The Valuation Multiples method is one of the most common approaches to valuation because it is quick and does not require detailed analysis of a company’s annual accounts
It is also an excellent approach when a company is private and the share price is not available.
Which Valuation Multiple to Use?
The best multiple for a particular company will depend on its industry and growth opportunities. Common multiples include:
|Enterprise Value/EBITDA||Price/Book Value of Equity||Sales/EBIT|
Note: Enterprise Value = Market value of equity + Debt – Cash and Cash Equivalents
Four Key Steps
- Identify peers/benchmarks for the company.
- Find valuation multiples for the comparator firms.
- Calculate the median or mean multiples of the peer group.
- Calculate the expected multiple for your chosen firm and use to value equity.
Given we are in December and the weather is dreadful outside, let’s use the Cruise firm, Carnival plc as a case study for the Valuation Multiple approach.
Step 1: Identify peers/benchmarks
Carnival plc is an international leisure and cruise firm with operations throughout the world. You can find out more about the company on their corporate website.
Our first step is to find Carnival’s peers. For a listed firm it’s as easy as searching for “company name peers” in Google. I did this and got the following set of results:
I went with the first entry in the list above and found that Carnival had two main competitors:
We have two peers: Norwegian Cruise Line Holdings Ltd, and Royal Carribean Cruises Ltd – both private firms.
Step 2: Find valuation multiples for the comparator firms.
Given we have private firms, there will be no share price available so we will use Enterprise Value ratios
*** For clarity, I don’t know anything about the Hotels and Leisure industry sector. To check, I did another search on google with the following request, “what are the best valuation multiples for hotels and leisure?”. The first result that came up was Enterprise Value/EBITDA, which is one of our ratios so we are on the right track ****
Step 3: Calculate the median or mean multiples of the peers
Simply calculate the average of the peer ratios and compare it to your target firm.
For our case study, let’s focus only on Enterprise Value/EBITDA. If you are doing a full analysis, you should use other ratios as well to triangulate your values.
The internet is a wonderful resource. I did another search on google for “Carnival plc Enterprise Value/EBITDA“. Our old friend, gurufocus.com, came to the rescue:
Doing the same thing for Norwegian Cruise Line Holdings, we get:
For Royal Caribbean Cruises Ltd we get:
Let’s bring the data together.
|Norwegian Cruise Line Holdings Ltd||12.25|
|Royal Caribbean Cruises Ltd||11.63|
|Average of Norwegian and Royal||11.94|
Step 4: Calculate the expected multiple for your chosen firm and use to value firm
From Gurufocus.com, Carnival has an Enterprise Value of $48.451 billion and an EBITDA of $4.430 billion.
On the basis of the comparator EV/EBITDA figure, you would expect the Enterprise Value for Carnival to be 11.94 x $4.430 billion = $52.894 billion, which is higher than the actual Enterprise Value of $48.451 billion.
It would look as if Carnival is underpriced compared to its two peers.
Strengths and Weaknesses of the Valuation Multiple Approach
- There is a massive number of different multiples you could look at and so you have different ways to carry out firm valuations.
- Ratios are simple to calculate and easy to interpret.
- You are valuing a firm based on other companies in the same sector. Differences between the actual share price and estimated values can provide much insight into where the company could improve its operations.
- This method is used for private firms and each industry will have standard valuation multiples to arrive at an expected value for a company. This is important when you are looking to sell your firm.
- It can be difficult to identify appropriate peers for the company. Choose the wrong ones and your value estimates will be wrong.
- It is easy to focus on the wrong multiples given that there are so many to choose from.
- The method does not actually look at the company’s figures but uses other company data to arrive at a value.
In this series of articles, I have shown a number of different ways to value companies. The exposition was necessarily simple to ensure the central concepts are presented in a clear and concise way.
There are many factors I didn’t consider as my objective was to show you the general approach to value firms, rather than to look at the specific valuation of any one firm.
If you want to know more about valuation multiples, you should check out Chapters 12 and 13 of my book, Financial Markets and Corporate Strategy, where I explore the method in much more depth.
I’m now going to take a break for a couple of weeks and when I return in January, I will continue with my valuation videos on YouTube.
See you in a few weeks!