Multiples from properly selected comparable firms can support a small business valuation effort. It is especially useful used in combination with other methods. Multiples of public issuers show what price the market pays on average for those issuers. For example, let’s say an average price to earnings (P/E) multiple of 17.5 is derived for a comparable group of companies and carefully selected for comparison to the valuation of XYZ Company. The application of the multiples from the comparable group, to XYZ Company, could roll up like the following simplified (hypothetical) example:
Applying the multiple to the XYZ Company business valuation effort was not the hard part. What was more difficult was to pick the comparable firms; more difficult still, to pick public issuing comparable firms to apply to a private firm business valuation, namely XYZ Company. It was important to understand in this case that XYZ Company was driven by a relatively non-diversified product portfolio, aimed mainly at a specific industrial sector, and its original equipment manufacturer (OEM) customers. The markets for a majority of XYZ Company sales were driven by a particular product, supported by regulatory action in the utilities industry, and used in various real estate development situations, and requirements driven in part by the solar power industry.
For just such a business valuation effort we selected a group of companies in the industrial and technology sectors to evaluate as a small universe of comparable firms, and listed the various manufacturing industries from these sectors. These sectors were selected to match XYZ Company’s sector and industry classification and manufacturing industry types, and for all firms exposed to selling components into OEM systems. We also use comparable firms that match the capital structure and risk profile, while focusing on companies where data is available publicly, unless we have true inside access to comparable private firms.
This data was then compiled in complete detail in a matrix, using pre-selected criteria, as given in the example below. We then evaluated which of these firms met a majority of the criteria, and that more closely matched asset and policy structure of XYZ Company. The technical problems encountered to normalize larger or more diverse public firms to a smaller private firm we leave for another posting.
Further analysis led to selection of firms to use as comparable firms for price versus earnings, to derive P/E ratio in a matrix with the pre-selected criteria, as shown below. The resulting multiples used to project onto XYS Company’s actual and forecasted earnings per share. The purpose of this was to value XYZ Company, and straddle the XYZ Company valuation with the comparable firms’ multiples that are over or under valued by the markets. We further compared the resulting XYZ Company multiples valuation to the free cash flow to operations analysis performed in the same effort.
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