CHAPTER 16
A “THEORY” OF MULTIPLES
LEARNING OBJECTIVES
1.
How and why analysts use the multiples approach to value companies.
2.
What are the arguments for and against using multiples to value companies.
3.
Why the multiples approach requires that firms be comparable.
4.
How to identify comparable firms.
5.
How earnings quality issues affect comparability in the multiples approach.
6.
How the multiples approach can be an acceptable shortcut to discounted cash flow valuation.
TRUE/FALSE QUESTIONS
1.
Research has shown that multiples such as the price/earnings and market/book ratios can be used to
predict future stock returns, suggesting that firms with low multiples are undervalued and multiples can
be used to rank investments.
(moderate, L.O. 1, Section 1, true)
2.
In the multiples valuation, the forecast is summarized using many variables as in the cash flow models.
(moderate, L.O. 1, Section 1, false)
3.
The analyst is comparing “apples and oranges” if the consistency requirements are not met for the
multiples formula.
(easy, L.O. 1, Section 1, true)
4.
When the analyst examines several firms, it is unlikely that their multiples will be identical.
(moderate, L.O. 1, Section 1, true)
5.
The analyst will use different steps when using a multiple to estimate the value of a company’s equity.
(moderate, L.O. 1, Section 1, false)
6.
The multiples approach requires only one explicit assumption whereas the discounted cash flow model
requires several explicit assumptions.
(moderate, L.O. 1, Section 1, true)
7.
Arguments for and against the use of the multiples approach can both be correct when placed in the
proper context.
(difficult, L.O. 2, Section 2, true)
8.
The multiples approach is less scientific because it does not involve a number of assumptions.
(moderate, L.O. 2, Section 2, false)
9.
An analyst can use the multiples approach, but the analyst must understand that doing so is only valid
when it is acknowledged that cash flow actually creates value and the multiples analysis is a shortcut to
valuing cash flow.
(difficult, L.O. 2, Section 2, true)
10.
The key step in a successful multiples valuation is using a discounted cash flow analysis of the target
firm to support the multiples valuation findings.
(moderate, L.O. 3, Section 3, false)
11.
Many variables differ across firms, yet, to be comparable, firms do not need to have similar values for all
of these variables.
108