Multiples

Enzo Mondello
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Enzo Mondello: CfBS Center for Business Studies AG

Chapter 10 in Applied Fundamentals in Finance, 2023, pp 327-363 from Springer

Abstract: Abstract The intrinsic value of an equity security is determined on the basis of a cash flow model using the growth rate of the cash flows and the expected return. Relative valuation analysis, on the other hand, assesses the value of an equity security against a benchmark employing a multiple. This approach makes it possible to examine whether the security is valued correctly relative to the stocks of comparable companies. The fundamental economic principle of the comparables method is based on the law of one price, according to which two identical assets are traded at the same price. A distinction is made between price multiples and value multiples. With a price multiple, the price of an equity security is set in relation to a financial variable that has a significant influence on the share price. The variable chosen for this purpose is, for example, the earnings or the book value per share. The intuition behind value multiples is similar. Investors evaluate the market value of an entire company relative to the amount of earnings before interest, taxes, depreciation and amortisation (EBITDA), sales, operating cash flow, or free cash flow to firm. Thus, the enterprise value is considered in relation to a financial variable that affects its value. This chapter examines the price-to-earnings ratio, the price/earnings-to-growth ratio, and the price-to-book ratio as examples of price multiples. It goes on to discuss the enterprise value EBITDA ratio, which belongs to the value multiples.

Date: 2023
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DOI: 10.1007/978-3-658-41021-6_10

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