COMPARABLE COMPANY APPROACH (“MULTIPLES”)

DR. GUILLERMO L. DUMRAUF

 WHAT IS A MULTIPLE?

A multiple is simply a ratio of market value of an asset relative to a key

statistic - usually some measure of the company’s earnings - that is assumed
to have a logical relationship to the market value observed. One of the most
popular multiple is the Price-earnings ratio or P/E ratio.

Price per share

P/E =
Earnings per share

Walt Disney had a P/E ratio of 23.22 on December 2015 (Quotes from
Reuters on 12/17/2015):
113.79
P/E = = 23.2
4.90

What a P/E=23 does mean? A possible interpretation is that investors are

willing to pay 23 dollars for one dollar of the company’s earnings.
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 PRICE EARNING

Other possible interpretation is that P/E ratio represents the number of

earnings required to recover the investment. It can be calculated as:

Price per share

P/E =
Earnings per share

A stock is currently trading at $10 and its earnings per share over the last 12
months were $1.9 per share. The P/E ratio is calculated as 10/1.9, or 5.26

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 CONNECTION BETWEEN NUMERATOR AND DENOMINATOR

P/E is calculated using a numerator relevant to equity holders.

Therefore, the relevant denominator must be computed after interest and

taxes, preferred dividends, and minority interest expense.

Instead, EBITDA multiples use EBITDA in the denominator, which is relevant

to all stakeholders.

Therefore, the appropriate numerator should be the enterprise value (EV)

which is equal to equity value or market capitalization plus debt or net debt
and the appropriate denominator must be computed before interest
expense, preferred dividends and minority interest expense.

Market Cap + Debt

EV/EBITDA =
EBITDA
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 ADJUSTED (NORMALIZED) EBITDA

Adjusted or normalized EBITDA, is usually calculated for valuation purposes.

Especially for small companies, it is necessary to eliminate abnormalities or
idiosyncrasies such owners personal expenses, rentals above or below fair
market value, non-recurring income and expenses, depreciation and
amortization methods, goodwill impairments, and compensations paid to
owners.

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 EXERCISES

1. VVV Corp. has $100 million in revenues and $ 50 million in operative

expenses, taxes of $ 5 million, 5 million in interest and depreciation and
amortization of $12 million in the last fiscal year. The senior management
have been recognized adjustments of $8 million from litigation expenses,
goodwill impairment, and compensations paid to owners. Calculate the
standard EBITDA and the normalized EBITDA.

2. TTT company wants to calculate the normalized EBITDA for the past five
years. The net income is $100,000, interest expenses of $20,000 and
depreciation and amortization of $10,000, income taxes of $70,000 and
adjustments of $45,000 for litigation expenses. Calculate the standard
EBITDA and the normalized EBITDA.

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 SOLUTION

1. First, we calculate the VVV Corp’s net income by subtracting operative

expenses from revenue: $100-50=50. To calculate the standard EBITDA, we
must add to the net income taxes, interest, and D&A: 50+5+5+12=72.
Finally, to obtain the normalized EBITDA we must add all adjustment of $8
million to the standard EBITDA: 72+8=80

2. Standard EBITDA= 50,000+20,000+10,000+70,000=150,000. To calculate

the normalized EBITDA, we must recognize that litigation and forex losses
were not realized, therefore, they must be added to the standard EBITDA:
150,000+45.000=195,000

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 COMPARABLE APPROACH

• The comparable approach is another valuation technique that consists in

using a handful of “comparable” companies.

• Once the selected multiple had been calculated for each company in the
peer group, we simply had to multiply the mean or the median of the
peer group by the firm’s own earnings to obtain the company fair value.

• The basic assumption underlying to the comparable approach is that

there are firms with similar characteristics that can be grouped in “similar
classes”.

Comparable approach recognizes two variants: market comparable and

precedent transactions comparable approaches.

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 MARKET COMPARABLE APPROACH

This is the most common approach and looks at market comparables for a
firm and its peers. Market comparable are used by traders, analyst and
consultants.

The comparable approach is used in different contexts:

1. In merger and acquisitions, consultants on both sides of the transaction

use multiples to estimate the fair value of a company.
2. Traders use multiples in a more active way to take advantage of the
discrepancies in the market value between similar firms and could
suggest an strategy consisting in selling the overvalued stock and buying
the undervalued stock and held it until the value increases.
3. It is also used in a variety of litigation contexts. For instance, dissident
shareholders may take legal action to dispute the price proposed for
their shares in a merger.
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 MARKET PRECEDENT TRANSACTIONS COMPARABLE APPROACH

• Comparable transactions consider past deals of similar firms which have

been acquired.

