How to value a company using multiples - MoneyWeek Investment Tutorials

so welcome back to my short series on valuing companies short sharp not a degree course and the next topic I want to take on fits in to my introductory video three ways to value a company and its method number two I've already done one video which is out there on how to value a company using the assets so let's go straight in to the second of the three approaches outline in the introductory video and that is valuing a company using multiples okay if you see in the first video and urge you to take a look at three ways to value a company you'll see that I mention now sits based approach as one multiple based approach that's now today and then there's full-blown DCF for discounted cash flow and I'll deal with that in another video ok so in this short shop series of introductory videos what is the way you go about valuing a company using multiples it's a bit quick and dirty this method certainly not scientifically foolproof but it's a useful check on whether your other methods net assets DCF are throwing out sensible numbers so see it that way back of an envelope check does this valuation make sense who would use the method of Matt describe while a predator may be looking value a company for example somebody who's looking to maybe list a private company lots of private company worth there's no share price had weight and start can use this approach and an investor just thinking well is the company I'm looking at good value relative to other companies can also use this approach it's got a few approaches but is a little bit quick and dirty now it rests on a key point which is if you're going to value anything using a multiple and this fast approach you need to pick the right multiple what I mean by that well basically what I'm suggesting is there is a way of using or ratios to get a quick and dirty valuation of a company if you need to sort of choose the right one for the company or sector okay and what I mean by that is if you're choosing a ratio by the way do take a look at my other ratios videos if you're unsure about some of this stuff on edge them at the end all right if you're planning a company using a multiple you've got the earnings based multiples like classic example the old-fashioned p/e ratio there's one or two others out there too then you've got sales based multiples like the price to sales ratio okay for those people thinking Crikey's well this is a bit quick there are videos out there called what is a p/e ratio what is the price to sales ratio okay and then you've got like all sort of asset driven multiples like the price to book ratio all right now my point is this if you're looking at a company thinking too dirty quick and dirty check on its valuation or I'm looking at a private company I'm not sure quite what to compare it to you need to compare it to something which is similar so you need to decide what sort of beast it is you're trying to do this method on you know is it the company that's driven by earnings as a clue is it even generating any earnings because if it isn't not much point in trying to value it using an earnings based approach there are companies that are lost making grabbing market share telecoms coms for example they don't have earnings so you can't use an earnings based method to value them you have to use like a sales based method we even sylia you know a sort of price to click or a price to eyeballs method or eyeball leave some of our calm silliness behind for today so you know is it a sales driven company ie it doesn't have any earnings is it learnings driven which is obviously what frankly you'd like to see in most cases or is it asset driven is it the size of the balance sheet that drives the industry in the sector or investment trusts company's property companies for example is that the key driver because that's going to influence how you go about what I'm about to suggest next so let's number one pick the right multiple here's his head than done right but important now let's assume you've decided you want to get on an earnings based route so how do you do it how does any of this stuff give you a valuation for a company or a quick and dirty check as to whether a company is cheaper expensive well the answer to that question is you can simply rearrange a p/e ratio or a price to sales ratio or a price to book ratio to give you what you're looking for let me show you what I mean some very simp maths in here if for example I was to say to you a p/e ratio for a particular company is five now if you're not sure about what I'm talking about here do see my what is a p/e ratio video first okay and what you're trying to get out of this exercise is the value of the company the price because the p/e ratio is the price per share to earnings per share or the entire market capitalization to one year's earnings historic or forecast and you know the answers five okay you can rearrange this by multiplying both sides by E so the value of the company if you like the price is equal to five times e my fatha is multiply both sides by E and it becomes this price is five times e now here's my point okay it's not the maths that I'm worried about too much I wasn't too bad though hopefully it's this well let's say you have an earnings figure for the company will find a value okay you think a realistic earnings figure is 100 million all right and what you've done is you've gone out look for firms imagine you're trying value a private company using private publicly quoted companies for example that have share prices it's all determined by the market you've decided that comparable firms in the market have let's say call those benchmark firms other firms like this one typically have a p/e ratio of five probably you're on going with it so you've decided similar firms of P ratio five to this firm liable estimate earnings 100 million a year you could on that basis say well the expected price the value of this thing is five times e which is five times 100 million so 500 minute very quick and dirty all right so saying this company is worth really using a very quick comparative method looking other companies about 500 million all right now who would that be useful to you can clearly see it's a very simplified method no one would actually go buy a company on this base I hope they wouldn't just using this one method they do other things like the asset based approaching in a previous video or the DCF approach I'll mention it in a future one but to whom would this be useful I gave anybody and the answer is well if you're looking at a company that's already listed as an investor and trying to get comparison is it cheap is it expensive you might say well similar companies trade on a pu5 this one's got reliable earnings 100 million a year expected value 500 million if it's actually valued at only 300 million its market capitalizations only 300 million you might say well actually maybe it's a little bit cheaper there should be maybe the scope to investigate further is is the company I'm looking at undervalued okay so there's one little use of it somebody trying to bring let's say a private company to the market for the first time if they can find comparable companies and that's easier said than done of course most directors say our company's unique and all the rest of it make fine comparable companies they would say well let's look at those comparable companies average the p/e ratio multiplied our company's earnings by that and get a ballpark figure for what this new one to the markets worth so it's pretty pretty quick and dirty approach alright so as a couple of sort of uses of this technique if you're in a negotiation to buy a company let's say unlike a situation for a lot of you are no but you might use this as a backup as I mentioned before you might do some DCF which is pretty meaty you might do some asset based valuation and you might use this as a kind of sensibleness check if you like you know did does this answer come anywhere near the other answers all right so there it is very very fast isn't introductory video the multiples based approach to valuing a firm deciding how much is worth whether an existing firm to cheaper expensive all right like all these methods it's more art than science in so far as you've got to pick the right multiple all right as that decision to make first of all yeah am I looking at an earnings based or sales based an asset based or a watt based sort of company that's fairly key and then secondly you've got to be comfortable equal your benchmark right okay it's easier said than done just say well I'll go out and find a bunch of similar companies I'll use them as a benchmark for this one how many there are and how similar they actually are is a matter of judgment in practice there it is the second of three methods that you could use to go about putting some sort of value on a company you

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Keywords: ratios, stocks, shares, profit, loss, Bid, offer, spreads, Trading, trade, economy, tim bennett, Banking, Accounting, Asset, Company valuation, How to value shares, Valuation techniques

Id: g4_eKPJmy1E

Length: 9min 23sec (563 seconds)

Published: Fri Jun 28 2013