Past, Current, and Forward Multiples in Equity Valuation

Use of Multiples to Estimate Equity Value

Having established the mechanics of calculating multiples, constructing peer groups, and applying both comparables-based and fundamentals-based approaches, we now turn to the practical application of these tools in estimating equity value. A robust valuation exercise does not rely solely on current multiples; rather, it synthesizes information from multiple time horizons to build a comprehensive picture of a company’s relative worth.

A critical warning must precede this discussion: the peer group itself may not be fairly valued. When an entire industry or market sector trades at inflated multiples, comparing a target company to its peers may falsely suggest it is attractively priced. Conversely, during periods of market pessimism, a company may appear overvalued relative to peers that are themselves undervalued. This phenomenon underscores why relative valuation should always be complemented by absolute valuation methods such as discounted cash flow analysis.

This section examines three distinct time-based perspectives on multiples:

1. Current Multiples: Based on the most recent financial data available
2. Historical Multiples: Drawing on past observations for the company and its peers
3. Projected Future Multiples: Incorporating forward-looking estimates, frequently used in terminal value calculations

Each perspective offers unique insights, and the most defensible valuation conclusions emerge from synthesizing all three.

The Peer Group Overvaluation Warning

A fundamental limitation of relative valuation is its implicit assumption that the comparator group is appropriately priced. However, entire industries can become detached from fundamental value during periods of investor exuberance, or depressed during periods of pessimism.

Consider a scenario where a company’s intrinsic value appears attractive relative to its peers, but this is because the entire peer group is trading at multiples that exceed their justified levels:

$$ \begin{array}{c} \text{Observed Peer Multiple} > \text{Justified Peer Multiple} \end{array} $$

In such cases, concluding that the company is undervalued based on a discount to peers would be erroneous—the peers themselves may be overvalued. This is why relative valuation is most powerful when combined with present value methods that anchor valuation to cash flow fundamentals.

Multiples Based on Current Values

Current multiples represent the ratio of a company’s current share price (or enterprise value) to the most recently reported fundamental measure—typically the last four quarters of earnings, cash flow, sales, or the most recent book value per share.

Strengths of Current Multiples:

• Reflect the most up-to-date market information and pricing
• Readily observable and straightforward to calculate
• Consistent with the traditional application of the method of comparables

Limitations of Current Multiples:

• Non-recurring items: One-time gains, losses, or restructuring charges may distort the denominator
• Accounting differences: Varying depreciation methods, inventory valuation, and revenue recognition across firms affect comparability
• Cyclical sensitivity: The most recent period may not represent long-term earning power (the “base-year effect”)
• Transitory factors: Temporary market conditions may distort pricing

When using current multiples, analysts should carefully examine whether the denominator reflects sustainable, recurring performance or has been distorted by transitory factors.

Multiples Based on Past Values

Historical multiples serve two distinct purposes in relative valuation analysis.

Purpose 1: Company-Specific Trend Analysis

By comparing a company’s current multiple to its own historical average or range, analysts can identify whether the company’s valuation has materially shifted relative to its own past. This analysis can signal:

• Fundamental improvement: Rising multiples accompanied by improving growth, profitability, or reduced risk
• Fundamental deterioration: Declining multiples associated with weakening competitive position or increased risk
• Cyclical patterns: Multiples that move predictably with the economic cycle

Purpose 2: Peer-Relative Historical Comparison

Comparing a company’s historical multiples to those of its peers over the same period allows analysts to assess whether the company’s relative performance has changed. This provides essential context about whether a current discount or premium is historically typical or represents a recent divergence.

Important Consideration: The method of forecasted fundamentals can be applied to historical periods as well, enabling analysts to determine whether observed changes in multiples are justified by corresponding changes in underlying fundamentals such as growth, profitability, and risk.

