Comments on: The earnings multiple valuation method

By: The Private Equiteer

The Private Equiteer — Sat, 17 Jul 2010 09:19:31 +0000

Hey Sebasm611, great to hear from you . I've actually heard from a few people in Columbia; look forward to making it there some time next year.

I agree, theoretically DCF takes more into account, but multiples and DCF suffer from the same problem, which is “garbage in, garbage out”. The discount rate in a DCF affects the value greatly, yet it's about as the most arbitrary as all financial metrics.

This is going to sound somewhat cynical, but the calculated financial value of a business is pretty trivial in private equity. It's based on past metrics and any attempt to include the future is futile. In university you want to believe it's as formulaic as the professors suggest, but it just isn't.

The real-life drives of good returns in private equity are purchase price, sale price and leverage. Sales growth matters, and so does profit growth, but we're mostly talking about legacy businesses in PE. Buying in at 4 times compared to 8 times and selling at 12 times compared to 6 times makes a big difference. All of the financial models and DCF calculations in the world won't predict the manipulation of a great purchase/sale price.

All the best S – just my opinion

By: Sebasm611

Sebasm611 — Thu, 15 Jul 2010 11:20:19 +0000

First of all... I want to congratulate you for this blog, I find it most interesting to read. I'll be posting some comments.

Now, about the topic... I find the multiple approach a very dangerous approach because of the reasons it's actually used. I should point out also that a DCF valuation, if done right, should yield the same value that the multiple approach and vice-versa.

One of the reasons the multiple approach is so widely used, which in my opinion make the multiple approach dangerous is "because it's easy" and don't have to calculate all the inputs the DCF have. Another is the misuse of the multiples, for example, the P/Sales or P/EBITDA used when earnings are negative is a mistake because price is an equity value and sales is a pre-debt firm value, there's no possible sensible interpretation possible because I'm leaving out all debt incidence in value.

Another is the argument for those comparable companies, because to have the same multiple, the company must have the same amount of debt, same growth, same revenues, etc... than the average.

So the conclusion for me would be, if multiples are to be used... then it'd be good to make a DCF valuation also just to support the multiple, know what am I selling and make adjustments to the company Vs the comparables and arrive to a fairer value.

Again congrats and thanks for the blog...
1st year undergrad from Colombia.

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[...] estimate of $100m is found by one of many valuation methods, with the most common being the earnings multiple method. For example, if the company’s EBIT is $20m and the typical multiple in the industry for this [...]

By: the Private Equiteer

the Private Equiteer — Fri, 16 Jan 2009 09:59:46 +0000

http://www.avc.com/a_vc/2009/01/the-valuation-b.html An interesting take on the whole valuation conundrum from the ‘A VC’ blog.

Of course, PE and VC are totally different beasts. So while I think ‘fair value’ is the best of a bad lot for PE, I agree it’s ludicrous for VC.