23 May Triangulating Business Valuations Based on Market Multiples
In general, multiples boost the valuation of a business above a typical DCF (discounted cash flow) analysis. Hence, it is always helpful–and I would argue–essential to come at the valuation of the business from multiple directions. Typically, multiples–and especially multiples of EBITDA–are the most used barometer for valuation in almost every industry. When performing a business valuation, it can be extremely helpful to triangulate various business valuation methods as a simple “gut check” on actual value. When comparing multiple market multiples, the following should be considered:
1. Is the right multiple being used? Is the industry SIC/NAICS code completely congruent? Familiarity with the market can be extremely helpful here.
2. Is the multiple being calculated across deals in a consistent manner? When comparing apples-to-apples, even in the same industry how are multiples being calculated? What matter is less important than consistency across comparisons. It makes it easier to triangulate across deals when consistency is present. In some cases, EBITDA is calculated without including ALL the investor capital attributable to to assets that generate the cash flow of the business. Consistency is key.
3. Are you comparing the right peers within a market? In other words, is the comparison a true comparison. Consistent production, distribution and R&D across the comparable companies is helpful to solidifying similar growth and ROIC metrics.
Most frequently both buyer and sellers settle on some value-to-EBITDA ratio (see the graphic above). However, there are many other common valuation metrics that are used (sometimes in different industries as “standard”) and which are helpful if a buyer or seller is looking to truly triangulate the value. For instance, value-to-revenue and the price-to-earnings-growth (PEG) ratio are both value multiples often used. It is important to note that valuations derived from multiples are based on forward-looking data rather than historical financials. Business owner should not get overly excited as most strategic and financial buyers will rebut an assumed hockey-stick growth assumption in a proforma by saying something to the effect, “the best way for us to gauge future performance to to look at past performance.”
The above value-to-EBITDA comparison is far superior to the typically used P/E ratio for a number of reasons. First, the capital structure impacts the P/E ratio. A highly-levered company is going to be weighed down on P/E, but it may ultimately have a higher value based on cash flow. Second, non-operating gains and losses can have an impact on P/E as well. For instance, one-time, non-recurring expenses can spike or tank the P/E number.
A few more ancillary items to consider when triangulating business valuations:
- Growth rates and ROIC can vary greatly among companies within the same industry. Comparing apples-to-apples there is not a “best practice.” Tax and WACC vary less across a given industry and are more frequently used in comparisons.
- It is not best practice to compare a company’s multiples to the arithmetic average within an industry.