Multiplesareeasytouseandeasytomisuse.Therearefour
basicstepstousingmultipleswiselyandfordetectingmisuse
in thehands ofothers. Thefirst step is toensure that the
multiple is defined consistently and that it is measured
uniformlyacrossthefirmsbeingcompared.Thesecondstep
is to be aware of the cross-sectional distribution of the
multiple,notonlyacrossfirmsinthesectorbeinganalyzed
butalsoacrosstheentiremarket.Thethirdstepistoanalyze
the multiple and understand not only what fundamentals
determine the multiple but also how changes in these
fundamentalstranslateintochangesinthemultiple.Thefinal
step is finding the rightfirms to use for comparison and
controlling for differences that may persist across these firms.
Definitional Tests
Even the simplest multiples are defined differently by
differentanalysts.Consider, forinstance,theprice-earnings
(P/E) ratio, the most widely used multiple in valuation.
Analysts define it to be the market price divided by the
earnings per share, but that is where the consensus ends.
Therearea numberofvariantsontheP/Eratio.Whilethe
currentpriceisconventionally usedin thenumerator,some
analystsusetheaveragepriceoverthelastsixmonths ora
year.Theearningspershareinthedenominatorcanbethe
earnings per share from the most recent financial year
(yieldingthecurrentP/E),thelastfourquartersofearnings
(yieldingthetrailingP/E),orexpectedearningspersharein
the next financial year (resulting in a forward P/E). In
addition, earnings per share can be computed based on
primary sharesoutstanding or fullydiluted shares and can
includeorexclude extraordinaryitems.Figure7.1provides