Withequitymultiples,wescalethemarketvalueofequityto
some measure of equity earnings, book value, or even
revenues.The most commonly used equitymultiple is the
price-earnings ratio, where the market value of equity is
scaled to netincome. Even thatsimple ratio isdefined in
different ways by different analysts, and we began this
chapter by looking at the variations. We then considered
variationsontheP/Eratioaswellasprice-to-bookequityand
price-to-salesratios; thelatterisnot a consistently defined
multiple but still remains widely used.
Equity multiples are ultimately determined by the same
fundamentals that determine the value of equity in a
discountedcash flow model—expectedgrowthin earnings,
equity risk, and cash flow potential. Firms with higher
growth, lower risk, and higherpayout ratios, other things
remainingequal, should tradeat muchhighermultiples of
earnings,bookvalueofequity,andrevenuesthanotherfirms.
Totheextentthattherearedifferencesinfundamentalsacross
countries,across time,and acrosscompanies, themultiples
willalso vary.Afailure tocontrolfor thesedifferencesin
fundamentalscanleadtoerroneousconclusionsbasedpurely
upon a direct comparison of multiples.
Thereareseveralwaysinwhichequitymultiplescanbeused
in valuation. One way is to compare multiples across a
narrowlydefinedgroupofcomparablefirms andto control
for differences in growth, risk, and payout subjectively.
Anotheristoexpandthedefinitionofacomparablefirmto
includetheentiresector(suchastechnology)orthemarket
andtocontrolfordifferencesinfundamentalsusingstatistical
techniques, such as regressions.