Relative valuation
Multiples relate the market price to a financial measure of the company: profit, equity, EBITDA or dividends. The idea behind relative valuation is that similar assets should trade at similar multiples. The method is quick and reflects current market conditions, but it depends critically on the choice of comparables.
The distinction between market capitalization and EV is essential. Two companies with the same market capitalization can have very different enterprise values if one has large debts and the other holds a lot of cash. A buyer of the whole business would take on the debt but would also benefit from the existing cash; that is why EV is the right measure when comparing businesses with different financing structures. In more complete forms, EV also includes preferred shares and non-controlling interests.
The main multiples
| Multiple | When it is useful | Main limitations |
|---|---|---|
| P/E | Profitable companies with stable earnings | Unusable when there are losses; sensitive to non-recurring items and leverage |
| P/BV | Banks, companies with mainly financial or tangible assets | Less relevant for businesses built on intangible assets |
| EV/EBITDA | Comparing companies with different levels of debt | Ignores CAPEX, taxes and changes in working capital |
| Dividend yield | Investors focused on current income | A high yield may reflect a falling price or an unsustainable dividend |
Example: multiples and comparables
| Hypothetical comparable company | P/E | EV/EBITDA |
|---|---|---|
| Comparable A | 8.5 | 6.0 |
| Comparable B | 11.0 | 7.5 |
| Comparable C | 12.5 | 8.0 |
| Median | 11.0 | 7.5 |
Applying the median P/E: implied price = 11.0 × 3.52 = MDL 38.72. Applying the median EV/EBITDA: implied EV = 7.5 × 13,000 = MDL 97,500 thousand; equity value = 97,500 − 19,700 (net debt) = MDL 77,800 thousand; per share = 77,800,000 ÷ 2,000,000 = MDL 38.90. Both values are above the illustrative price of MDL 35, but the difference must be explained before drawing any conclusion.
The limits of multiples
- Comparables should be similar in sector, size, growth, risk and accounting policies.
- In markets with few listed companies or thin trading, prices may not reflect fundamental value.
- Non-recurring items should be removed from earnings before calculating multiples.
- Multiples should be cross-checked against other methods, such as DCF.
Key takeaways
- Multiples relate price to earnings, equity, EBITDA or dividends and enable relative valuation.
- EV = market capitalization + financial debt − cash; it is paired with firm-wide measures such as EBITDA.
- Implied value comes from applying the comparables' median to the metrics of the company being analyzed.
- The quality of the analysis depends on how truly comparable the companies are and on adjusting for non-recurring items.
- A low multiple is not, on its own, an argument for investing.
Check your knowledge
Answer all the questions. If you answer all of them correctly, the lesson is marked as completed automatically.
Explanation: EV = 70,000 + 22,000 − 2,300 = MDL 89,700 thousand.
Explanation: EV captures the value for all providers of capital, and EBITDA is calculated before interest, so the comparison is less distorted by leverage.
Explanation: Implied price = P/E × EPS = 11.0 × 3.52 = MDL 38.72.
Educational material only. It does not constitute investment, legal or tax advice. Numerical examples are hypothetical.