Multiple Multiples The use of multiples as a measure of the value of a business is a widespread practice in the world of acquisitions and divestitures in the chemical industry. As depicted in the illustration above however, these types of comparisons can be very misleading. Looking at the world’s largest chemical company on the same day, we see that two highly regarded financial publications come up with multiples that are markedly different (yet entirely accurate). If you are selling a business, you would probably like to use The Wall Street Journal calculation as a benchmark. If you are a buyer, The Value Line formula would be the better of the two, but perhaps a different multiple would be even better yet. In the article that follows, we will look at some of the common multiples employed in the industry, how they are calculated, and how they are used, and in some cases, misused. Multiple Multiples Earnings Multiples What Earnings Are Measured? 1. Net Income – Multiples based on the net income of a business, after all expenses are deducted, are the most common measure, and probably the most useful, when valuing or comparing businesses that are publicly held or where an entire company, including debt, is being acquired or evaluated. 2. EBIT – Multiples based on earnings before interest and taxes are commonly used (as are EBITDA multiples discussed next) when a business is being acquired or evaluated without any assumption of debt and/or is a division or part of a larger company. EBIT is a measure of the operating earnings of a business without regard to its debt level or tax situation, and includes non-cash expenses such as depreciation and amortization. 3. EBITDA – Multiples based on earnings before interest, taxes, depreciation and amortization are also commonly used when looking at a business with no debt or which is a part of another company. Since depreciation and amortization are not included here and distinguish this measure from EBIT, EBITDA is sometimes referred to as cash flow. However, it differs from a true "cash flow" measuring stick because items such as capital expenditures and changes in working capital are not included. Over What Period? 1. Trailing 12 Months – Earnings multiples based on the last 12 months are perhaps the most common. The Wall Street Journal for example, as depicted on the cover, calculates multiples this way. 2. Forward 12 Months – Calculating an earnings multiple based on projected earnings over the next 12 months can be a very useful mechanism, but only if the projects are sound. Since projections in the acquisition context are inherently suspect, this method may not be appropriate. For a public company with a sound track record and a sizable analyst following however, this method may be more appropriate. 3. 6 months trailing/6 months forward – A middle ground between a multiple based on trailing earnings and one based on future earnings is one based half on each. The Value Line Investment Survey uses this method, as is depicted on the cover. Thus the difference in how they and The Wall Street Journal report DuPont’s multiple. 4. Average over more than one year – For cyclical businesses and businesses which otherwise have large swings in earnings, it may be more appropriate to average earnings over more than 12 months to get to a more accurate measure of value. In all cases, it is important to make sure that 1. the most appropriate earnings measure is used; 2. the most appropriate time period is used; and 3. comparisons to other deals and other companies are apples to apples comparisons. Other Multiples Price/Book Value – In some cases, multiples based on book value are used. These can be helpful, but when used alone, they have limited appeal. Book value bears no relation to the earnings of a business or its ability to generate cash. In addition, book value in some cases has no relation to actual net asset value. But where the book value of a business does have some relation to its actual net asset value, looking at a book value multiple can provide a measure of the level of downside risk. If a business is valued at or near its book value, and book value approximates real net asset value, then there is little downside to the acquisition. Conversely, if such a business is acquired at a steep multiple of book value, then there is a significant downside risk if the business does not perform as planned. Price/Sales – In some cases, a multiple based on sales is used. This has very limited usefulness unless comparing companies in similar industries with similar cost and margin structures.