Mathematics
Condition: Peer company is profitable.
Rf = discount rate during the last forecast year
tf = last year of the forecast period.
C = correction factor
P = current stock Price
NPP = net profit peer company
NPO = net profit of target company after forecast period
S = number of shares
Process data diagram
The following diagram shows an overview of the process of company valuation using multiples. All activities in this model are explained in more detail in section 3: Using the multiples method.
Using the multiples method
Determine forecast period
Determine the year after which the company value is to be known.
Example:
'VirusControl' is an ICT startup that has just finished their business plan. Their goal is to provide professionals with software for simulating virus outbreaks. Their only investor is required to wait for 5 years before making an exit. Therefore, VirusControl is using a forecast period of 5 years.
Identifying peer company
Search the (stock)market for companies most comparable to the target company. From the investor perspective, a peer universe can also contain companies that are not only direct product competitors but are subject to similar cycles, suppliers and other external factors (e.g. a door and a window manufacturer may be considered peers as well).
Important characteristics include: operating margin, company size, products, customer segmentation, growth rate, cash flow, number of employees, etc.
Example:
VirusControl has identified 4 other companies similar to itself.
- Medical Sim
- Global Plan
- Virus Solutions
- PM Software
Determining correct price earning ratio (P/E)
The price earnings ratio (P/E) of each identified peer company can be calculated as long as they are profitable. The P/E is calculated as:
Particular attention is paid to companies with P/E ratios substantially higher or lower than the peer group. A P/E far below the average can mean (among other reasons) that the true value of a company has not been identified by the market, that the business model is flawed, or that the most recent profits include, for example, substantial one-off items. Companies with P/E ratios substantially different from the peers (the outliers) can be removed or other corrective measures used to avoid this problem.
Example:
P/E ratio of companies similar to VirusControl:
One company, PM Software, has substantially lower P/E ratio than the others. Further market research shows that PM Software has recently acquired a government contract to supply the military with simulating software for the next three years. Therefore, VirusControl decides to discard this P/E ratio and only use the values of 17.95, 21.7 and 20.8.
- P/E = Current stock price / (Net profit / Weighted average number of shares)
Determining future company value
The value of the target company after the forecast period can be calculated by:
Average corrected P/E ratio * net profit at the end of the forecast period.
Example:
VirusControl is expecting a net profit at the end of the fifth year of about €2.2 million. They use the following calculation to determine their future value:
((17.95 + 21.7 + 20.8) / 3) * 2,200,000 = €44.3 million
Determining discount rate / factor
Determine the appropriate discount rate and factor for the last year of the forecast period based on the risk level associated with the target company
Example:
VirusControl has chosen their discount rate very high as their company is potentially very profitable but also very risky. They calculate their discount factor based on five years.
Determining current company value
Calculate the current value of the future company value by multiplying the future business value with the discount factor. This is known as the time value of money.
Example:
VirusControl multiplies their future company value with the discount factor:
44,300,000 * 0.1316 = 5,829,880 The company or equity value of VirusControl: €5.83 million
Determine forecast period
Determine the year after which the company value is to be known.
Example:
'VirusControl' is an ICT startup that has just finished their business plan. Their goal is to provide professionals with software for simulating virus outbreaks. Their only investor is required to wait for 5 years before making an exit. Therefore, VirusControl is using a forecast period of 5 years.
Identifying peer company
Search the (stock)market for companies most comparable to the target company. From the investor perspective, a peer universe can also contain companies that are not only direct product competitors but are subject to similar cycles, suppliers and other external factors (e.g. a door and a window manufacturer may be considered peers as well).
Important characteristics include: operating margin, company size, products, customer segmentation, growth rate, cash flow, number of employees, etc.
Example:
VirusControl has identified 4 other companies similar to itself.
- Medical Sim
- Global Plan
- Virus Solutions
- PM Software
Determining correct price earning ratio (P/E)
The price earnings ratio (P/E) of each identified peer company can be calculated as long as they are profitable. The P/E is calculated as:
Particular attention is paid to companies with P/E ratios substantially higher or lower than the peer group. A P/E far below the average can mean (among other reasons) that the true value of a company has not been identified by the market, that the business model is flawed, or that the most recent profits include, for example, substantial one-off items. Companies with P/E ratios substantially different from the peers (the outliers) can be removed or other corrective measures used to avoid this problem.
Example:
P/E ratio of companies similar to VirusControl:
One company, PM Software, has substantially lower P/E ratio than the others. Further market research shows that PM Software has recently acquired a government contract to supply the military with simulating software for the next three years. Therefore, VirusControl decides to discard this P/E ratio and only use the values of 17.95, 21.7 and 20.8.
- P/E = Current stock price / (Net profit / Weighted average number of shares)
Determining future company value
The value of the target company after the forecast period can be calculated by:
Average corrected P/E ratio * net profit at the end of the forecast period.
Example:
VirusControl is expecting a net profit at the end of the fifth year of about €2.2 million. They use the following calculation to determine their future value:
((17.95 + 21.7 + 20.8) / 3) * 2,200,000 = €44.3 million
Determining discount rate / factor
Determine the appropriate discount rate and factor for the last year of the forecast period based on the risk level associated with the target company
Example:
VirusControl has chosen their discount rate very high as their company is potentially very profitable but also very risky. They calculate their discount factor based on five years.
Determining current company value
Calculate the current value of the future company value by multiplying the future business value with the discount factor. This is known as the time value of money.
Example:
VirusControl multiplies their future company value with the discount factor:
44,300,000 * 0.1316 = 5,829,880 The company or equity value of VirusControl: €5.83 million
