How can you use multiples in a discounted cash flow analysis?

Discounted cash flow (DCF) analysis is a method of valuing an investment based on its future cash flows. It estimates the present value of the cash flows by applying a discount rate that reflects the risk and opportunity cost of the investment. However, DCF analysis can be challenging and sensitive to the assumptions and inputs used, such as the growth rate, the terminal value, and the discount rate. Therefore, it is useful to complement DCF analysis with multiples, which are ratios that compare the value of an investment to a relevant metric, such as earnings, sales, or assets. Multiples can help you validate, cross-check, and adjust your DCF valuation by using market data and comparable companies. In this article, you will learn how to use multiples in a DCF analysis in four steps.

1 Select the multiples

The first step is to select the multiples that are appropriate for your valuation. There are different types of multiples, such as enterprise value (EV) multiples, equity multiples, and industry-specific multiples. EV multiples relate the value of the entire business to a measure of its operating performance, such as EBITDA, EBIT, or revenue. Equity multiples relate the value of the equity to a measure of its profitability, such as earnings per share (EPS), book value per share, or dividends per share. Industry-specific multiples are tailored to the characteristics and drivers of a particular industry, such as price-to-earnings (P/E) ratio for technology companies, or price-to-book (P/B) ratio for financial companies. You should choose the multiples that are most relevant, consistent, and reliable for your valuation.

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Vladimir Baydin, PhD, MBA

Financial Modelling | Business Cases | Financial Analytics & Forecast | Strategy
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You can come up with any number of multipliers: EV/EBITDA, EV/Revenue, EV/Sqf, EV/Headcount, EV/assets, etc. But in practice, the most often used are EV/EBITDA and EV/Revenue

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San Kalra

Technical Recruiter
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Market Multiples, a valuation method that compares similar public companies based on financial ratios. Why Use Multiples • Easy to calculate and understand. Based on publicly available information and use simple ratios. • Reflect the current market, tells about current market conditions and expectations based on prices investor are willing to pay for similar companies. • Quickly provides estimate of a company • Cross check other valuation method, it can serve as a sanity check for other valuation methods such as Discount Cash Flow. • Most commonly used multiples by investors will have the most impact and will work as a useful framework in making fair value judgment and relative value.

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2 Calculate the multiples

The second step is to calculate the multiples for your target investment and a set of comparable companies. Comparable companies are those that operate in the same industry, have similar size, growth, and risk profiles, and are publicly traded. You can use financial databases, websites, or reports to obtain the market data and financial statements of the comparable companies. You should calculate the multiples using the most recent and normalized data available, and adjust for any non-recurring or extraordinary items that may distort the results. You should also calculate the average, median, minimum, and maximum of the multiples for the comparable companies to get a range of values.

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Vladimir Baydin, PhD, MBA

Financial Modelling | Business Cases | Financial Analytics & Forecast | Strategy
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A couple of thoughts: 1) Comparable companies (peers) are not necessary public. It's just easier to find information about public companies 2) It's almost impossible to find a company which is simultaneously similar to target in size, growth, industry segment, and risk profile. Here comes an analysts' judgement. 3) I don't know what did you mean by company risk profile :) It's a very vague term which can be applied to the size of a company, to it's supply chain, to it's financial strength, to the management competency and so on. 4) The most important piece is of course data normalization. For instance, every company has it's own definition of EBITDA, so it's absolutely important to "normalize" EBITDA across all peers.

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San Kalra

Technical Recruiter
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ENTERPRISE VALUE /EBITDA MULTIPLE Establish the fair market value of a company Suppose a company is valued at 8 times its EBIDA. For example, if the last twelve months EBITDA equals $50 millions, then the company's value would be estimated at $400 million.

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3 Apply the multiples

The third step is to apply the multiples to your target investment to estimate its value. You can do this by multiplying the target's metric by the average or median multiple of the comparable companies. For example, if the target's EBITDA is $100 million, and the average EV/EBITDA multiple of the comparable companies is 10x, then the estimated EV of the target is $1 billion. You can also use the minimum and maximum multiples to get a lower and upper bound of the value. For example, if the minimum and maximum EV/EBITDA multiples of the comparable companies are 8x and 12x, respectively, then the estimated EV of the target ranges from $800 million to $1.2 billion. You should apply the same multiple or multiples to your target and the comparable companies to ensure consistency and comparability.

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San Kalra

Technical Recruiter
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ESTIMATE SHARE PRICE WITH EV/EBITDA EV: Enterprise value EBITDA: Earnings before interest, taxes, depreciation, and amortization Need: Yearly EBITDA income EV/EBITDA ratio: get average of comparable companies Enterprise value = Ratio X EBITDA To get shareholders equity value, need to subtract debt from the enterprise value. Implied equity value = Enterprise value - debt To get share price divide equity value by total outstanding shares price per share = Equity value / outstanding shares

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4 Compare the multiples

The fourth step is to compare the multiples-based valuation with the DCF valuation and analyze the differences. You can use the multiples-based valuation as a sanity check, a benchmark, or a refinement for your DCF valuation. For example, if the multiples-based valuation is significantly higher or lower than the DCF valuation, you may want to revisit your assumptions and inputs in the DCF analysis and see if they are realistic and reasonable. Alternatively, you may want to adjust your discount rate or terminal value in the DCF analysis to align them with the market data and expectations reflected in the multiples. You should also consider the advantages and disadvantages of each method and the sources of uncertainty and error in your valuation.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Bret Brewer, CPA/ABV, CVA, ASA, CFF, CBA

Owner, 59-60, Inc.
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Debt... do not forget debt. A multiple of EBITDA can give you a $1 Billion value for a Company with no debt and a Company with $1 Billion in debt. Are they really worth the same?

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How can you use multiples in a discounted cash flow analysis?

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1 Select the multiples

2 Calculate the multiples

3 Apply the multiples

4 Compare the multiples

5 Here’s what else to consider

Financial Management

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