Investors and key stakeholders often toss around the term “multiple.” It sounds technical, perhaps even intimidating, but it’s one of the most useful tools in business valuation.
Multiples offer a quick and efficient way to determine a company’s worth. They can show a company’s value relative to its peers or industry averages. But what exactly is a multiple? How are they calculated, and why are they such a big deal in M&A transactions? Let’s dive in.
What Exactly Are Multiples?
In financial terms, a multiple is a ratio that compares two metrics of a company. It’s a way to learn about a company. Multiples can help quantify how much a company is worth based on its revenue, profits, or some other financial measure. You can use multiples as shorthand to quickly gauge a company’s value.
This is helpful in M&A when speed is essential and you have good comparable company data. Multiples act like a valuation lens, helping to assess whether a company is undervalued, overvalued, or just right compared to its peers.
Commonly Used Multiple Types
Investors and financial analysts often rely on several types of multiples. Each one offers a unique perspective on a company’s financial health. By using these together, you can gain a better understanding of the company’s total valuation.
Price-to-Earnings (P/E): Compares a company’s stock price to its earnings per share. A higher P/E ratio indicates the market expects higher future earnings growth.
Enterprise Value-to-EBITDA (EV/EBITDA): A popular metric in M&A that shows the company’s total value relative to its earnings before interest, taxes, depreciation, and amortization.
Price-to-Sales (P/S): This is a transaction multiple that you can use when companies don’t have earnings. This compares the market value of the company to sales.
Enterprise Value-to-Sales (EV/Sales): Similar to P/S but factors in a company’s debt and cash, providing a wider view of the company.
Price-to-Book (P/B): Compares a company’s market value to its book value or the value of the company’s assets minus liabilities.
Each multiple gives a different perspective. Investors can use these together to build a clearer picture of a company’s potential. This is an important step for better M&A deals.
Examples of Multiples With Calculations
Let’s take a look at some basic calculations to show how these multiples work.
P/E Multiple Calculation:
- Stock Price: $100
- Earnings per Share (EPS): $5
- P/E Ratio Calculation: You divide 100 by 5, which gives you a P/E ratio of 20.
This means that for every dollar of earnings, investors are willing to pay $20.
EV/EBITDA Calculation:
- Enterprise Value (EV): $500 million
- EBITDA: $50 million
- EV/EBITDA Calculation: You divide 500 by 50, which gives you an EV/EBITDA of 10.
This means the company’s value is 10 times its EBITDA.
Multiples, however, are only as good as the context in which you use them. Different industries have different standards and averages. The “right” multiple also depends on market conditions, future growth prospects, and more.
How Multiples Are Relevant in M&A
In the world of M&A, multiples provide a simple and effective way to compare companies and valuations. They help investors answer key questions: “Is this deal worth pursuing?” “How does this company compare to its competitors?” or “Is this company overvalued or undervalued?”
Multiples also offer a common language during negotiations. This makes them indispensable for investors, acquirers, and financial advisors.
How Investors Use Multiples for M&A Deals
Investors and other stakeholders apply multiples in several ways when evaluating a deal:
- Valuation Comparison: Before diving into more analysis, investors use multiples to compare the target company with similar firms.
- Finding Undervalued Targets: Multiples can help detect companies trading at lower-than-average values. This can help with finding acquisition targets.
- Assessing the Premium: In M&A, acquiring companies often pay a premium over the target’s market price. Multiples help determine if the premium is justified by the target’s profitability and growth prospects.
- Guiding Negotiations: Multiples help frame negotiations, setting expectations for both buyers and sellers. They help both sides determine a fair price for the deal.
- Forecasting Future Growth: For companies with high multiples, stakeholders may expect rapid growth in the coming quarters and years. In contrast, low multiples might suggest slower growth and other issues.
Examples of How to Apply Multiples in M&A
- Private Equity Firms: Use EV/EBITDA to assess how much debt they can leverage for an acquisition. Companies and industries operate efficiently with different leverage ratios.
- Strategic Buyers: Focus on P/E ratios to evaluate how earnings will change post-acquisition. Acquiring a company at a high P/E ratio should require higher growth ahead or unlocking other value from the deal.
- Financial Advisors: Leverage multiples like EV/Sales to create valuation models that help guide deal negotiations.
Key Takeaways on Multiples
Multiples can act as a compass in the sea of valuation. Investors and advisors use them to navigate M&A deals, offering insights into a company’s worth. Understanding the context and appropriate multiple to use is critical when making acquisition decisions.
- What are Multiples? Multiples are financial ratios that compare a company’s value to its earnings, revenue, or assets. This offers quick insights into its valuation.
- The Relevance of Multiples in M&A: Multiples allow investors and stakeholders to compare companies, find undervalued targets, and set expectations for deal negotiations.
- How Advisors Can Help: M&A advisory firms exist precisely for this purpose. We help stakeholders with navigating the valuation process. Seasoned advisors play a pivotal role in helping clients understand which multiples are most relevant and how to apply them in M&A. With our expertise, stakeholders can make informed decisions and achieve better outcomes.
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