Valuation using multiples

In economics, valuation using multiples is a process that consists of:

Multiples analysis is one of the oldest methods of analysis. It was well understood in the 1800s and widely used by U.S. courts during the 20th century, although it has recently declined as Discounted Cash Flow and more direct market-based methods have become more popular.

A valuation multiple is simply an expression of market value of an asset relative to a key statistic that is assumed to relate to that value. To be useful, that statistic – whether earnings, cash flow or some other measure – must bear a logical relationship to the market value observed; to be seen, in fact, as the driver of that market value.

In stock trading, one of the most widely used multiples is the price-earnings ratio (P/E ratio or PER) which is popular in part due to its wide availability and to the importance ascribed to earnings per share as a value driver. However, the usefulness of P/E ratios is lessened by the fact that earnings per share is subject to distortions from differences in accounting rules and capital structures between companies.

Other commonly used multiples are based on the enterprise value of a company, such as (EV/EBITDA, EV/EBIT, EV/NOPAT). These multiples reveal the rating of a business independently of its capital structure, and are of particular interest in mergers, acquisitions and transactions on private companies.

Not all multiples are based on earnings or cash flow drivers. The price-to-book ratio (P/B) is a commonly used benchmark comparing market value to the accounting book value of the firm's assets. The price/sales ratio and EV/sales ratios measure value relative to sales. These multiples must be used with caution as both sales and book values are less likely to be value drivers than earnings.

Less commonly, valuation multiples may be based on non-financial industry-specific value drivers, such as enterprise value / number of subscribers for cable or telecoms businesses or enterprise value / audience numbers for a broadcasting company. In real estate valuations, the sales comparison approach often makes use of valuation multiples based on the surface areas of the properties being valued.

...
Wikipedia