Valuation using multiples
A method for determining the current value of a company by example ratio’s of relevant peer groups. Most widely used multiple is the Price Earnings Ratio (PER) of stocks in a similar industry. Using the average of multiple PER’s improves reliability but it can still be necessary to correct the PER for current market conditions.
Math
Condition: Peer company is profitable.
Rf = discount rate during the last forecast year tf = last year of the forecast period. C = correction factor P = current stock Price NPP = net profit peer company S = number of shares NPO = net profit of target company after forecast period
Process Data Diagram
The following diagram shows an overview of the process of company valuation using multiples. All activities in this model are explained in more detail in section 3: Using the Multiples method.
Using the Multiples Method
Determine Forecast Period
Determine the year after which the company value is the be known.
Example:
‘VirusControl’ is an ICT startup that has just finished their business plan. Their goal is to provide professionals with software for simulating virus outbreaks. Their only investor is required to wait for 5 years before making an exit. Therefore VirusControl is using a forecast period of 5 years.
Identifying peer companies
Search the (stock)market for companies most comparable to the target company. Important characteristics include: operating margin, company size, products, customer segmentation, growth rate, cash flow, nr of employees, etc.
Example:
VirusControl has identified 4 other companies similar to itself.
• Medical Sim • Global Plan • Virus Solutions • PM Software
Determining correct Price Earning Ratio (PER)
Calculate the price earnings ratio (PER) of each identified peer company as long as the company is profitable. Calculating the PER is done by:
PER = Current Stock Price / (Net Profit / Number of shares)
Take notion of any PER’s out of line with the rest of the PER’s. A PER far below the average of all PER’s can mean that the true value of a company hasn’t been identified by the market or that their business model is flawed. Therefore remove PER’s not in line with the current market or apply a correction factor to the average PER.
Example:
PER of companies similar to VirusControl:
|
Current Stock Price |
Net profit |
Number of Shares |
PER |
Medical Sim |
€16.32 |
€1.000.000 |
1.100.000 |
19.95 |
Global Plan |
€19.50 |
€1.800.000 |
2.000.000 |
21.7 |
Virus Solutions |
€6.23 |
€3.000.000 |
10.000.000 |
20.8 |
PM Software |
€12.97 |
€4.000.000 |
2.000.000 |
6.5 |
One company, PM Software, has substantially better PER then the other ones. Further market research shows that PM Software has recently acquired a government contract to supply the military with simulating software for the next three years. Therefore VirusControl decides to discard this PER and only use the ones of 19.95, 21.7 and 20.8.
Determining future company value
The value of the target company after the forecast period can be calculated by:
Average corrected PER * net profit at the end of the forecast period.
Example:
VirusControl is expecting a net profit at the end of the fifth year of about € 2.2 million. They use following calculation to determine their future value:
((19.95 + 21.7 + 20.8) / 3) * 2.200.000 = € 45.8 million