Equity Valuation Using Multiples: Controlling for Differences Between Firms

Abstract

This study addresses the problem of differences between firms and the impact on valuations based on multiples. We investigate the extent to which industry-based multiples ignore additional firm-specific information and develop measures for identifying peer groups that are not comparable with the target firm. Additionally, we compare the performance of different methods that control for differences between firms. We find that differences between firms lead to systematic errors in the value estimates of different multiples. These errors are consistent with our hypotheses, statistically significant, economically substantial, consistent between different value drivers and robust over time. We find that these errors can be predicted very accurately by comparing the financial ratios of the target firm with the financial ratios of its peer group. We show that when adequately controlling for differences between firms, valuation accuracy is improved substantially and all considered value drivers perform almost equally well.

Keywords: equity valuation, multiple valuation method, price-earnings, comparables, ratio analyses, financial ratios

JEL Classification: G12, M41