• In principle, the Market Precedent Transaction Comparable method has

an advantage related to the Market Comparable method; while the later
used prices observed in the market in a certain moment or in a certain
period of time, the former represents the actual price paid in a deal.

• However, the difficulty with this approach is the limited availability of

financial data regarding past transactions between private companies,
especially in emerging markets. To get a more accurate valuation, more
than one comparable transaction should be used.

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 EBITDA MULTIPLES

Market capitalization Market capitalization + D

P/EBITDA = EV/EBITDA =
EBITDA EBITDA

It is argued that P/EBITDA does not reflect the diferences in capital structure.
This issue is signaled as a disadvantage of P/EBITDA. Suppose for instance,
two firms with identical EBITDA, but diferente capital structures. While A is
strongly levered, B is almost full equity.

A B
EBITDA 5 5
Market Cap. 20 40
Debt 40 20
Firm Value 60 60
P/EBITDA 4 8
EV/EBITDA 12 12

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 SELECTING THE RIGHT COMPARABLES

How the comps are selected? Although no company is perfectly comparable,

we can narrow down our search using some operational and financial filters
in four steps:

1. Selecting the “Comps” peer group

2. Selecting the right multiples

3. Spreading the trading comparables

4. Calculate target’s implied value

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 STEP ONE: SELECTING THE “COMPS” PEER GROUP

The first step is looking comparable that operate in the same industry or/and
having similar characteristics as the company you are trying to value. You can
search and screen using natural, operational filters like

• Industry/sector
• Product & Services
• Customers/distribution channel
• Geography

In practice, we will not so lucky to find some kind of comparable companies.

Sometimes the classifications available are very broad ones and cannot be
relied completely. If we are not sure about the industry classification (which
is the case most of the times), try to identify some keywords relevant to the
business descriptions of the companies.

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 STEP ONE: SELECTING THE “COMPS” PEER GROUP

Suppose you are valuing “Target” a company primarily involved in the

distribution of technology products from the industry’s computer hardware
suppliers, software and consumer electronics. Notice that if you look for a
company in the industry (for example Tech Data) in the Reuters website a
list of its competitors is suggested.

However, how many of these

companies are good
comparables? We must
search in each company
webpage what the company
do, what kind of product the
company produces, and
compare some financial
filters.

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 STEP ONE: SELECTING THE “COMPS” PEER GROUP

Financial filters could include profitability ratios, asset managent ratios and
return on capital invested...

Target Tech Data Ingram Avnet Arrow Average

Liquidity
Current ratio 1,3 1,5 1,5 1,7 1,5 1,6
Quick ratio 0,7 0,9 1,0 1,2 1,1 1,1
Leverage
Total liab./Total assets 76% 5,8% 10,0% 19,5% 18,6% 13%
Activity
Days on sales 20 41 47 71 95 64
Days on inventories 59 30 31 39 44 36
Days on payable 64 49 57 54 92 63
Cash cycle 14 22 22 57 47 37
Total assets turnover 3,6 4,2 3,5 1,2 1,8 3
Profitability
EBIT/Sales 3,5% 1,5% 1,0% 3,0% 3,5% 2%
Profit margin 3,9% 1,0% 0,5% 2,1% 2,1% 1%
ROIC 41,4% 13,8% 5,7% 8,7% 8,3% 9%

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 STEP TWO: SELECTING THE RIGHT MULTIPLES

The choice of a multiple in valuing and comparing companies depends on

the nature of the business and on the industry in which the business
operates. While the appropriate multiple is not the same for all industries,
there are some hints that can help us:

• Looking at equity research reports to see what multiples analyst are using
for similar business you are considering.

• While EV/EBITDA multiple can be appropriate for telecommunications

companies, could not be appropriate for financial entities.

• Price earnings or P/Book Value could be appropriate for banks, but could
not be appropriate for telecommunications companies.

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 STEP THREE: SPREADING THE TRADING COMPARABLES

The next step is organizing the information and analyzing comparable

multiples such as

• Enterprise Value / Sales

• Enterprise Value / EBITDA
• Stock Price / EPS (Price earning)

For each company in the peer group, we have to calculate the selected
multiples and the mean/median of the sample.

