Trading Multiples | Definition | Steps to Valuate Company

hello everyone hi welcome to the channel of WallStreetmojo watch the video till the end and if you're new to this channel then you can subscribe us by clicking the bell icon friends today we are going to learn a topic that is trading multiple something which is really very significant and important when you are doing valuations of companies or stock and so on and so forth so let's learn exactly what the concept is all about trading multiples or trading multiple is nothing but identifying comparable companies comparable company means all those companies who are in the same industry literally let's say you're working in pharmaceutical industry and you want to value that pharma company then you need to take the pure pharma company in the industry itself and performing relative valuation like an expert to find a fair value fair value means your valuation of the form so what exactly is this trading multiple okay let's begin see trading multiple valuation is nothing but identifying comp companies it's comparable companies but it's also known as com companies and performing relative valuations like expert to find the fair value that is the valuation the price of the firm the trading multiple valuation it process starts with first you know you identify you need to identify the comp companies in the market and then selecting the right valuation tools so you can say the evaluation tools is the next task and finally then preparing the table that can provide a easy inferences about the fair value of the industry and the company so before digging into the nitty-gritty of trading multiples first let's take a very simple trading example or trading multiple example to illustrate how exactly the thing works let's say that you are comparing between two companies let's say company Y and this company Z at this moment as an investor you only know that the share price the number of is outstanding for each company and the market capitalization because if you have the share price if we have the number of shares then it's really easy to find the market gap so comparing the share price of why let's say the share price I'm indicating it as P which is 10 per share and for company Z it's 25 per share you don't understand anything out of this so how would you tell which company is doing great by looking at the share price is it possible see that's why you would look for relative value by using trading multiples first and foremost you will look at the EPS of each company you found out let's say that the EPS of company Y EPS of company Y is let's say 5 per share and that of EPS of companies there is let's say 9 per share so by looking at EPS you come to the conclusion that company Z is making more money than company y but that doesn't mean that it has benefited to you or it has given some benefit to you see to find how much you would get out of the company or how much you will perceive if you would buy them in the first place you need to look at the most important multiple that's called PE that's priced to earning ratio see by looking at the PE show you you can find the value or you can find the multiple as price divided by earning per share so that is control R so you can see it's 2 let's see how what is the difference so that it's 2 and 2.77 and now it becomes clear that which company is more profitable as you as an investor so you would get $1 worth of earning by paying 1.5 to company Y whereas this is the perfect interpretation of PE ratio and in case of Z you would get $1 worth of earning by paying 2.77 to company z now that means company y is certainly you can say more beneficial for you as an investor so let's go a step by step approach let's take a step by step approach for trading multiple valuation table see in this particular section we'll will go step by step and we'll talk about how each step briefly after going through the whole section you would get a very clear idea how to use a trading multiples for a value in your company a crystal-clear idea the step one that starts as you need to identify as we are discussed the comparable companies in the industry itself as you can see there are lists of companies and this are the comparable which will be used we have prized market Cap so by that we can receive number of shares and there is an order valuation metric that is EV that has been used the first question that investor us and how much we identify the comparable company how would we identify the question is quite obvious since there are many companies in the industry how would one know which is the right company so first what you need to do is that you need to look for you need to look for business mix that's the most important thing in this business mix okay under the business mix you would see the three things one is called the product the another is called the service and offered by the company and the third is the geographical area by which the today's these of the customer the second most important thing is that you would see the size of the company under the size you can choose any or all three determinants like revenue okay then you have the total assets and or you can say and an or a better margin very important see the idea is to find out the right industry right service products and right trading multiples additionally you know we can we'll be looking in in in example if possible second say second step looking at the trading multiple for valuation for trading multiple okay this is how we are going to value now there are lists of trading multiples that will evaluate see there are various multiple we can use for value accompany and here we are going to talk about the same the first and the foremost is EV by EBITDA now this is one of the most trade most common trading multi but the purpose of using EV that is enterprise value not only considers the market cap you can say but it also takes into account also takes the debt into account even EBITDA also takes that into account and not the immediate cash item and that's why EV by EBITDA is the most reliable multiple in and analyst analyst used to value the company the right range of EV/EBITDA is close enough to 6 to 15 X usually in that scenario then we have next in our list is you EV /revenue now this is also another common multiple that is used a lot the multiple is applicable to only those situation where EBITDA of the company is negative now EV/EBITDA is negative EV/EBITDA wouldn't be much useful and for the companies that have just started their journey and negative EV/EBITDA is is a way to common however EV/revenue is integrate multiple to be used when two companies have similar revenue but can be pretty different and how much operate see you can say that EV/ revenue multiple ranges in close enough to 1 to 3 X the next set that we are going to understand is the p/e ratio now the p/e ratio this multiple is specifically useful because EBIT it is calculated after adjusting the depreciation amortization you know but there is another common multiple that investor used to find out about the price they need to pay for the earning $1 it is almost similar to equity value to net income it usually should range around 12 X to 30 X so this are the trading multi you should use the next step is going to be comparing you need to compare the multiples with the comparable company compare the multiples with comp companies right this is the last step of the whole process and in this stage you will look at various trading multiples of the target company and we'll compare the comparable companies now the general metrics to look at are very simple like you know you can use mean median low or high if a company is multiple is above the mean and median you can say that we tend to in for the company and may be overvalued on the other hand if the multiple is below the mean and median we may infer it as undervalued right so high and low helps us understand understanding the outliers and the case to remove those if they are too far away from the mean and the median now there are a couple of things that you need to load while interpreting the trading multiples were while going through the trading multiple see first is many trading multiples can miss you you know it's it's better if you look for the forward that's very important forward or trading multiples instead of looking at the past data second EV/EBITDA down multiple we just discussed over here EV/EBITDA multiple is one of the best use if you are comparing the target company with big companies okay and for start-up one of the best multiple is EV/revenue which we just learned now P/E ratio that is a third should be used at all should it shouldn't be used at all now there are two reason behind it first P/E ratio are mostly affected by the cap sources that capital sources and secondly P/E ratio is calculated by taking the overall earnings into account and overall earnings include the non ops that is the non operating charges like write-offs and restructuring extra charges restructuring charges and some time authorization expenses and so on and so forth if you have learned and you know liked with the video if you think that you know if you have enjoyed and learned watching this video please like comment on this video and subscribe to our channel for all the latest updates thank you everyone Cheers

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