Equity Valuation Using Multiples: An Empirical Investigation

Comprehensive multiples valuation 51method is the “comparable transaction method,” where historical corporate transactionsin the same industry or country form the peer group (Pratt 2005, p. 35). Atfirst sight, the comparable transaction method suits the valuation of M&A deals becauseit includes the premiums over the market values paid by acquiring firms forgaining controlling power and expected synergies, and directly yields transactionmultiples. However, the comparable transaction method involves two problems,which limit its use in research as well as in practice. First, the number of industrydeals within a specific industry or country is typically very small and does not sufficethe statistical requirements for a clean multiples analysis. Second, even moreimportantly, capital market conditions for industry deals constantly change andtherefore transaction premiums paid in the past are not representative for currentpremiums. Instead, for the valuation of M&A and all other forms of corporatetransactions, I recommend to calculate trading multiples first and then to adjustthese multiples based on the current environment in the market of corporate controlto eventually end up with a suitable transaction multiple and consequently an appropriatetransaction value for the deal. 25As with the selection of value relevant measures, I also ascertain three unsettledquestions for the process of identifying comparable firms:• Firms from the same industry are the most obvious candidates to form the peergroup; but how do we define an industry (e.g., which industry classificationsystem should we use)?• Comparables ought to have similar operating and financial characteristics; butdoes an industry definition fulfill the condition of comparability unaccompaniedor are there further adjustments (e.g., for size or region) to be made?• Eventually, a peer group consists of several comparables; but what is the idealsize of a peer group?25 If not indicated differently, any reference to multiples or the multiples valuation method refers totrading multiples and the guideline public company method.