Relative valuation
Relative valuation (Multiples)
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Assumption: similar assets should have similar prices
Challenge: finding similar/comparable assets
Basis
– Price multiples
– Enterprise Value (EV) multiples
Process
1. Identify comparable assets (the peer group) and obtaining market values
for these assets.
2. Convert these market values into standardized values relative to a key
statistic (value drivers). Since the absolute prices of different firm’s assets
cannot be compared this process of standardizing creates valuation
multiples which gives price per unit of value driver
3. Apply the valuation multiple to the key statistic of the asset being valued,
controlling for any differences between asset and the peer group that
might affect the multiple.
Price Multiples
• Assumes that security prices move in response to value
drivers and this rate of response remains comparable across
peer firms
Price to Earnings Ratio
• Many analysts relate earnings per share to price.
• The price-earnings ratio is calculated as the current stock price
divided by annual EPS.
– The Wall Street Journal uses last 4 quarter’s earnings
– Forward P/E looks at the expected earnings in future
Price per share
P/E ratio 
EP S
Price-to-sales ratio
• Many analysts’ associate price of an asset to the firm’s sales
• Price to sales ratio = Share price per share / Sales per share
• Especially applicable if the assets’ value is associated to its
sales performance (Eg. Manufacturing and trading firms,
sales organisations)
Price-to-book ratio
• Many analysts’ associate price of shares to the book value of
shares
• Price to book ratio = Share price per share / Book value per
share
• Especially applicable if the firm’s value is associated to its
underlying assets (Eg. Land bank for a developer)
Price to CF ratio
• Many analysts’ associate price of shares to the firm’s Cash
Flow
• Price to Cash flow ratio = Share price per share / Cash flow
per share
• Especially applicable if the firm’s value is associated to firm’s
Cash generation capacity (Eg. Project based organizations)
EV multiples
• EV reflects on the market value of business (as a whole)
• Enterprise Value = Mkt Value of shares + Mkt value of debt –
Cash
• Assumes that Enterprise value move in response to
value drivers and this rate of response remains
comparable across peer firms
EV/Sales multiple
• Many analysts’ associate Enterprise Value with the capability
of the firm to generate sales
• EV to sales multiple = EV / Sales
EV to EBIT multiple
• Many analysts’ associate Enterprise Value with the capability
of the firm to generate EBIT
• EV to EBIT multiple = EV / EBIT
• Especially if the EV is derived out of firm’s Operating margins
(when the fixed cost charges are included)
EV to EBITDA multiple
• Many analysts’ associate Enterprise Value with the capability
of the firm to generate EBITDA
• EV to EBITDA multiple = EV / EBITDA
• Especially if the EV is derived out of firm’s Operating margins
(when the fixed cost charges are ignored)
Note: remember some firms might have fully depreciated
(tangible) or amortized (intangible) assets making it difficult to
compare them with firms having assets subject to depreciation
and amortization.