Equity Valuation Using Multiples: An Empirical Investigation

Comprehensive multiples valuation 81• Accrual flow multiples dominate cash flow multiples.• If the target firm and its peers are profitable, multiples based on value driversfurther down in the income statement dominate multiples based on value driversat the top of the income statement.• An international peer group requires multiples to be defined before taxes.• Alternative multiples dominate traditional accrual flow multiples in sciencebasedindustries.• And, if forecast data is available, two-year forward-looking multiples are thefirst choice.Book value multiples must be treated separately since they are linked to thebalance sheet and not to the income statement (Penman 1998, p. 294-295). In asituation where the balance sheet contains value relevant information, which thefirst decision relevant multiple misses, either the P/B or the EV/IC multiple serve asthe second decision relevant multiple. This is particularly the case for firms in capital-intensiveindustries that follow mark-to-market accounting rules.The choice of equity value versus entity value multiples is tricky because itinvolves the tradeoff between capital structure and noise. The fact that firms fromthe same industry tend to operate at similar debt levels, gives equity value multiplesan advantage. Whichever type of multiple we prefer in a specific context; we mustfollow the matching principle and be consistent in the definition of the numeratorand the denominator.4.6.2 Combination of two decision relevant multiplesThe main message of the preceding paragraphs is that only the first best or thetwo first best multiple(s) constitute(s) the core of effective investment or transactiondecisions; all other multiples act as controlling variables. Given the situation of asingle best multiple, formula (4.15) or (4.16) yields one valuation result, which wecan then verify by using hedging multiples. The case of two decision relevant multiplesimposes the problem that we get two, mostly different, valuation results andwe are left with the question of how to combine them into one valuation. One optionis to simply take the average. By doing so, we put an equal weight on each de-