Comparable Companies And Transactions - Why would someone want to use valuation multiples to ascribe a value to a business?

Valuation and Modeling

Comparable Companies And Transactions
Why would someone want to use valuation multiples to ascribe a value to a business?

There are three key reasons to use valuation multiples in the context of M&A analysis:

  • Objectivity. Valuation is partly a subjective process. Multiples can provide a useful framework for introducing a level of objectivity to the process. Whereas the cash flow numbers used in DCF valuations are future estimates, the numbers used in valuation multiples are current or recent facts (or as close to them as audited financial statements can be). At a minimum, valuation multiples can serve as the proverbial rule of thumb to double-check other valuation measures—especially with respect to a particular industry.
     
  • Ease of use. Valuation multiples are easy to calculate, which makes them an appealing and user-friendly method of assessing value. Also they do not require any guesses about the future.  By contrast, DCF involves complex calculations and involves what-if scenarios.
     
  • Relevance. Valuation multiples focus on the key metrics that investors use to make their investment decisions. Key examples include a business’s revenue (price-to-sales ratio), earnings (earnings-per-share or price-to-earnings ratio) as well as non-GAAP measures  EBIT and EBITDA mentioned earlier. Since investors in aggregate make the market—and thus dictate relative value—the most commonly used metrics and multiples will have the most impact.