Aswath Damodaran 537
Multiples and Fundamenals
! Gordon Growth Model:
! Dividing both sides by the earnings,
! Dividing both sides by the book value of equity,
! If the return on equity is written in terms of the retention ratio and the
expected growth rate
! Dividing by the Sales per share,
P 0 =rD!PgS^1 n
P 0
EPS 0 =PE=^
Payout Ratio*( 1 +gn)
r-gn
P 0
BV 0 =PBV=^
ROE - gn
r-gn
P 0
BV 0 =PBV=^
ROE*Payout Ratio*( 1 +gn)
r-gn
P 0
Sales 0 =PS=^
Profit Margin*Payout Ratio*( 1 +gn)
r-gn
All multiples have their roots in fundamentals. A little algebra can take a
discounted cash flow model and state it in terms of a multiple. This, in turn,
allows us to find the fundamentals that drive each multiple:
PE : Growth, Risk, Payout
PBV: Growth, Risk, Payout, ROE
PS: Growth, Risk, Payout, Net Margin.
Every multiple has a companion variable, which more than any other variable
drives that multiple. The companion variable for the multiples listed above are
underlined. When comparing firms, this is the variable that you have to take the
most care to control for.
When people use multiples because they do not want to make the assumptions
that DCF valuation entails, they are making the same assumptions implicitly.
