Reading: Lesson 4 - Multiple Market Analysis

7.4.A - Multiple Market Analysis

1. Multiple Market Analysis

1. Some analysts use market multiple analysis to estimate a company’s value. The analyst chooses a metric for the firm—say, its EPS—and then multiplies the company’s EPS by a market-determined multiple such as the average P/E ratio for a sample of similar companies. This would give an estimate of the stock’s intrinsic value. Market multiples can also be applied to total net income, to sales, to book value, or to number of subscribers for businesses such as cable TV or cellular telephone systems. Whereas the discounted dividend method applies valuation concepts by focusing on expected cash flows, market multiple analysis is more judgmental. 
   
2. To illustrate the concept, suppose Tapley Products is a privately held firm whose forecasted earnings per share are $7.70, and suppose the average price/earnings (P/E) ratio for a set of similar publicly traded companies is 12. To estimate the intrinsic value of Tapley’s stock we would simply multiply its $7.70 EPS by the multiple 12, obtaining the value $7.70(12) = $92.40.
   
3. Another commonly used metric is earnings before interest, taxes, depreciation, and amortization (EBITDA). The EBITDA multiple is the total value of a company (the market value of its equity plus that of its debt) divided by EBITDA. This multiple is based on total value, since EBITDA is used to compensate the firm’s stockholders and bondholders. Therefore, it is called an entity multiple. The EBITDA market multiple is the average EBITDA multiple for a group of similar publicly traded companies. This procedure gives an estimate of the company’s total value, and to find the estimated intrinsic value of the stock we would subtract the value of the debt from total value and then divide by the shares of stock outstanding.
   
4. As suggested previously, in some businesses, such as cable TV and cellular telephone, a critical factor is the number of customers the company has. For example, when a telephone company acquires a cellular operator, it might pay a price that is based on the number of customers. Managed care companies such as HMOs have applied similar logic in acquisitions, basing valuations primarily on the number of people insured. Some Internet companies have been valued by the number of “eyeballs,” which is the number of hits on the site.