Level 1 CFA® Exam:
Multiplier Models & Asset-Based Valuation Models

We can divide multiplier models according to the type of multiples they use. Multiplier models use either:

• multiples which depend on the share price, or
• multiples which depend on the enterprise value.

Price Multiples

The common examples of such multiples include ratios like:

• a price-to-earnings ratio,
• a price-to-book ratio,
• a price-to-sales ratio, or
• a price-to-cash-flow ratio.

The selection of ratios used for valuation depends on the analyst who can also apply other ratios, for example, ratios characteristic for particular industries. These ratios will allow him for a more accurate description of the performance of particular business entities.

Using price multiples, the intrinsic value of a security is estimated based on the prices of securities issued by companies engaged in similar business activities.

The method of comparables is based on the law of one price which says that identical assets should be sold for the same price. So, to value a company we should find a company or companies that are well priced and share similar characteristics as the company we intend to value.

Of course, using this method we can find it difficult to select appropriate comparable companies. Especially nowadays when many companies are international businesses operating in various fields and in different geographical areas. For this reason, selecting comparable companies can be problematic and greatly complicate the analysis.

Enterprise Value Multiples

Enterprise value is defined as the sum of the market capitalization, the market value of the preferred stock, and the market value of debt minus cash equivalents and short-term investments. In other words, enterprise value is equal to the capital needed to take over an enterprise.

If the company and comparable companies are characterized by significant differences in the capital structure or for example the net income is negative, enterprise value multiples should be used instead of price multiples.

From this group, the EV-to-EBITDA ratio is most commonly used by analysts. Of course, an analyst can also use other enterprise value multiples, like EV-to-total revenue or EV-to-operating income.

To calculate the enterprise value, we need to know the debt value of the company. If market quotations are not available, it is possible to estimate bond values based on current quotations of bonds with the same maturity and similar characteristics.

The following example shows how enterprise value multiples can be applied to companies valuation.

In the case of asset-based valuation, we compute the equity value as the difference between the fair value of assets and liabilities.

This method of valuation can be used for companies with a low level of intangible assets and a high level of current assets and current liabilities.

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