Three Easy Business Valuation Multiples

A question we have all asked ourselves, what is a company worth? Let us look at some simple business valuation metrics that you can apply with information that is readily available.

Three business valuation aspects

While many metrics helps us show how a company is performing in these aspects, we are going to show three examples in this post, how you can calculate them, and think about what they mean.

1.    Earnings- and Free Cash Flow Yield

A company that does not generate money cannot keep going forever. Smaller companies however might not generate a profit, but what all companies need is a positive cash flow. If it costs more money to run a business than it is making, it is a bad sign for the company’s longevity. These two metrics which we have put under the same heading gives you an idea of how many %’s of your investment is profit or cash flow. They are key metrics that will give you insights as to how large of a return you might expect.   

\text{Enterprise Value = Market Cap + Total Debt - Cash}

These metrics could also be calculated by simply using the market cap instead of the enterprise value. EBIT is also known as the “gross profit”.

\text{Earnings Yield} = \frac{\text{EBIT}}{\text{Enterprise Value}}

The importance of cash flow

Another take on Earnings Yield is the free cash flow yield. Which basically shows how much free cash flow (FCF) your investment is generating. It is calculated the same as earnings yield but replacing EBIT with the FCF.

\text{Free Cash Flow Yield} = \frac{\text{Free Cash Flow}}{\text{Enterprise Value}}
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What we want is a metric that shows us how much of a return we would expect from our investment. The reason we like this metric is that it also allows you to compare an investment in a company with any other investment, like an interest-bearing return or other companies.

Most of us, when we look at a company, looks at revenue, profit, and the balance sheet. Unfortunately, cashflow is usually overlooked, perhaps since it is not as easy to intuitively understand such as revenue, profit, or assets. What cashflow shows is if and “where” the company generates money in their business. For smaller companies that do not have a reliable profit to base an earnings yield on, the free cash flow yield might be better suited. If they cannot generate positive cash flow (at least operative cash flow), they will never achieve a stable profit.

It makes it easier to compare your stock investment to other forms of investments as it shows the expected profit or cash flow as a percentage of the company’s value.

2.    Net Current Asset Value (NCAV)

Benjamin Graham is famous for his Net-Net valuation of companies, where if a company is valued less than their current assets minus liabilities, it is undervalued.

\text{NCAV = Total Current Assets - Total Liabilites}

What this metric shows is basically the company’s liquidation value. The metric can be viewed like a worst-case valuation for a company, and therefore, any company valued below their NCAV could be considered undervalued. A rule of thumb used by Graham was to look for companies valued at 67% of their NCAV.

This truly is a simple metric and should perhaps be wielded with caution. While it could be a good sign that a company is valued beneath its liquidation value, always ask, why is it? No metric alone is sufficient to give a full picture of a company, this one included.

Other simple asset valuation metric is the P/B ratio which shows the price in comparison to the company’s total assets.

3.    Price/Earnings-to-Growth (PEG)

Let us end off easy with a twist on the classic P/E value. This metric shows if a company grows quickly and turns a profit. Simply put, it shows what we pay for growth. Therefore you are looking for companies with as low PEG value as possible.

\text{PEG} = \frac{\text{P/E}}{\text{Profit Growth (\%)}}

This means that if a company has a P/E = 25, and an annual profit growth of 20 % we get the following PEG:

\text{PEG} = \frac{\text{25}}{\text{20\%}} =1.25

PEG and stock prices

One of the things that makes this metric a little bit harder to apply is how and when to look at earnings, prices and growth. Essentially all three components of the metric. For a better estimate of valuing a company’s profit growth we would suggest taking a three- or five-year average of the profit growth. If a company has not grown significantly for two consecutive years, but then made a huge jump in earnings, the PEG metric for that year would be thrown off and not show the whole picture. In that case it helps to average the earnings growth.

The price of the company also effects the PEG value. A sudden drop in stock price might show a low PEG value. But does that mean the stock is suddenly a good investment? It is always important to think critically in these scenarios and question the metric, and the potential future of the company.

The growth of a company can also be done without looking at the current valuation of the stock. Year to year revenue, profit and asset growth are easily shown. Is the company growing consistent over the years, or does it fluctuate?

Summary

These metrics can hopefully give you more insights and angles to do a business valuation other ways than the common ones.

There is a plethora of metrics that you can use to valuate a company. Use your common sense and apply those that seems to fit best. If is a small company, focus on looking at its growth and cash flow rather than its asset valuation. If the company is more mature and its stable dividends are what you care about, use metrics that shows how well the company is suited to do that, such as assets, cash flow, and dividend yield.

Check out our post on investing in the tech industry where you can apply these metrics. This is also great source for more metrics and how to use them.