Valuation Multiples

Quick Valuation Using Comparable Company Analysis

What are Valuation Multiples?

Valuation multiples are ratios that compare a company's market value to a specific financial metric, allowing you to quickly assess if a stock is overvalued or undervalued relative to peers.

Unlike DCF models that project future cash flows, multiples-based valuation relies on relative comparison. You determine what similar companies are trading for (their multiples), then apply those multiples to your target company's financial metrics.

Key Insight: Multiples provide quick, market-based valuations but reflect current market sentiment. They're best used alongside DCF analysis for comprehensive valuation.

Price-to-Earnings (P/E) Ratio

The P/E ratio is the most widely used valuation multiple, comparing share price to earnings per share.

P/E Ratio = Share Price / Earnings Per Share (EPS)

Or: P/E = Market Capitalization / Net Income

Types of P/E Ratios:

Trailing P/E (LTM)

Formula: Share Price / Last 12 Months EPS

When to use:

  • Mature, stable companies
  • When earnings are predictable
  • For historical comparison
Forward P/E

Formula: Share Price / Next 12 Months Estimated EPS

When to use:

  • Growth companies
  • When current earnings are depressed
  • For forward-looking comparisons

P/E Ratio Example:

Company ABC:

  • Share Price = $150
  • Trailing EPS = $10
  • Forward EPS (estimated) = $12

Trailing P/E = $150 / $10 = 15.0x

Forward P/E = $150 / $12 = 12.5x

Limitation: P/E ratio is meaningless for companies with negative or near-zero earnings. Use alternative multiples like EV/Revenue for unprofitable companies.

Enterprise Value / EBITDA (EV/EBITDA)

EV/EBITDA is the gold standard for comparable company analysis, especially in M&A and leveraged buyouts.

EV/EBITDA = Enterprise Value / EBITDA

Where Enterprise Value = Market Cap + Debt - Cash

Why EV/EBITDA is Superior:

  • Capital structure neutral: Uses Enterprise Value, so debt levels don't distort comparison
  • Pre-tax: EBITDA excludes tax differences between companies
  • Pre-depreciation: Removes accounting policy differences in D&A
  • Cash flow proxy: EBITDA approximates operating cash generation
  • Industry standard: Most widely used by investment bankers and PE firms

EV/EBITDA Calculation Example:

Company XYZ:

  • Market Cap = $5,000M
  • Total Debt = $1,500M
  • Cash = $500M
  • EBITDA (LTM) = $600M

Step 1: Enterprise Value = $5,000M + $1,500M - $500M = $6,000M

Step 2: EV/EBITDA = $6,000M / $600M = 10.0x

Typical Ranges by Industry:
  • Tech/Software: 15-25x EBITDA
  • Healthcare: 12-18x EBITDA
  • Industrials: 8-12x EBITDA
  • Retail: 6-10x EBITDA

Price-to-Sales (P/S) Ratio

The P/S ratio is useful for unprofitable companies or those with volatile earnings.

P/S Ratio = Market Capitalization / Revenue

Or: Price per Share / Revenue per Share

When to Use P/S Ratio:

Good Use Cases
  • Early-stage growth companies
  • Companies with negative earnings
  • High-growth tech startups
  • Turnaround situations
  • Revenue is more stable than profits
Poor Use Cases
  • Mature, profitable companies
  • Companies with stable earnings
  • When P/E or EV/EBITDA are available
  • Low-margin businesses (misleading)

P/S Ratio Example:

High-Growth SaaS Company:

  • Market Cap = $2,000M
  • Annual Revenue = $200M
  • Net Income = -$50M (unprofitable)

P/S Ratio = $2,000M / $200M = 10.0x

P/E ratio cannot be used here (negative earnings), making P/S the appropriate metric

Important: P/S ignores profitability. A company with 5% margins and 10x P/S is very different from one with 30% margins and 10x P/S. Always consider profit margins alongside P/S ratios.

PEG Ratio (P/E to Growth)

The PEG ratio adjusts the P/E ratio for growth, helping identify whether a high P/E is justified by growth prospects.