Illustrative Example: Historical Multiples Analysis for a European Luxury Goods House

Maison d’Aurora, a European luxury goods manufacturer, has experienced shifting multiples over the past decade. An analyst evaluating the company gathers the following data:

$$
\begin{array}{l|c|c}
\textbf{Metric} & \textbf{Maison d’Aurora Current} & \textbf{10-Year Historical Average} \\
\hline
\text{P/E} & 18.50 & 22.30 \\ \hline
\text{EV/EBITDA} & 11.20 & 13.80 \\
\end{array}
$$

Step 1: Compare to Own History

The analyst observes that Maison d’Aurora’s current P/E (\(18.50\)) is below its 10-year historical average (\(22.30\)), and its EV/EBITDA (\(11.20\)) is also below its historical average (\(13.80\)). This initially suggests the company may be undervalued relative to its own history.

Step 2: Compare to Peer History

To provide context, the analyst compares Maison d’Aurora’s multiples to those of its peers—Côte d’Azur Holdings and Alpine Brands Group—over the same period:

$$
\begin{array}{c|c|c|c}
\textbf{Year} & \textbf{Maison d’Aurora EV/EBITDA} & \textbf{Côte d’Azur EV/EBITDA} & \textbf{Alpine Brands EV/EBITDA} \\
\hline
2014 & 14.2 & 16.8 & 10.5 \\ \hline
2015 & 15.1 & 17.2 & 10.8 \\ \hline
2016 & 14.8 & 16.5 & 10.2 \\ \hline
2017 & 13.5 & 15.9 & 9.8 \\ \hline
2018 & 12.9 & 15.1 & 9.2 \\ \hline
2019 & 11.8 & 14.2 & 8.5 \\ \hline
2020 & 10.2 & 12.8 & 7.2 \\ \hline
2021 & 12.5 & 14.5 & 9.0 \\ \hline
2022 & 12.0 & 13.8 & 8.5 \\ \hline
2023 & 11.2 & 13.2 & 8.0 \\
\end{array}
$$

Interpretation:

Over the 10-year period, Côte d’Azur consistently maintained the highest EV/EBITDA multiple, while Alpine Brands consistently had the lowest. Maison d’Aurora’s historical average (\(13.1x\)) was between its peers (Côte d’Azur: \(15.0x\), Alpine Brands: \(9.2x\)). Currently, Maison d’Aurora trades at \(11.2x\), which is a slight premium to Alpine Brands (\(8.0x\)) but a significant discount to Côte d’Azur (\(13.2x\)).

The analyst notes that Maison d’Aurora’s relative standing has remained broadly consistent over time—it has always traded between the high and low peer multiples. However, the general decline in multiples across all three companies suggests either:

1. The luxury goods sector has experienced a structural re-rating due to lower growth expectations, increased competition, or higher risk
2. The entire industry may be undervalued relative to its own history

This analysis illustrates why historical comparisons alone cannot determine mispricing—they must be combined with fundamental analysis. The analyst should consider whether Maison d’Aurora’s fundamentals have changed over the period. If growth and profitability have improved, the lower multiple would suggest undervaluation. If they have deteriorated, the lower multiple may be justified.

Multiples Based on Projected Future Values

Multiples based on future values incorporate forward-looking estimates in the denominator. The most common example is the forward P/E, which uses next year’s expected earnings per share:

$$ \begin{array}{c} \text{Forward P/E} = \frac{P_t}{\text{EPS}_{t+1}} \end{array} $$

These multiples offer several advantages:

• Eliminate base-year effects: Using expected rather than historical earnings
• Reflect market expectations: Incorporating consensus views on future performance
• Better comparability: Particularly useful when companies have had unusual recent events

Applications of Projected Future Multiples

Application 1: Direct Relative Valuation

Analysts can compare forward multiples across peers to assess relative value. This is especially useful for companies with volatile or negative trailing earnings.

