Valuing by multiples

A DCF needs dozens of assumptions. Multiples ask a simpler question: how much are you paying, compared with something else?

It is the estate agent's method: a price per square metre, compared with the houses next door.

The best known is the PE ratio: the share price divided by earnings per share. The price of one euro of profit.

Say a share at fifty euros, earning two euros fifty a year. Its PE is twenty: twenty euros paid for one euro of profit.

Flip it: one in twenty is five per cent. That is your earnings yield, to compare with a bond's.

But the PE ignores debt. Two companies with the same PE can hide very different debts.

Hence the favourite multiple of those who buy whole companies: enterprise value over EBITDA.

Enterprise value is the price of all the shares, plus net debt. Because the buyer also takes on the debts.

For the example: five billion euros of shares, one billion of net debt. Enterprise value: six billion.

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EBITDA is earnings before interest, taxes and depreciation. Here, six hundred million. The multiple is ten.

Careful: EBITDA forgets that machines wear out and will need replacing. It is not money available.

Third multiple, price to book: the price compared with equity, what the company is worth in its accounts.

Our share is worth fifty euros, for twenty-five euros of equity per share: a price to book of two. It matters most for banks.

Fourth marker, the dividend yield: the yearly dividend divided by the price. One euro fifty on fifty euros is three per cent.

Classic trap: when the price collapses, this yield climbs. A very high yield sometimes signals a dividend about to be cut.

Last marker, the PEG: the PE divided by earnings growth. It was popularised by the fund manager Peter Lynch.

A PE of twenty, with ten per cent growth a year: a PEG of two.

A PE of thirty, with thirty per cent growth: a PEG of one. The one that looks dearer is less so, if the growth holds.

A multiple alone says almost nothing. It is compared: with the sector, the company's past, the rest of the market.

A low PE can signal a bargain, or a company in decline. A high PE, a bubble, or a real growth machine.

Multiples are shortcuts. They say how much you pay. Never, on their own, whether it is worth it.