Key Valuation Multiples to Value a Business

A business valuation is a process of deriving the economic value of a business, which can be utilised for a variety of reasons. When valuing a company as a going concern, the discounted cash flow (DCF) and relative valuation (comparable companies) approaches are often used. Relative valuation approach (multiple-based) is based on the premise that similar assets sell at similar prices. A valuation multiple shows a relation between the market value of a company/ business and certain fundamental financial metrics such as revenue, earnings, or cash flows. There are various multiples which can be used to value a business, with the selection of a multiple being dependant on the availability of data, stage of company in its life cycle, nature of business activity, among other factors. The most used multiples are as follows:

Enterprise Value-to-EBITDA (EV/ EBITDA) EV/ EBITDA is the ratio of enterprise value to earnings before interest, taxes, depreciation, and amortization. Essentially, the ratio suggests how many multiples of EBITDA is needed to acquire the business (EV is essentially equity value plus debt less cash).

When to use EV/EBITDA	Pros	Cons
Companies with high debt Capital intensive industries (substantial depreciation) When the purpose is to value the business (debt + equity) instead of only equity	Incorporates the balance sheet (includes equity and debt) Provides a clear picture of the company’s financial performance, since it ignores debt costs, taxes, depreciation, and amortization	More difficult to compute since it requires detailed calculations requiring information (to make any adjustments, as required)

Price-to-Earnings (P/E) The P/E ratio shows the relationship between the price per share and the earnings (net profit). This is the amount any common stock investor would pay for a single dollar of earnings.

When to use P/E	Pros	Cons
Valuing companies which are profitable	Easy to use	Easily manipulated, since earnings are calculated with accrual accounting and are subject to ‘window-dressing’

Price-to-Book (P/B) P/B is the ratio of price to book value per share. Book value is the value of assets less liabilities on the balance sheet.

When to use P/B	Pros	Cons
For companies with liquid assets and liabilities on their balance sheet such as banking and financial services companies, or capital-intensive businesses, such as energy or transportation firms, large manufacturers Can also be used during the years of negative earnings, however the overall equity should be positive	Stable metric. Given the relative stability of the base metric (book value), this ratio does not fluctuate as significantly as other multiples such as P/E	Since P/B is useful to value businesses with high tangible asset values (substantial inventory, buildings, equipment), it is not suitable for valuing firms with limited tangible assets (technology/software companies, service providers), as their book value ignores valuable intangible assets such as intellectual property, customer relationships, to name a few

Price-to-Sales (P/S) P/S is the stock price divided by sales per share. Whilst earnings and book value ratios are commonly more appropriate for large companies with consistent positive earnings, the P/S ratio is often used as a comparative price metric for companies that are not profitable. Revenue depends less heavily on accounting practices than earnings and book value measures.

When to use P/S	Pros	Cons
Used for loss-making companies Suitable for early growth/ start-up entities	More difficult to manipulate compared to earnings Relatively stable metric compared to earnings	It does not take profitability into account

Valuation analysis using multiple methods help analysts make thorough estimates when valuing businesses. Further, multiples provide information regarding a company’s financial status and are relevant because they involve statistics that are key to investment decisions. The simpler approach of using multiples, compared to a DCF, makes them easy to apply for valuers, as well as investment professionals. However, application of the multiple-based approach can be challenging, since an analyst relies on multiples of publicly listed comparable companies which are not always necessarily available, especially for relatively less active secondary security markets such as the Middle East. Further, for valuing businesses in niche industries, finding comparable listed companies could be a challenge. Therefore, selection of comparable companies in such cases requires the expertise and judgement of a valuer.

PKF UAE has a team of highly experienced professionals with many years of expertise, offering a wide range of advisory services across sectors. PKF has assisted clients by undertaking valuation engagements across a wide range of sectors for various purposes such as M&A, financial reporting, sale of minority shares, among others. We would be happy to discuss any of your requirements. Please feel free to get in touch with us on difc@pkfuae.com or at www.pkfuae.com.