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Chapter 9. Valuation of Companies > Methods Based on Multiples

Methods Based on Multiples

Principles

Valuation methods which are based on multiples of projected financial data are easily applied—in theory. The guiding principle is that multiplying projected financial data which are directly or indirectly related to the future profitability of the company, by a number which is the multiple by which similar public companies are traded, or according to which similar private companies have raised capital, provides a scale for valuating the assessed company. The method identifies a set of companies that is comparable on various dimensions, such as area of operation, the maturity of the company, and its size. It looks at the set of appropriate variables for comparison and then compares the ratios of market valuation to these variables. The ratios are then applied to the parameter values of the valued company.

The best-known multiple is, of course, the earnings multiple (namely, the ratio between the price of a share and the earnings it yields, otherwise known as the price/earnings, or P/E, ratio). For example, assuming that Speed, Inc. generates current annual earnings of $10 million, and that similar companies are traded on the stock exchange according to an earnings multiple of 40, then the value of Speed Inc. (without taking into account other data) is $400 million.


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