Variables Overlooked with Multiples

In a terrific paper focused on value creation, authors Michael Mauboussin and Dan Callahan explain what is overlooked when multiples are used in place of models.

Investors generally “value” businesses using multiples. The most common are price/earnings (P/E) and enterprise value/earnings before interest, taxes, depreciation, and amortization (EV/EBITDA). Multiples are not valuation. They are a shorthand for the valuation process. Importantly, multiples obscure the value drivers that investors most care about. These include growth, return on incremental invested capital, and the discount rate. As a consequence, investors who do not think in first principles will not understand the justified changes in multiples as the result of changes in these value drivers.

The full model provides an opportunity to review the assumptions behind the value drivers listed above. When an investor applies a multiple to a stream of earnings, all of those inputs are assumed, but without the model they cannot be shared.

EBITDA multiple valuation
Source: Michael J. Mauboussin and Dan Callahan | "The Math of Value and Growth" | Morgan Stanley | 06/09/2020 | Visit