Valuation course · Lesson 8 of 10
A multiple is a DCF with the assumptions hidden.
A multiple is a quick way to compare prices. But every multiple contains a growth rate, a return and a hurdle. The multiple does not tell you which ones.
Three multiples for Example Co.
| Multiple | Example Co. | How we get it |
|---|---|---|
| Price to earnings | 21.8x | $30 divided by earnings per share of $1.37 |
| Value of the business to operating income | 17.2x | Market value plus net debt, $3,100 million, divided by $180 million |
| Owner earnings yield | 3.0% | $90.1 million divided by $3,000 million |
Price to earnings uses the equity. Value of the business to operating income uses the whole business, so it is not affected by debt. The yield turns the multiple upside down, so you can compare it with an interest rate.
What a fair multiple contains
Lesson 3 showed a fair multiple for a company in steady state. It depends on growth, on the return on new capital and on the hurdle. Two companies at the same multiple can be very different.
At a 9% hurdle, a company that earns only the hurdle on new capital is worth 11.1 times at any growth rate. A company that earns 25% and grows 6% is worth 25.3 times. A multiple of 21.8 can be cheap for the second company and expensive for the first.
Use multiples to ask questions
A multiple says that a stock is cheap or expensive compared with others. It does not say why. When a multiple looks low, find the growth rate and the return that it implies. Then compare those with the record, as in lesson 7.
Key points
- Every multiple contains a growth rate, a return on new capital and a hurdle.
- Use the value of the business for companies with different amounts of debt.
- A low multiple is a question, not an answer.