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In this blog we’ll understand when and how to use valuation multiples across different businesses and industries.
Introduction
Multiples based valuation is one of the most widely used methods for valuing companies in equity markets. Instead of estimating absolute intrinsic value, this approach compares a company’s valuation metrics with those of similar businesses or with its own historical averages. The logic is simple. Markets tend to value similar businesses in similar ways over time, and deviations from these norms often signal opportunity or risk.
Investors prefer multiples because they are intuitive, quick to apply, and useful for relative comparison. They also help cut through forecasting uncertainty, especially in industries where long term cash flows are difficult to estimate precisely. However, multiples are not interchangeable. Each metric captures a different aspect of a business, and using the wrong multiple can lead to misleading conclusions.
Overview of Common Valuation Multiples
Price to Sales (P/S)
P/S compares a company’s market value with its revenue. It is useful when profits are low, volatile, or temporarily suppressed. This multiple focuses on the scale of the business rather than profitability.
Price to Earnings (P/E)
P/E measures how much investors are willing to pay for each unit of earnings. It is the most commonly used valuation multiple and works best for stable, profitable businesses with predictable earnings.
Price to Book (P/B)
P/B compares market value with the company’s book value or net assets. It is particularly relevant for asset heavy businesses where balance sheet strength matters more than short term earnings.
Price to Cash Flow (P/Cash Flow)
This multiple looks at operating cash flows instead of accounting profits. It helps adjust for non cash expenses and is useful when earnings are distorted by depreciation or accounting choices.
Enterprise Value to Sales (EV/Sales)
EV/Sales compares total firm value including debt with revenue. It allows comparison across companies with different capital structures and is often used for early stage or capital intensive businesses.
Enterprise Value to EBITDA (EV/EBITDA)
EV/EBITDA measures valuation relative to operating profitability before capital structure and depreciation. It is widely used in capital intensive industries and for comparing firms with varying leverage.
Which Multiple to Use and When