Company Com Set EV/EBITDA P/EBITDA P/Sales P/E

Arrow Electronics 7,6 5,8 0,3 12,1
Avnet 7,4 6,2 0,2 10,6
Ingram Micro 10,0 9,8 0,1 26,4
Tech Data 5,5 6,1 0,1 10,4
Mean 7,6 7,0 0,2 14,9

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 STEP FOUR: CALCULATE TARGET’S IMPLIED VALUE

The final step once you have spread the multiples for your custom universe
is to use this information for determining valuation. We do that multiplying
the predicted EBITDA for the selected multiple.

Predicted EBITDA x Average EV/EBITDA

20 million x 7.6= 152 millions
(if your company is predicting to have an EBITDA of $20 million in 2016 and the comp universe is trading on average at 7.6
then your company would be worth approximately $152 millions).

Sometimes we could prefer to use a competitor’s ratio if we think that is

more appropriate than the industry average. Or we can use our company’s
historic multiple. This approach is both versatile and simple to use, which
might explain its popularity with the financial press

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 EXCERCISES

Suppose you are valuing “Petropackaging” a company that produces plastic

packaging for pet foods. After searching for comparables, you find that 7
companies constitute reasonable comps:

Company Country EV/ P/ P/E PSR EBIT/ Cash EBITDA/S Capex/D EBITDA Enterprise Market Cap
EBITDA EBITDA Sales cycle ales epr. value
Aptargroup US 11,1 10,5 25,0 2,1 14,0 46,5 20,0 127,8 463.038 5.162.542 4.862.763
Armstrong US 13,5 10,3 26,6 1,0 5,0 20,2 9,9 144,3 239.600 3.229.453 2.471.253
Convertidora MX 8,5 4,0 25,1 0,4 6,4 158,2 10,3 67,0 110.547 941.946 440.987
Evora BR 5,1 2,4 124,9 0,5 13,5 71,8 22,2 120,8 542.850 2.794.898 1.321.492
Greif US 9,3 5,4 28,1 0,4 4,3 39,0 8,1 115,5 281.000 2.621.369 1.508.269
Newell US 18,5 15,0 33,5 1,9 10,2 84,0 13,1 -2,0 773.000 14.336.624 11.535.024
Sealed Air US 13,8 10,0 29,2 1,4 10,9 37,7 13,9 39,4 976.700 13.489.565 9.256.765
Tupperware US 9,6 7,7 15,7 1,3 13,8 84,3 16,6 68,2 378.400 3.622.436 2.931.536
Mean 11,2 8,2 38,5 1,1 9,8 67,7 14,2 85,1
Median 10,4 8,8 27,3 1,1 10,5 59,1 13,5 91,8

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 EXERCISES

At first look, it seems to be a relationship between EBITDA and Enterprise

Value in the plastic packaging industry...

Plastic packaging industry

16.000.000

14.000.000 Newell
y = 16,21x - 1.854.631,03 Sealed Air
12.000.000 R² = 0,82

10.000.000
Enterprise Value

8.000.000

6.000.000
Aptargroup
4.000.000
ArmstrongTupperware
Greif Evora (BR)
2.000.000
Convertidora (MX)
0
0 200.000 400.000 600.000 800.000 1.000.000 1.200.000
-2.000.000
EBITDA
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 EXCERCISES

Petropackaging’s current financial data:

EBITDA: 10 million
Sales: 90 million
Debt: 20 million
Net income: 3 million

Taking into account the average or the median for the EBITDA multiples of
the peer group, estimate the fair value of the company.

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 SOLUTION

Multiplying the predicted EBITDA by the median EV/EBITDA of the peer

group, we have

11,2 x 10 million=112 million

Since Enterprise Value represents the business value, to obtain the equity
value we have to subctract the financial debt

112 – 20=92 million

If we had used the median P/EBITDA instead EV/EBITDA, the equity value
would have been

8.2 x 10 million= 82 million

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 MULTIPLES: SOME VERSIONS

For each multiple, there are or could be some slightly different versions.
Many of them are:

• “trailing”
• “forward”
• Different numerators in the case of EBITDA or sales multiples

In general, analyst think that the lower the ratio, the more attractive the
investment. However, as with all valuation techniques, these metrics are just
the beginning. The worst that we can do is buy stocks without looking at
underlying fundamentals.