Application 2: Terminal Value Estimation

The most common application of projected multiples is in determining terminal value within a discounted cash flow framework:

$$ \begin{array}{c} \text{IV}_0 = \sum_{t=1}^{n} \frac{E(\text{CF}_t)}{(1+r)^t} + \frac{E(P_{t+n})}{(1+r)^n} \end{array} $$

The numerator of the second term, \(E(P_{t+n})\), represents the expected value at the end of the forecast horizon and is often estimated using an appropriate multiple:

$$ \begin{array}{c} E(P_{t+n}) = \text{Forecasted Fundamental}_{t+n} \times \text{Peer Group Multiple} \end{array} $$

Critical Consideration: The peer group used for terminal value estimation should reflect the mature, steady-state characteristics expected at the end of the forecast period, not the company’s current high-growth characteristics. Using a high-growth peer group multiple for a company expected to transition to slower growth would materially overstate terminal value.

Comprehensive Example: Terminal Value Estimation for Swiss Advisory Partners

Swiss Advisory Partners is a business consulting firm being valued by an analyst. The company’s base-year Free Cash Flow to Equity (FCFE) is CHF \(3,120,000\). The analyst expects FCFE to grow at \(12\%\) annually over a three-year forecast period, with a required return on equity of \(10\%\).

Alternative Approach: Terminal Multiple Method

The analyst believes that after three years, Swiss Advisory Partners will resemble more mature consulting firms and will trade at a price-to-FCFE multiple of \(15x\).

Step 1: Forecast FCFE for Years 1-3

$$ \text{FCFE}_t = 3,120,000 \times (1+0.12)^t $$

$$
\begin{array}{c|c|c}
\textbf{Year} & \textbf{Calculation} & \textbf{FCFE} \\
\hline
1 & 3,120,000 \times 1.12 & \text{CHF } 3,494,400 \\ \hline
2 & 3,120,000 \times 1.12^2 & \text{CHF } 3,913,728 \\ \hline
3 & 3,120,000 \times 1.12^3 & \text{CHF } 4,383,375 \\
\end{array}
$$

Step 2: Calculate Terminal Value at Year 3

$$ \begin{align*} \text{Terminal Value}_3 & = \text{FCFE}_3 \times 15 \\
\text{Terminal Value}_3 & = 4,383,375 \times 15 = \text{CHF } 65,750,625 \end{align*} $$

Step 3: Discount All Future Cash Flows

$$ \begin{align*} \text{PV}(\text{FCFE}_1) & = \frac{3,494,400}{1.10^1} = \text{CHF } 3,176,727 \\
\text{PV}(\text{FCFE}_2) &= \frac{3,913,728}{1.10^2} = \text{CHF } 3,234,486 \\
\text{PV}(\text{FCFE}_3) &= \frac{4,383,375}{1.10^3} = \text{CHF } 3,293,295 \\
\text{PV}(\text{Terminal Value}) & = \frac{65,750,625}{1.10^3} = \text{CHF } 49,399,422 \end{align*} $$

Step 4: Sum All Present Values

$$ \begin{align*} \text{IV}_0 &= 3,176,727 + 3,234,486 + 3,293,295 + 49,399,422 \\
\text{IV}_0 &= \text{CHF } 59,103,930 \end{align*} $$

Interpretation: The estimated equity value of Swiss Advisory Partners is approximately CHF \(59.1\) million. This represents the sum of the present value of explicit forecast FCFE plus the present value of the terminal value derived from the peer group multiple.

Critical Consideration: The analyst must ensure that the peer group used for the \(15x\) multiple consists of mature, slower-growth consulting firms—not high-growth firms that might trade at higher multiples. Using the wrong peer group would materially distort the valuation.

The Overvaluation Warning Revisited

Returning to the earlier warning, consider what happens if the peer group multiple of \(15x\) is itself inflated due to sector-wide overvaluation. If the justified multiple based on fundamentals is only \(12x\), then:

\( \text{Actual Terminal Value} = \text{FCFE}_3 \times 12 = 52,600,500 \)

\( \text{Overstatement} = 65,750,625 – 52,600,500 = \text{CHF } 13,150,125 \)

This represents a \(25\%\) overvaluation of the terminal value, which would materially distort the final equity value estimate. This reinforces the importance of cross-validating multiples with DCF analysis and fundamental valuation.

