Another Look at Equity and Enterprise Valuation Based on Multiples

Abstract:     
We examine errors in enterprise and equity valuation based on multiples of firm fundamentals. Our study, which is based on a more representative sample (including firms with losses, smaller start up firms, etc.), complements extant studies, which are based on larger, profitable firms followed by analysts. Contrary to the results in the extant studies, we find that: (1) valuation errors for multiples based on sales are often lowest for both enterprise and equity value; and, (2) when we compare book value and earnings as valuation fundamentals, we find that book-value-based multiples outperform earnings-based multiples. Our focus is on multiples of current financial variables. We show vast improvement in valuation errors when an average omitted variable (intercept) is incorporated in the calculation of harmonic means. We extend the extant literature by demonstrating how harmonic means can be calculated when different multiples are combined, enabling us to examine the change in valuation errors when a combination of multiples is used instead of just a single multiple. Our results show that valuation errors are significantly improved when combining fundamentals from different financial statements; the largest improvement is observed when balance sheet fundamentals (net operating assets and book value of equity) are combined with fundamentals from the income statement (for example, EBITDA).

Number of Pages in PDF File: 45

Keywords: Valuation, Financial Statement Analysis, Multiples, Market Efficiency

JEL Classification: G12, M41

working papers series