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 PRICE EARNING VERSIONS

Trailing P/E

The “Trailing P/E" is the most common and uses net income for the last 12-
month period. Since monthly earnings data are not available, the previous
four quarterly earnings reports are used and earnings per share are updated
quarterly. Some databases give the option to calculate the P/E using the last
12-month period or another period.

Trailing P/E de Telecom: 11,4

It is not a good idea calculating the

P/E using the annual net income of
the last Income Statement, since in
this case we would compare the
actual Price with an old measure of
earnings.
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 PRICE EARNING VERSIONS

Forward P/E

Instead of using the historical net income, the Forward P/E is calculated
estimating net income over next 12 months. Therefore, Forward P/E is
calculated based on analysts’ estimations about the expected earnings for
the next years.

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 GRUPO CEMENTOS DE CHIHUAHUA COMPETITORS

Based on the current EV/EBITDA multiples in the construction materials

industry, make some comments about the reasonableness of them, taking
into account the key metrics.

LT Debt to
Current Total Capital Cash CAPEX/E
Identifier (RIC) Company Name EV/EBITDA (FY0) Cycle BITDA
GCC.MX GCC SAB de CV 6,92 19,6% 60,00 15,7%
CX.N Cemex SAB de CV 5,31 43,6% -6,00 35,1%
CCB.CN Cementos Argos SA 5,61 29,6% 42 21,0%

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 EXERCISES

The growth perpetutity formula to estimate the Terminal Value is

TV= FCFT(1+g)/(WACC-g)

1. Supossing a company has un FCFT=100, WACC= 10%, ¿which is the long-

term growth rate if TV=1.100?
a) g=0,00833
b) g=0,03

2. Suppose that EBITDA=500, FCFT=100, WACC=12% and the terminal value

is calculated as 10 x EBITDA, which is the implicit long-term growth rate
using the TV formula?
a) 10%
b) 9,8%

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 P/E 10 RATIO

The P/E 10 ratio is a measure that uses real per-share earnings over a 10-
year period to control for cyclical effects, since it allows to eliminate the
fluctuations in net income caused by variations in profit margins over a
typical business cycle.

The ratio was popularized by Yale University professor Robert Shiller, who
won the Nobel Prize in Economic Sciences in 2013. The P/E 10 ratio is also
known as the "cyclically adjusted PE (CAPE) ratio" or "Shiller PE ratio.“

It is possible to think about others cyclically adjusted multiples.

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 P/E IS ALSO USED IN COURTS: THE CASE OF YPF

District Judge Loretta Preska ruled in favor of Burford Capital, Petersen Energia Inversora,
and Eton Park Capital Management LP against YPF and Argentina, basing her ruling on the
P/E ratio. A U.S. judge ruled that Argentina must pay $16.1 billion to minority
shareholders of state-controlled oil company YPF.
The rule was based on the highest Price earning that was observed on the use of Q-4
2008 earnings, arguing that this was the information available to investors deciding
whether to invest in YPF as of February 22, 2010, the date considered as the time
Argentina took the control of the Company.

EPS 2007-2012
0,80
0,70
0,60
0,50
0,40
0,30
0,20
0,10 0,11
0,00
Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
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 P/E IS ALSO USED IN COURTS: THE CASE OF YPF

Benjamin Graham and David Dodds

(1934): the investors attributed
illogical P/E ratios due to temporary
and sometimes extreme fluctuations
in the business cycle. To smooth a
firm´s earnings over a period, they
recommended using an average of
earnings per share over a long
period, five or ten years when
computing P/E ratios. Molodvsky
(1960) stated that at the bottom of
the economic cycle, P/E are high,
and earnings are low. At the top of
the economic cycle, it is the
opposite: the P/E ratios are low, and
earnings are high. This is due that
the earnings reflect the historical
earnings while the stock prices
reflect expectations.

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 EBITDA MULTIPLES: A REAL WORLD CASE

In 2008 we performed the valuation of “Papelera” a company that

produces mainly tissue paper. Looking for comparables in the NAICS[1] we
found 7 comparables in the industry.

Papelera’s EBITDA implicit multiples (2) seem to be a bit higher both than
the average and the median of the peer group.