Illustrative Example: Multiple Time-Horizon Analysis for a Global Automaker

Scenario: An analyst is evaluating Atlas Motors Corporation, a global automobile manufacturer. The company has exhibited cyclical performance over the past decade.

Data:

$$
\begin{array}{c|c|c|c}
\textbf{Year} & \textbf{P/E (Atlas)} & \textbf{EV/EBITDA (Atlas)} & \textbf{EV/EBITDA (Peer Average)} \\
\hline
2014 & 9.2 & 4.8 & 6.5 \\ \hline
2015 & 9.8 & 5.1 & 6.8 \\ \hline
2016 & 10.5 & 5.5 & 7.2 \\ \hline
2017 & 11.2 & 5.8 & 7.5 \\ \hline
2018 & 10.8 & 5.6 & 7.3 \\ \hline
2019 & \text{N/A} & 4.2 & 6.8 \\ \hline
2020 & \text{N/A} & 3.8 & 6.2 \\ \hline
2021 & 8.5 & 4.5 & 7.0 \\ \hline
2022 & 7.8 & 4.0 & 6.6 \\ \hline
2023 & 6.5 & 3.4 & 6.0 \\ \hline
\text{Current} & 6.5 & 3.4 & 6.0 \\
\end{array}
$$

Note: P/E is not meaningful for 2019-2020 due to net losses.

Step 1: Historical Company Analysis

Atlas’s current P/E of \(6.5\) is below its pre-cyclical average of approximately \(10.3\) (excluding the loss years). Similarly, its EV/EBITDA of \(3.4\) is well below its historical average of \(4.8\). This suggests the company may be undervalued relative to its own history.

Step 2: Peer-Relative Historical Analysis

Historically, Atlas traded at a discount to its peers—its EV/EBITDA averaged approximately \(5.0\) versus the peer average of \(6.6\). Currently, Atlas trades at \(3.4\) versus peers at \(6.0\). The discount has widened from approximately \(24\%\) historically to approximately \(43\%\) currently.

Step 3: Forward-Looking Analysis

Using consensus analyst estimates, the analyst projects forward P/E for Atlas:

\( \text{Forward EPS (Year 1)} = \$4.50 \)

\( \text{Forward P/E} = \frac{\$72.00}{\$4.50} = 16.0x \)

Step 4: Terminal Value Application

The analyst plans to value Atlas using a three-stage DCF model. The terminal multiple to be applied at the end of Year 5 should reflect Atlas’s expected mature-state characteristics. The analyst uses the current peer average EV/EBITDA of \(6.0x\) for the terminal value calculation, acknowledging that by Year 5, Atlas is expected to have a more normalized margin structure.

Step 5: Integrate Findings

$$
\begin{array}{l|l|l}
\textbf{Perspective} & \textbf{Indicator} & \textbf{Valuation Signal} \\
\hline
\text{Current vs. Historical (Own)} & \text{Current multiples below 10-year average} & \text{Potentially undervalued} \\ \hline
\text{Current vs. Historical (Peers)} & \text{Discount to peers has widened} & \text{Potentially undervalued} \\ \hline
\text{Forward Multiples} & \text{Forward P/E of 16x suggests recovery} & \text{Growth expectations are reasonable} \\ \hline
\text{Terminal Value} & \text{Uses mature peer average of 6.0x} & \text{Conservative terminal value approach} \\
\end{array}
$$

Overall Conclusion: The combined evidence suggests Atlas Motors may be undervalued. However, the analyst must consider whether the auto industry itself is undervalued (due to cyclical trough) or whether Atlas’s fundamentals have structurally deteriorated (loss of market share, increased competition). A thorough fundamental analysis—including margin trends, competitive positioning, and return on invested capital—is needed to distinguish between these possibilities.

