{"id":19837,"date":"2021-08-18T11:33:57","date_gmt":"2021-08-18T11:33:57","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=19837"},"modified":"2024-04-05T06:43:51","modified_gmt":"2024-04-05T06:43:51","slug":"price-and-enterprise-value-multiples-in-valuation","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/price-and-enterprise-value-multiples-in-valuation\/","title":{"rendered":"Price and Enterprise Value Multiples in Valuation"},"content":{"rendered":"<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/0kMmbenpFuo\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><\/iframe><\/p>\r\n\r\n<p>There are two methods of using price and enterprise value multiples:<\/p>\r\n<ul>\r\n\t<li>The method of comparables.<\/li>\r\n\t<li>The method based on forecasted fundamentals.<\/li>\r\n<\/ul>\r\n<h2>The Method of Comparables<\/h2>\r\n<p>The method of comparables is the valuation of an asset based on multiples of a similar asset (comparables or guideline assets).<\/p>\r\n<p>Multiplying a benchmark value of the price-to-earnings (P\/E) multiple by an estimate of a company\u2019s earnings per share provides a quick estimate of the value of a company\u2019s stock that can be compared with the stock\u2019s market price.<\/p>\r\n<p>Also, comparing a stock\u2019s actual price multiple with a relevant benchmark multiple should come up with the same conclusion on a stock\u2019s relative valuation.<\/p>\r\n<p>The economic rationale behind the method of comparables is the law of one price, i.e., the economic principle that two identical assets should have a similar price.<\/p>\r\n<h2>The Method Based on Forecasted Fundamentals<\/h2>\r\n<p>This method refers to the use of multiples that are derived from forecasted fundamentals rather than comparables with other companies. Fundamentals are characteristics of a business related to profitability, growth, or financial strength.<\/p>\r\n<p>The justified price multiple is the multiple\u2019s estimated fair value, which can be justified based on the method of forecasted fundamentals or the method of comparables.<\/p>\r\n<p>The economic rationale underlying the method based on forecasted fundamentals is that the numerator value used in the justified price multiple is derived from the DCF model.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>The economic rationale underlying the method of comparables is <em>most likely:<\/em><\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>The law of one price.<\/li>\r\n\t<li>The characteristics of a business related to profitability, growth, or financial strength.<\/li>\r\n\t<li>The justified P\/E is higher than the actual P\/E.<\/li>\r\n<\/ol>\r\n<h3>Solution<\/h3>\r\n<p><strong>The correct answer is A.\u00a0<\/strong><\/p>\r\n<p>The law of one price is the economic rationale underlying the method of comparables that states that two identical assets should sell at the same price.<\/p>\r\n<p><strong>B is incorrect.\u00a0<\/strong>The characteristics of a business related to profitability, growth, or financial strength are called fundamentals.<\/p>\r\n<p><strong>C is incorrect.\u00a0<\/strong>The justified P\/E being higher than the actual P\/E indicates that the stock may be undervalued.<\/p>\r\n<\/blockquote>\r\n<p>Reading 25: Market-Based Valuation: Price and Enterprise Value Multiples<\/p>\r\n<p><em>LOS 25 (a) Contrast the method of comparables and the method based on forecasted fundamentals as approaches to using price multiples in valuation and explain economic rationales for each approach.<\/em><\/p>\r\n","protected":false},"excerpt":{"rendered":"<p>\ufeff\ufeff There are two methods of using price and enterprise value multiples: The method of comparables. The method based on forecasted fundamentals. The Method of Comparables The method of comparables is the valuation of an asset based on multiples of&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,401],"tags":[216,402,475,474],"class_list":["post-19837","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","tag-cfa-level-2","tag-equity-valuation","tag-price-and-enterprise-value-multiples-in-valuation","tag-reading-29-market-based-valuation","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Price and Enterprise Value Multiples in Valuation - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"The method of comparables is the valuation of an asset based on multiples of a similar asset (comparables or guideline assets).\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/price-and-enterprise-value-multiples-in-valuation\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Price and Enterprise Value Multiples in Valuation - 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