Companion Variable
Although the variables that determine a multiple can be
extracted from a discounted cash flow model and the
relationshipbetweeneachvariableand themultiplecanbe
developed by holding all elseconstant and asking what-if
questions,thereisonevariablethatdominateswhenitcomes
toexplainingeachmultiple(anditisnotthesamevariablefor
everymultiple).Thisvariable,whichiscalledthecompanion
variable, is critical to using multiples wisely in making
valuationjudgmentsandcanbeidentifiedbylookingforthe
variablethat bestexplains differences acrossfirms usinga
particularmultiple.Inthenexttwochapters,thecompanion
variables for the most widely used multiples from the
price-earnings ratio to the value-to-sales multiple will be
identified and then used in analysis.
Application Tests
Whenmultiplesareused,theytendtobeusedinconjunction
withcomparablefirmstodeterminethevalueofafirmorits
equity. But what is a comparable firm? While the
conventional practice is to look at firms within the same
industryorbusiness,thisisnotnecessarilyalwaysthecorrect
or thebest wayof identifyingthesefirms. In addition, no
matter how carefully we choose comparable firms,
differenceswillremainbetweenthefirmwearevaluingand
thecomparablefirms.Figuringouthowtocontrolforthese
differences is a significant part of relative valuation.
What Is a Comparable Firm?