7.6 Multiples, Private Company Valuation, and Equity Case Lab

Why multiples are popular

Relative valuation compares a company with peers, transactions, or its own history. Multiples are popular because they are simple, market-based, and easy to communicate. They are also dangerous when used mechanically. A cheap multiple can signal undervaluation, weak growth, poor quality, high risk, or distorted accounting.

Common price multiples include price-to-earnings, price-to-book, price-to-sales, and price-to-cash-flow. Common enterprise value multiples include EV-to-EBITDA, EV-to-EBIT, and EV-to-sales. Enterprise value represents the value of operating assets available to all capital providers, so it should be matched with pre-interest operating measures.

Matching numerator and denominator

Price belongs with equity-level denominators such as earnings per share, book value per share, sales per share, or cash flow per share. Enterprise value belongs with firm-level denominators before payments to debt and equity, such as EBITDA or EBIT. Mixing price with EBITDA or EV with net income creates a mismatch.

Trailing multiples use past results. Forward multiples use forecasts. Forward multiples can be more relevant when earnings are changing quickly, but they depend on forecast quality. Normalized multiples adjust for unusual cycle effects, one-time charges, nonrecurring gains, or temporary margins.

Interpreting common multiples

A high P/E can reflect strong expected growth, high payout quality, low risk, or overvaluation. A low P/E can reflect undervaluation, weak growth, low earnings quality, high leverage risk, or cyclically high current earnings. Candidates should avoid equating low multiple with cheap without checking fundamentals.

P/B is useful for financial firms and asset-heavy companies when book value is meaningful. It is less useful for companies whose value comes from internally generated intangibles such as brands, software, data, or human capital. P/S can help when earnings are temporarily negative, but it ignores margins.

EV/EBITDA is often used for comparing firms with different capital structures because EBITDA is before interest. It also ignores capital intensity, taxes, working capital, and depreciation economics. A capital-light software firm and a capital-heavy telecom firm can have the same EV/EBITDA but different free cash flow quality.

Justified multiples

A justified multiple is derived from fundamentals. For example, the Gordon growth model implies P0 / E1 = payout ratio / (r - g) when dividends equal payout ratio times earnings. Higher growth and payout raise justified P/E, while higher required return lowers it, holding assumptions constant.

The justified P/B can be linked to ROE, growth, and required return. Higher ROE relative to the required return supports a higher P/B. If ROE equals the required return, P/B tends toward one under stable assumptions. If ROE is below the required return, a premium to book is hard to justify.

Private company valuation

Private companies can be valued using income, market, or asset-based approaches. The income approach discounts expected cash flows. The market approach uses public company or transaction multiples. The asset approach values assets minus liabilities and is most relevant for asset-heavy or liquidation contexts.

Private company analysis often requires adjustments. Earnings may need normalization for owner compensation, related-party rent, nonrecurring expenses, or tax choices. A control premium may apply when the buyer gains decision power. A discount for lack of marketability may apply because private shares are harder to sell.

Other private-company risks include customer concentration, key-person dependence, limited disclosure, weaker controls, and financing constraints. These risks can affect cash flow forecasts, required return, or selected multiples. The adjustment must match the valuation premise.

Structured aid: equity case workflow

Exam focus

For multiple questions, first ask whether the numerator and denominator belong to the same capital providers. Price with EPS is consistent. EV with EBITDA is consistent. EV with net income is usually inconsistent because net income is after interest and belongs to equity holders.

For private company questions, identify the premise. A controlling interest can justify a control premium relative to a minority public price. A less liquid private interest can justify a marketability discount. A valuation can require both, but only if the base value and ownership interest make each adjustment relevant.

For integrated cases, move in order. Market structure tells how the stock trades. Index and efficiency concepts frame benchmarking. Security features define the claim. Industry and company analysis drive forecasts. DDM and multiples translate those forecasts into value. Private-company adjustments refine the conclusion when public market liquidity and disclosure are absent.