In finance, a multiple is a valuation ratio that divides a price or value measure by a financial performance measure, so that value is expressed as a number of times that measure. A price paid for a business, divided by the earnings that business produced in a year, is a multiple of earnings. It is used mainly in the market approach to valuation, and it is an analytical construct rather than a term any accounting standard defines.
The General Form
Every multiple has the same two parts.
multiple = value measure / performance measureThe value measure is the price of a claim on the business, either the equity claim alone or the whole capital structure. The performance measure is a figure the business produced over a period, such as revenue or earnings, or in some cases holds at a date, such as book value. The answer is read as a number of times, never as a percentage.
Price Multiples and Enterprise Value Multiples
Which family a ratio belongs to is settled by its numerator. Price multiples are ratios of a stock’s market price to some measure of fundamental value per share, while enterprise value multiples relate the total market value of all sources of a company’s capital to a measure of fundamental value for the entire company (CFA Institute, Market-Based Valuation: Price and Enterprise Value Multiples). What goes into that second numerator, and why no accounting rule pins its components down, is set out in enterprise value.
The two families are not interchangeable. Enterprise value over earnings before interest, taxes, depreciation and amortization is preferred to price over that same measure because EBITDA, as a pre-interest number, is a flow to all providers of capital (CFA Institute, Market-Based Valuation: Price and Enterprise Value Multiples). The numerator and the denominator have to be claimed by the same providers of capital. Earnings struck after interest belong to shareholders alone, so they pair with an equity numerator. A figure struck before interest is available to lenders and shareholders together, so it pairs with enterprise value.
A Worked Example
Say a business carries the values and the results below for one year.
Enterprise value 6,000,000
Equity value 4,500,000
EBITDA for the year 750,000
Net income for the year 500,000
EV / EBITDA 6,000,000 / 750,000 = 8.0
Equity / net income 4,500,000 / 500,000 = 9.0Both of those hold. Dividing enterprise value by net income does not, even though the arithmetic runs.
EV / net income 6,000,000 / 500,000 = 12.0Net income is what is left after lenders have been paid, so it belongs to the shareholders, while enterprise value covers the lenders’ claim as well. That ratio counts a return to one group of claimants against a price paid by two, so a comparison built on it does not hold.
Where Multiples Show Up in a Firm’s Work
A firm meets the multiple in three places. The first is the valuation engagement, where the multiple works inside the market approach, one of the three approaches valuation sets out. Valuation techniques consistent with that approach often use market multiples derived from a set of comparables, those multiples might lie in ranges with a different multiple for each comparable, and selecting where within the range the appropriate multiple falls requires judgment, considering factors specific to the measurement (FASB Statement No. 157, paragraph 18).
Goodwill impairment testing is the second place, and it runs on the reporting unit, the level of reporting at which goodwill is tested for impairment (FASB Statement No. 142, Appendix F). In estimating the fair value of one, a valuation technique based on multiples of earnings or revenue or a similar performance measure may be used if that technique is consistent with the objective of measuring fair value, and use of multiples would not be appropriate where the entity whose multiples are known is not of a comparable nature, scope or size as the reporting unit being measured (FASB Statement No. 142, paragraph 25).
Purchase price allocation is the third, meaning the spread of what was paid across what was acquired. The acquirer shall measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values (FASB Statement No. 141 (revised 2007), paragraph 20), and a market-approach measurement of any of them can carry a multiple inside it.
None of those passages defines a multiple. They name it, permit it and set conditions on its use, which is as close to an authority as the term has. All three Statements have since been superseded: on the effective date of Statement No. 168 all then-existing non-SEC accounting and reporting standards were superseded, except for a short list of named Statements that stayed authoritative until each was integrated into the Codification, and all nongrandfathered non-SEC accounting literature not included in the Codification was deemed nonauthoritative (FASB Statement of Financial Accounting Standards No. 168, paragraph 15). In the Board’s view the issuance of that Statement and the Codification would not change GAAP, apart from one revenue recognition change for certain nonpublic nongovernmental entities (the same Statement, Summary), so those conditions are read out of the Codification now rather than out of the Statements. The same change is set out in accruals.
The rule of thumb a partner is most likely to have heard, one times gross revenue for an accounting practice, is a payment convention rather than a valuation, and how to value a CPA firm works that difference through.
Multiples and the Equity Multiplier
The similar name hides a different kind of ratio. The equity multiplier is total assets divided by total shareholders’ equity, a leverage ratio that says how much of the asset base creditors funded. Both of its inputs are balance sheet totals and neither is a price, so it values nothing. A valuation multiple always carries a market price or a value conclusion in its numerator.
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