Empresa EV/EBITDA Price/EBITDA Price earning Price/Sales

Avery Dennison 7,2 4,4 10,7 0,5
Bemis 6,7 5,2 13,6 0,6
Inforsa 4,9 5,7 6,7 1,9
Kimberly Clark México 7,6 6,7 14,5 2,1
Packaging 3,9 2,9 9,5 0,6
Pactiv 7,6 5,3 15,6 0,9
Sonoco Products 6,4 5 12,8 0,5
Promedio 6,3 5 11,9 1
Mediana 6,6 5,1 12,4 0,8
Papelera 6,82 7,48 11,54 1,22

(1) North American Industry Classification System

(2) We refer as the “implicit multiple” the multiple calculated as DCF value/EBITDA
 EBITDA MULTIPLES: A REAL WORLD CASE

Although Papelera’s EBITDA multiples were higher in 2008, looking for

the multiples observed in a longer period, we notice that the average
EV/EBITDA has fluctuated between 6.3 and 10:

Empresa dic-00 dic-01 dic-02 dic-03 dic-04 dic-05 dic-06 dic-07 dic-08
Avery Dennison 11 12,7 13,5 12,4 12,3 10,5 11,9 10,4 7,2
Bemis 6,9 8,2 8,2 8,3 8,5 7,8 8,7 7,4 6,7
Inforsa 4,8 5,3 7,5 11,6 12,7 8,3 11,4 9,2 4,9
Kimberly Clark Mex 5,8 6,6 6 6,8 8,1 8,5 8,9 8,7 7,6
Packaging 6,6 6 7,3 8,6 9,4 9,6 6,5 6,8 3,9
Pactiv 7 7,1 7,4 7,9 9,5 8,7 9,6 7,8 7,6
Sonoco Products 6,2 9 7,4 9,3 9,2 8,3 9,2 8,2 6,4
Promedio 6,9 7,8 8,2 9,3 10,0 8,8 9,5 8,4 6,3
Mediana 6,6 7,1 7,4 8,6 9,4 8,5 9,2 8,2 6,7
 PRICE/BOOK VALUE

Price/book value, also known as the “price-equity ratio” relates the stock
price with the stock’s book value, which in turn is calculated as the Equity
Book Value divided by the number of shares. This multiple can be
interpreted as how much times the investor is willing to pay for the equity
book value.

Stock price per share

P/B =
Book value per share

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 PRICE TO SALES RATIO (P/S)

P/S ratio or PSR relates the company’s stock price to its revenues. It is usually
calculated by dividing the market capitalization by its total sales over a 12-
month period (or on a per-share basis by dividing the stock price by sales per share for a 12-month
period). It can be interpreted as how much an investor is paying for each dollar
of a company’s sales.
Market capitalization
P/S =
Sales
Advantages:
• Lower accounting distortion by sales numbers
• It can be used for companies with negative or abnormally high/low earnings.

Disadvantages:
• It does not take into account the profitability

Like all ratios, the price-to-sales ratio is most relevant when used to compare
companies in the same sector. For example, P/S could be useful for companies
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with similar operative margins.
 KAPLAN AND RUBACK STUDY

Kaplan and Ruback (1996) made a research comparing the differences

that both methodologies present with respect to the final price achieved
in 51 levered transaccions.

Peviously, the authors established different measures for beta and

multiples, as follows:

• Assets betas, industry betas and observed betas were estimated.

• Multiples were calculated for companies in the same industry and for
similar transaccions.
 KAPLAN AND RUBACK STUDY

Métodos basados en DCF Métodos basados en múltiplos comparables

Cía comparables y
Beta Beta Beta Cías Transacción transacción
Estadístico activo industria observado comparables comparable comparable
Mediana 6,00% 6,20% 2,50% -18,10% 5,90% -0,10%
Media 8,00% 7,10% 3,10% 16,60% 0,30% -0,70%
Desvío estándar 28,10% 22,60% 22,60% 25,40% 22,30% 28,70%
Beta 0,81 0,84 0,91
Porcentaje dentro del
15% de desvío 47,1% 62,7% 58,8% 37,3% 47,1% 57,9%
Media de los cuadrados
de error 8,40% 6,70% 5,10% 9,10% 4,90% 8,00%

The DCF methodology exhibited higher percentage of transactions

whithin of a 15% deviation with respect to the effective Price.

Kaplan y Ruback conclude saying that when both methodologies were

used together more confident results were obtained.