Equity Valuation Using Multiples: An Empirical Investigation

2 Literature reviewDespite their widespread usage, only limited theory is available to guide theapplication of multiples. With a few exceptions, the finance and accounting literaturecontain inadequate support on how or why certain multiples or comparablefirms should be chosen in specific contexts. Compared to the DCF and RIV approach,standard textbooks on valuation devote little space to discussing the multiplesvaluation method. 9Although most authors of these textbooks affirm the importance of the multiplesvaluation method in practice, along with its usefulness in supporting morecomplex valuations and making investment decisions, they do not provide thereader with a functional manual. Therefore, some practitioners suggest that the selectionof comparable firms and multiples is essentially an art form, which shouldbe left to professionals. Yet the degree of subjectivity involved in their applicationis awkward from a scientific point of view (Bhojraj, Lee & Ng 2003, p. 7).Nevertheless, when going into detail, both standard literature and empiricalstudies provide helpful insights into specific aspects of the multiples valuationmethod. In fact, putting all the single items of information together ultimately leadsto a thorough understanding of how to make the multiples approach work.2.1 Coverage in standard literatureOf all the standard textbook authors, Damodaran (2001, 2002, and 2006) is theone who puts the most weight on the explanation of the characteristics and determinantsof various multiples, which he enhances with illuminative descriptive statisticsfor different countries and industries, and over time. The book by Lundholm &Sloan (2004) is another source which helps to better understand the determinants ofthe P/E, the price to book value of common equity (P/B), and the price to earnings9 E.g., Benninga & Sarig (1997), Palepu, Healy & Bernard (2000), Damodaran (2001, 2002, and2006), Penman (2004), Lundholm & Sloan (2004), Arzac (2005), or Koller, Goedhart & Wessels(2005) in English and Spremann (2002, 2004, and 2005), Ballwieser (2004), or Richter (2005) inGerman.