There are three implications for analysts using enterprise
value multiples in relative valuation. The first is that
companiesinriskierbusinesses(evenwithinthesamesector)
will trade at lower enterprise value multiples than more
mature and safer companies with predictable sources of
income.Thesecond isthatdifferencesinfinancialleverage
canaffectenterprise valuemultiplesindirectly,especiallyif
some firms are close to their optimal financial leverage
whereasothersareunder-oroverlevered.Thelatterwillhave
highercostsofcapitalandlowerenterprisevaluemultiples.
Thethirdisthatcomparingcompaniesinemergingmarkets
withcompaniesindevelopedmarketscanbeskewedbythe
factthattheformerareriskierandhavehighercostsofcapital
than the latter. Consequently, they should trade at lower
enterprise value multiples.
Quality of Investments Effect
While the growth rate matters, the quality of that growth
matters even more. With enterprise value multiples, the
qualityofgrowthisbestcapturedbythereturnoncapital.For
any givengrowth rate,ahigherreturnoncapitaltranslates
into a lower reinvestment rate and higher cash flows to