Valuation Multiples

Apple, Google, Facebook or Microsoft - who has got the best valuation multiple?

In this weeks edition, I am going to examine valuation multiples and compare the results for the some of the “Big Tech” namely Apple, Google, Facebook and Microsoft to see who comes out on top.

Valuation multiples are essentially a range of indicators that can be used to value a stock. A multiple is a ratio and therefore allows for comparable analysis to value similar companies using the same financial metrics. With valuation multiples, the lower the better. Valuation multiples can be divided into two main types:

  1. Equity Multiples

  2. Enterprise Value Multiples

Equity Multiples

The equity value (or net asset value) is the value that remains for the shareholders after any debts have been paid off. 

Luckily, most financial information websites already have the key multiples and ratios already calculated for us but I have listed the equations below for informational purposes. I personally use Yahoo Finance to source the majority of the financial data that I use.

P/E ratio

This is the most commonly used equity multiple because the data required is easily accessible. This ratio for valuing a company measures its current share price relative to its per-share earnings.

P/E = Price Per Share / Earnings Per Share (EPS)

Price/Book ratio

Most useful for companies that use assets to drive earnings. This ratio compares a company’s market capitalization to its book value.

Price/Book = Price Per Share / Book Value Per Share

Price/Sales ratio

More useful for companies that are not profitable yet or are in high growth phase. This valuation ratio compares a company’s stock price to its revenues. It is an indicator of the value that financial markets have placed on each dollar of a company’s sales.

Price/Sales = Price Per Share / Sales Per Share

PEG ratio

This ratio also factors in expected earnings growth so provides a more complete picture than the standard P/E ratio.

PEG = P/E ratio / EPS growth*

*EPS expected growth rate can be derived by using analyst estimates available on financial websites

The above table compares the equity multiples of four of the “Big Tech” companies based on 30th September 2020 data from Yahoo Finance (as at 11th December 2020) . Google has got the best (lowest) multiple in three of the four comparatives.

Enterprise Value Multiples

The enterprise value is the total value of the assets of the business, excluding cash.

Equity multiples can be artificially impacted by a change in capital structure even though there might be no change in enterprise value. Since enterprise value multiples allow for direct comparison of different firms, regardless of capital structure, they are believed to be better valuation models than equity multiples.

EV/EBITDA

This is one of the most commonly used valuation metrics because EBITDA (earnings before interest, taxes, depreciation, and amortization) is commonly used as an approximate for cash flow available to the company.

EV/Sales

When a company has negative EBITDA, the EV/EBITDA multiple will not be material. In such cases, EV/Sales may be the most appropriate multiple to use. This multiple is commonly used in the valuation of companies whose operating costs still exceed revenues, as might be the case with high growth technology companies.

In the above table I have again compared ratios for the “Big Tech” companies based on 30th September 2020 data from Yahoo Finance (as at 11th December 2020). The result is unanimous here as Google comes out on top in both.

Pros and Cons of Valuation Multiples

Pros

  1. Simple and easy to use.

  2. Time efficient can can give a quick computation to assess a company’s value.

  3. When used appropriately they provide valuable information about a company’s financial status.

  4. Relevant metrics because they they revolve around key statistics related to investment decisions.

Cons

  1. Too simplistic as it quantifies complex information into one single value. This can lead to misinterpretation and makes it challenging to break down the effects of various factors.

  2. Represent a company’s status at a moment in time rather than a period of time. Cannot easily show how a company grows or progresses.

  3. Reflect short-term data instead of long-term ones. Outcomes might only be applicable in the short-term and not in the longer future.

  4. Differing accounting policies between companies mean comparing multiples may not be as conclusive and lead to misinterpretations.

Recommended reading

This has been a whistle stop run through valuation multiples so if you would like to further develop your knowledge, The Intelligent Investor by Benjamin Graham is a good book that I have recommended previously.

Final Words

Valuation multiples are a great way to analyse a company and compare it to others. However, they should not be used in isolation when analysing a company. Google having the best valuation multiples above does not mean that it is the best investment. Full due diligence should always be performed when appraising potential investment opportunities.

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Happy investing

Wolf of Harcourt Street

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Disclaimer: I am not a financial adviser and I am not here to give specific financial advice. The opinions expressed are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The information is based on personal opinion and experience, it should not be considered professional financial investment advice. There is no substitute for doing your own due diligence and building your own conviction when it comes to investing.