Even with the same accounting standards governing
companies, there can be differences in firms that arise
becauseofdiscretionaryaccountingchoices.Thereisalsothe
additional problem posed by the fact that some firms use
differentaccountingrules(ondepreciationandexpensing)for
reporting purposes and for tax purposes and others do not.
2 Insummary,companiesthatuseaggressiveassumptionsin
measuringearningswilllookcheaperonearningsmultiples
than firms that adopt conservative accounting practices.
Descriptional Tests
Whenusingamultiple,itisalwaysusefultohaveasenseof
what ahigh value,alowvalue, oratypicalvaluefor that
multiple is in the market. In other words, knowing the
distributional characteristicsof a multiple is a key part of
usingthatmultipletoidentifyunder-orovervaluedfirms.In
addition, we need to understand the effects of outliers on
averagesandunearthanybiasesintheseestimatesintroduced
intheprocessofestimatingmultiples.Inthefinalpartofthis
section,welook athowthedistributionsofmultiplesshift
over time.
Distributional Characteristics
Many analystswho usemultiples havea sectorfocus and
haveagoodsenseofhowdifferentfirmsintheirsectorrank
onspecific multiples.Whatis oftenlacking,however, isa
sense of how the multiple is distributed across the entire
market. Why should a software analyst care about
price-earnings ratios of utility stocks? Both software and
utilitystocksarecompetingforthesameinvestmentdollar,so
theyhaveto,inasense,playbythesamerules.Furthermore,