What are the best practices for using valuation multiples and ratios in business valuation?

Valuation multiples and ratios are widely used tools for comparing the relative value of different businesses or assets. They are calculated by dividing a measure of value, such as market capitalization or enterprise value, by a measure of performance, such as earnings or sales. However, using valuation multiples and ratios effectively requires some best practices to avoid common pitfalls and errors. In this article, you will learn how to choose, apply, and interpret valuation multiples and ratios in business valuation.

1 Select appropriate multiples and ratios

When using valuation multiples and ratios, the first step is to select the most relevant and suitable ones for the business or asset. Examples include price-to-earnings (P/E), enterprise value-to-EBITDA (EV/EBITDA), or price-to-book (P/B). However, not all of them are appropriate for every situation. You should take into account the industry and sector of the business or asset, as different industries and sectors have different norms and standards for valuation multiples and ratios. For example, P/E is more suitable for mature and stable businesses, while EV/EBITDA is more appropriate for businesses with high debt or depreciation. Additionally, consider the growth and profitability of the business or asset; different multiples and ratios reflect different aspects of growth and profitability. Moreover, it is important to use multiples and ratios that are based on reliable and comparable data sources. Furthermore, adjust the data for any one-time or non-recurring items that may distort the true value of the business or asset.

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Harvinder Singh

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Different industries use different valuation multiples Eg, a technology company might use a price-to-sales (P/S) ratio, while a utility company might focus on price-to-earnings (P/E) ratio. Growth and profitability considerations eg, A high-growth company might prioritize EV/EBITDA to account for its high capital expenditures, while a stable company could focus on P/E ratio for its consistent earnings. Using multiples based on industry-specific data from reputable sources eg, Bloomberg or S&P Capital IQ ensures accuracy when valuing a for a healthcare company. When valuing a company with one-time expenses, such as a legal settlement, adjusting the multiples to reflect normalized earnings provides a more accurate valuation.

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Philippe Urbain Sarr

Co-founder et CIO at Delta Wealth Management
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🚀 Pour effectuer une bonne valorisation d'entreprise par la méthode des multiples, il faut : 🏗 Premièrement, 𝘀𝗲́𝗹𝗲𝗰𝘁𝗶𝗼𝗻𝗻𝗲𝗿 𝗹𝗲𝘀 𝘀𝗼𝗰𝗶𝗲́𝘁𝗲́𝘀 (𝗼𝘂 𝗰𝗼𝗺𝗽𝗮𝗿𝗮𝗯𝗹𝗲𝘀) en veillant à ce qu'elles soient du même secteur d'activité que notre entreprise et ont également une taille d'activité assez similaire. (Ex : Total vs Shell). 🚦 Deuxièmement, 𝗰𝗵𝗼𝗶𝘀𝗶𝗿 𝗹𝗲𝘀 𝗺𝘂𝗹𝘁𝗶𝗽𝗹𝗲𝘀 𝗮𝗱𝗲́𝗾𝘂𝗮𝘁𝘀 à utiliser pour la comparaison (Ex : PER, P/B, EV/EBITDA, ...) 🎭 Troisièmement, 𝗲𝗳𝗳𝗲𝗰𝘁𝘂𝗲𝗿 𝗹'𝗮𝗻𝗮𝗹𝘆𝘀𝗲 𝗱𝗲 𝗰𝗼𝗺𝗽𝗮𝗿𝗮𝗶𝘀𝗼𝗻 pour obtenir une valorisation et l'𝗶𝗻𝘁𝗲𝗿𝗽𝗿𝗲́𝘁𝗲𝗿 𝗲𝗻 𝗹𝗲 𝗽𝗼𝗻𝗱𝗲́𝗿𝗮𝗻𝘁 avec les autres méthodes pour avoir un résultat plus optimal. #Multipledevalorisation

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2 Apply consistent and comparable multiples and ratios

The second step in using valuation multiples and ratios is to apply them consistently and comparably across the business or asset you are valuing and its peers or benchmarks. This means that you should use the same multiples and ratios, the same data sources, the same time periods, and the same adjustments for all the entities you are comparing. This will ensure that you are comparing apples to apples and not apples to oranges. For example, if you are using P/E to value a business, you should use the same earnings definition, the same market price date, and the same adjustments for dividends or stock splits for all the businesses in your sample.

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3 Interpret multiples and ratios with caution and context

Interpreting valuation multiples and ratios with caution and context is the third step in using them. While these measures can provide useful insights and benchmarks, they should not be relied on blindly or exclusively, but rather used as a starting point or supplement to other valuation methods, such as discounted cash flow (DCF) or net asset value (NAV). When interpreting multiples and ratios, you should consider the drivers and assumptions behind them, such as growth rates, margins, risk, capital structure, or accounting policies. Additionally, be aware of the market conditions and expectations that influence the value of the business or asset. Comparing the multiples and ratios to their historical or forward-looking averages or ranges can help assess their reasonableness and attractiveness.

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Adélékè Òsúñlànà ©️

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Industry Variability: Multiples and ratios can vary significantly across industries. What might be considered normal or healthy in one industry could be entirely different in another. Always compare ratios within the context of the specific industry's norms and benchmarks. Economic Conditions: Economic conditions can impact the relevance of multiples and ratios. For instance, during economic downturns, traditional valuation metrics may not accurately reflect a company's long-term potential. Consider the economic environment when interpreting these metrics. Apply caution 🚧

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4 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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What are the best practices for using valuation multiples and ratios in business valuation?

1

2

3

4

1 Select appropriate multiples and ratios

2 Apply consistent and comparable multiples and ratios

3 Interpret multiples and ratios with caution and context

4 Here’s what else to consider

Technical Analysis

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What are the best practices for using valuation multiples and ratios in business valuation?

1

2

3

4

1 Select appropriate multiples and ratios

2 Apply consistent and comparable multiples and ratios

3 Interpret multiples and ratios with caution and context

4 Here’s what else to consider

Technical Analysis

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