CHAPTER 8
Equity Multiples
When investing in a stock, our interests primarily lie in
whethertheequityin acompanyisfairlypriced.It follows
logicallythatwelookatequitymultiples,wherewerelatethe
marketvalueofequitytotheearningsorbookvalueofequity
inthatcompany.Inthischapter,webeginbylookingatthe
variantsonequitymultiplesrangingfromthewidelyusedP/E
ratiostolesscommonlyusedmultiplessuchaspricetofree
cash flow to equity (P/FCFE). We then examine the
distributionalcharacteristicsofthemostwidelyusedequity
multiplesandthedeterminantsofthesemultiples.Weclose
thechapter witha series ofapplicationswhere we usethe
analytical tools developed to make judgments on valuation.
DEFINITIONS OF EQUITY MULTIPLES
Anequitymultiplerequirestwoinputs, oneforthemarket
valueoftheequityandoneforthevariabletowhichequity
valueisscaled—earnings,bookvalueofequity,orrevenues,
for instance.In this section,we first considerhowbest to
estimatethemarketvalueofequityandthenmoveontolook
at the choices when it comes to scaling variables.
Measuring the Market Value of Equity
Allequitymultiplesarescaledtothemarketvalueofequity.
Withpublicly traded firms, measuringthemarket value of
equitymayseemlikeatrivialexercisesincethereis,afterall,
onlyonestockpriceatanypointintime.Thereare,however,