PEG Ratio = (P/E Ratio) / (Earnings Growth Rate %)

Interpreting PEG Ratios:

  • PEG < 1.0: Stock may be undervalued relative to growth
  • PEG = 1.0: Fair value (P/E matches growth rate)
  • PEG > 1.0: Stock may be overvalued relative to growth
  • PEG > 2.0: Significantly overvalued or market expects acceleration

PEG Ratio Example:

Growth Company A:

  • P/E Ratio = 30x
  • Expected EPS Growth = 25% annually

PEG = 30 / 25 = 1.2 (Fairly valued for growth)

Growth Company B:

  • P/E Ratio = 50x
  • Expected EPS Growth = 15% annually

PEG = 50 / 15 = 3.3 (Expensive for growth rate)

Best Practice: Use 3-5 year expected growth rates, not single-year growth. Short-term growth can be volatile and misleading.

LTM vs Forward Multiples

Understanding the difference between trailing and forward multiples is critical for accurate valuation.

LTM (Last Twelve Months)

Also called: Trailing, TTM (Trailing Twelve Months)

Advantages:

  • Based on actual reported results
  • No estimation risk
  • Comparable across all companies
  • Verifiable and objective

Disadvantages:

  • Backward-looking
  • May not reflect current trends
  • Misleading if business is changing
Forward (NTM - Next Twelve Months)

Also called: Forward, NTM, 1-Year Forward

Advantages:

  • Forward-looking (values future)
  • Captures expected improvements
  • Better for growth companies
  • Market focuses on future, not past

Disadvantages:

  • Based on estimates (can be wrong)
  • Management guidance may be biased
  • Analyst estimates vary widely
Best Practice: Calculate BOTH LTM and forward multiples. If they diverge significantly, investigate why. Are expectations realistic? Is the business fundamentally changing?

Example: Why Both Matter

Turnaround Company:

  • LTM EBITDA = $50M (depressed due to restructuring)
  • NTM EBITDA = $100M (post-turnaround)
  • Enterprise Value = $1,000M

LTM EV/EBITDA = $1,000M / $50M = 20.0x (looks expensive)

Forward EV/EBITDA = $1,000M / $100M = 10.0x (looks reasonable)

The forward multiple better reflects the improved business. Using only LTM would miss the opportunity.

Choosing the Right Multiple for Your Analysis

Company Type Best Multiple Why
Mature, Profitable P/E Ratio Stable earnings make P/E reliable and comparable
Capital-Intensive EV/EBITDA Removes D&A differences from heavy asset bases
High Debt EV/EBITDA EV accounts for debt, P/E doesn't
Unprofitable Growth P/S or EV/Revenue Revenue is only meaningful metric available
High Growth PEG Ratio Adjusts valuation for growth rate
M&A Analysis EV/EBITDA Industry standard for acquisition pricing

Common Valuation Multiple Mistakes

Comparing Apples to Oranges

Always compare companies in the same industry with similar business models. A tech P/E of 30x is normal; an industrial P/E of 30x is expensive.

Ignoring Growth Differences

A 25x P/E for 30% growth is cheaper than 15x P/E for 5% growth. Always consider growth when comparing multiples.

Using One-Time Earnings

Normalize earnings for one-time items. A company with $10 EPS including a $5 one-time gain isn't really trading at its stated P/E.

Mixing Enterprise and Equity Multiples

Never divide Market Cap by EBITDA, or Enterprise Value by Net Income. Match enterprise metrics (EV) with enterprise earnings (EBITDA), equity metrics (Market Cap) with equity earnings (Net Income).

Outdated Comparables

Market multiples change with market conditions. Don't use 2019 multiples to value a company in 2025. Always use current trading multiples.

Small Peer Group

Using 1-2 comparables is unreliable. Aim for 5-10 comparable companies to get a meaningful average multiple.

Apply Multiples Analysis to Real Companies

Build a comparable company analysis with live market data and trading multiples

Start Comps Analysis

Compare valuation multiples across peer companies and identify relative value

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