Framework for Synthesizing Multiple Time Horizons

$$
\begin{array}{l|l|l|l}
\textbf{Multiple Type} & \textbf{Definition} & \textbf{Primary Use} & \textbf{Key Limitation} \\
\hline
\text{Current} & \text{Trailing 12-month denominator} & \text{Method of comparables} & \text{Base-year effects, non-recurring items} \\ \hline
\text{Historical (Own)} & \text{Company’s past multiples} & \text{Trend analysis, identifying changes in fundamentals} & \text{May not reflect current conditions} \\ \hline
\text{Historical (Peer)} & \text{Peer multiples over same period} & \text{Relative performance assessment} & \text{Peers may have changed} \\ \hline
\text{Projected (Forward)} & \text{Expected future denominator} & \text{Relative valuation, terminal value estimation} & \text{Forecast accuracy, appropriate peer selection} \\
\end{array}
$$

Question 1

Which of the following statements most accurately describes the use of past multiples in the relative valuation process?

1. Multiple comparisons for a company relative to peer historical averages allow one to gauge deterioration or improvement in company performance.
2. Past multiples relative to a company’s own history allow assessment of performance under similar market conditions relative to a peer group.
3. Results using historical multiples may be influenced by changes in business operations and strategy and/or those of peers.

Solution

Correct Answer is C.

Business operations or strategy changes can alter a company’s risk, growth, and cash flow characteristics, which affect multiples.

A is incorrect. Comparing to peer historical averages assesses relative performance, not company-specific deterioration or improvement.

B is incorrect. It reverses the two purposes of historical multiple analysis.

Question 2

NovaTech Solutions has experienced improving growth along with higher shareholder payouts over the last four years. The company trades at a current P/E multiple of \(22\). The analyst observes that over the last four years, NovaTech’s P/E multiple has ranged from a low of \(15\) to a high of \(30\). Average P/E by year is shown below:

$$
\begin{array}{l|c}
\textbf{Year} & \textbf{Average P/E} \\
\hline
\text{Year -3} & 19.8 \\ \hline
\text{Year -2} & 19.5 \\ \hline
\text{Year -1} & 21.1 \\ \hline
\text{Current Year} & 20.5 \\
\end{array}
$$

Which of the following statements is most accurate about NovaTech’s current P/E relative to its own historical P/E?

1. NovaTech is currently overvalued relative to its historically observed P/E multiples.
2. NovaTech is currently undervalued because of its improving fundamental characteristics.
3. NovaTech cannot be valued relative to its historical multiples without incorporating comparables.

Solution:

The correct answer is C.

Comparing a company’s current multiple to its own historical multiples does not allow for a conclusion of misvaluation.

A is incorrect. The current P/E (\(20.5\)) falls within the historical range (\(15-30\)) and near recent averages.

B is incorrect. More information about the improvement in fundamentals is needed, and a conclusion of undervaluation would require incorporating comparables.

Question 3

Quantum Innovations is a technology firm with high growth potential expected over the next seven years. Following the high-growth period, growth is expected to decline to a much more sustainable pace. An analyst is preparing a present value model for valuing Quantum’s stock and will use a peer group P/E multiple to estimate the stock’s terminal value at the end of seven years.

Which statement is most accurate about the analyst’s choice of peer group for the P/E multiple?

1. The analyst should use the current P/E multiple taken from a peer group of high-growth technology firms.
2. The analyst should use the current P/E multiple taken from a peer group of larger and slower-growth technology firms.
3. The analyst should use an average of Quantum’s historical P/E observations over the last seven years.

Solution:

The correct answer is B.

The most appropriate peer group consists of comparables that share the growth-rate characteristics expected for Quantum’s future (mature, slower growth).

A is incorrect. The high-growth peer group is more comparable to Quantum’s current fundamentals than to its expected future state.

C is incorrect. Quantum’s historical P/E multiples likely incorporated much different fundamentals, such as higher growth, and are unlikely to be useful for estimating a future multiple.