one firm based on the value of another. The multiples approach seeks to capture many of a firm's operating and financial characteristics (e.g. expected growth) in a single number that can be multiplied by some financial metric (e.g. EBITDA) to yield an enterprise or equity value.

Enterprise value multiples and equity multiples are the two categories of valuation multiples. Enterprise value multiples include the enterprise value-to-sales ratio (EV/sales), EV/EBIT, and EV/EBITDA. Equity multiples involve examining ratios between a company’s share price and an element of the underlying company's performance, such as earnings, sales, book value, or something similar. Common equity multiples include price-earnings (P/E) ratio, price-earnings to growth (PEG) ratio, price-to-book ratio, and price-to-sales ratio. Equity multiples can be artificially impacted by a change in capital structure, even when there is no change in enterprise value (EV). Since enterprise value multiples allow for direct comparison of different firms, regardless of capital structure, they are said to be better valuation models than equity multiples. Additionally, enterprise valuation multiples are typically less affected by accounting differences, since the denominator is computed higher up on the income statement. However, equity multiples are more commonly used by investors because they can be calculated easily, and are readily available on most financial websites and newspapers.

In order to build a multiple, the companies that are similar to each other have to be identified first, and each of their market values evaluated. A multiple is then computed for the comparable companies, and aggregated into a standardized figure using a key statistics measure such as the mean or median. The value identified as the key multiple among the various companies is applied to the corresponding value of the firm under analysis in order to estimate its value. When building a multiple, the denominator should use a forecast of profits, rather than historical profits. Unlike backward-looking multiples, forward-looking multiples are consistent with the principles of valuation—in particular, that a company’s value equals the present value of future cash flow, not past profits and sunk costs.

  1. Enterprise Multiple

    A ratio used to determine the value of a company. The enterprise ...
  2. Price Multiple

    A price multiple is any ratio that uses the share price of a ...
  3. Multiple Compression

    Multiple compression is when a company's P/E ratio is reduced ...
  4. Comparable Company Analysis - CCA

    A process used to evaluate the value of a company using the metrics ...
  5. Realization Multiple

    A private equity measurement that values the return paid to an ...
  6. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, ...
Related Articles
  1. Investing

    5 Common Trading Multiples Used In Oil And Gas Valuation

    Before you decide to invest in oil and gas, you should understand these multiples.
  2. Investing

    The Three Things Most Good Stocks Have In Common

    Uncover the three things most good stocks have in common: performance, profitability and value.
  3. Personal Finance

    What to know for an investment banking interview

    Find out what you need to know and how to prepare for an investment banking interview.
  4. Investing

    The Difference Between Enterprise Value and Equity Value

    Enterprise value calculates a business’s current value, while equity value offers a snapshot of that business’s current and potential future value.
  5. Investing

    Learn The Lingo Of Private Equity Investing

    Because of the non-public nature of private equity, it can be difficult to the learn the lingo. We break it down here.
  6. Financial Advisor

    Introduction To Enterprise Value

    Learn how enterprise value can help investors compare companies with different capital structures.
  7. Personal Finance

    What Is Your Financial Services Business Worth?

    Understanding how much your practice is worth can help you make decisions about whether or not to sell the practice.
  8. Investing

    SXC Health Solutions Corp. (USA) Among the Nasdaq's Biggest Movers

    The market is having a bad day so far: the Nasdaq is trading down 0.3%; the S&P 500 has declined 0.4%; and the Dow has slipped 0.5%. The Nasdaq Composite Index is a capitalization-weighted index, ...
  1. What is the difference between enterprise value and equity value?

    Valuating a business accurately depends heavily on the purpose of the valuation. Learn how enterprise value and equity value ... Read Answer >>
  2. How do I use ratios to perform a financial analysis?

    Learn which ratios are used in fundamental analysis. Find out how analysts measure company performance and financial health ... Read Answer >>
  3. What role does ratio analysis play in valuing a company?

    Learn about the role of ratio analysis in determining company value, including some of the most common ratios used by modern ... Read Answer >>
  4. Which financial metrics are best for analyzing companies in the chemicals sector?

    Learn about some of the key financial metrics that investors and market analysts commonly use to evaluate companies in the ... Read Answer >>
Hot Definitions
  1. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  2. Entrepreneur

    An Entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture. ...
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  5. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  6. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
Trading Center