1. Introduction

In principle, multiples can be used to value any asset or financial claim. Financial analysts, however, typically use them to value either the whole company or its equity. Accordingly, we distinguish between multiples to estimate enterprise value and multiples for equity valuation. This distinction is important to keep in mind when using relative valuation in practice. 

From the basic  accounting relation (in market values), we know how enterprise value and equity value are related:

If we want to estimate Enterprise Value, we can do so in two ways:

  • Either directly by using a valuation multiple with "Enterprise Value (EV)" in the denominator. Examples of such multiples are the EV-to-Sales ratio or the EV-to-EBITDA ratio. 
  • Alternatively, we can first estimate the firm's equity value using a multiple with "Price" in the denominator (for example the Price-Earnings ratio). To the resulting equity value, we then add the value of the firm's net debt to obtain enterprise value.

 

Similarly, if we want to estimate Equity Value, we can do so:

  • Either directly by using a valuation multiple with "Price" in the denominator. 
  • Alternatively, we can first estimate the firm's enterprise value using a multiple with "Enterprise Value (EV)" in the denominator and then subtract the value of the firm's net debt to obtain equity value.

 
Let's look at this with two simple examples.

 

Example 1: You want to estimate the theoretical stock price of the hypothetical firm A. The firm's EBITDA is 50 million, its Net Debt is 150 million, and it has 5 million shares outstanding. A comparable firm is trading at an EV-to-EBITDA multiple of 8. Based on this information, what's the theoretical stock price of firm A?

To find an answer, we proceed as follows:

  • Estimate the firm's enterprise value using the comparables EV-to-EBITDA multiple
  • Subtract net debt to obtain the firm's equity value
  • Divide by the number of shares to obtain the firm's theoretical stock price.

 

The numbers imply a theoretical enterprise value of 400 million for firm A:

 

Enterprise valueA = EBITDAA × EV-to-EBITDA multiple = 50 × 8 = 400 million.

 

Consequently, the firm's equity value is 250 million:

 

Equity value = Enterprise value - Net debt = 400 - 150 = 250 million.

 

Given 5 million shares outstanding, the theoretical stock price is 50:

 

Stock price = Equity value / Shares outstanding = 250 / 5 = 50. 

 

Example 2: You want to estimate the enterprise value of the hypothetical firm B. The firm's Earnings per share (EPS) are 3 dollars. It has 10 million shares outstanding and comparable firms trade at a Price-Earnings ratio of 20. The firm's net debt is 400 million. Based on this information, what's the theoretical enterprise value of firm B?

To find an answer, we proceed as follows:

  • Estimate the theoretical stock price using the comparables Price-Earnings multiple
  • Multiply by the number of shares to obtain the firm's equity value
  • Add net debt to obtain the firm's theoretical enterprise value.

 

The numbers imply a theoretical stock price 60 for firm B:

 

Stock priceB = EPSB × Price-Earnings ratio = 3 × 20 = 60.

 

Consequently, the firm's equity value is 600 million:

 

Equity value = Stock price × Number of shares = 60 × 10 million = 600 million.

 

Given a net debt of 400 million, the theoretical enterprise value is, therefore, 1 billion:

 

Enterprise value = Equity value + Net debt = 600 + 400 = 1'000 million.