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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.

EDUCATION, NOT ADVICE · The example company. Example Co. is a made-up company. A model script calculates every figure in this course, so you can check each one. The method works the same way on a real company. Full disclosures →

Three multiples for Example Co.

MultipleExample Co.How we get it
Price to earnings21.8x$30 divided by earnings per share of $1.37
Value of the business to operating income17.2xMarket value plus net debt, $3,100 million, divided by $180 million
Owner earnings yield3.0%$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.
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