The Basics of Multiple Analysis Capital Investment Analysis

What is multiple analysis? Multiple analysis is a form of relative valuation that is used to quantitatively compare a company’s financial statements to previous years, other companies, the industry, or even the economy in general.

Why is this important? Relative valuations are the most common valuation measures used on Wall Street Almost 80% of equity research reports are based on multiples and comparables Nearly 50% of all acquisition valuations are based on multiples Will allow valuations to be “tailored” or adjusted to meet the current market conditions, or to portray a company in a certain light It allows different companies to be easily compared through a set of common metrics or ratios Unfortunately, these ratios can often be abused or manipulated in number of ways

Steps to perform multiple analysis… One common reason for doing multiple analysis is to see if a company’s stock is correctly priced in the market Compare a number of the firm’s ratios to that of its competitors to determine if it is trading in an appropriate range Could provide justification for where the stock is currently priced, as well as to determine it is over/under priced

Steps to perform multiple analysis… First select a company that you wish to value Dell, Inc. Next create a list of comparable companies that are similar in size, maturity, and industry HP, IBM, Apple, etc. For each comparable company, calculate a number of ratios that you wish to compare to the selected company (Dell) For example: Price/ Earnings Price/ Sales

MS Excel Excel can be a very useful tool in multiple analysis… Here are some steps that can help you find a range of appropriate prices using Excel…

First: Choose a number of “comps”… Choose a list of multiples and compute them for a number of comparable companies

Second: Find the price for your selected company… The price will help you to derive a value Ex: P/E ratio If Dell’s P/E ratio is 21.63, and the price is $29.40, then we know the earnings per share must be $1.36

Third: Compare the value that you have found to a series of benchmarks…

Fourth: Use the multiples for the comparable companies or the benchmarks as well as a specific value to create a price… To find a price for Dell based on the average P/E ratio of 10 comparable companies, we could do the following: Find the average P/E ratio for the comparable companies, which is 24.46 (which happens to be close to Dell’s P/E ratio of 21.63) Then, we take the earnings per share for Dell of $1.36 Next, we multiple the EPS by the P/E ratio to get a “relative” price of $33.25 This tells us that if Dell’s price could be about $33.25 if it kept the same earnings of $1.36 per share, and it’s P/E ratio increased slightly to match that of its closest competition Using this information, someone may be able to say that Dell is slightly under-priced on a P/E basis when compared to its competition

This process can create a range of prices based off different multiples and benchmarks

Pricing the stock… As you have seen: Finding the range of prices for a stock can be done with individual companies, averages of a large group of comparable companies, or even with benchmarks composed of hundreds different stocks Many different multiples can be used to compare specific metrics or elements of a company on a relative basis to other organizations in order to determine an appropriate price Relative valuation is very useful, and can be used in conjunction with many different forms of valuation