One approach used is to apply average valuation multiples derived over multi-year periods, primarily with a view to smoothing cyclical effects.

Share-based multiples include:

  • Historic and forward price/earnings (P/E) ratios, based on normalised earnings before goodwill amortisation
  • Historic and forward price/cash-earnings (pre-depreciation) ratios
  • Price to net asset value per share
  • Dividend yields

Enterprise-based valuation multiples include:

  • Historic and forward earnings before depreciation, interest, tax, depreciation or amortisation (EBITDA) ratios; EBITDAR ratios are used where rental/lease charges (R) are material
  • Historic and forward EBITA ratios
  • Historic and forward operating cash-flow ratios
  • Enterprise value (EV)/sales ratios
  • EV/invested capital ratios

As enterprise values include net financial liabilities and minority interests, these are then deducted to arrive at the residual equity value.

Cyclical considerations

In the case of average earnings multiples, cognisance is given to the stage of the relevant industry cycle as it may not be appropriate to apply average multiples towards the peak or trough of a cycle. In such cases, earnings multiples prevailing at the corresponding stages of previous cycles may be used.

Asset-based valuations

In the case of asset-based valuations, reported net assets generally provide a floor to a company's valuation. In many cases, however, company accounts can understate the underlying economic value of a company's assets, and a ratio such as return on invested capital to weighted average cost of capital (ROIC/WACC) may provide a more appropriate indicator of the book value multiple.

Company comparisons

The ratings of similar companies may be taken into account in valuing shares, as indeed may average ratings for particular industry sectors. Such ratings are commonly used in analysts' sum-of-the-parts (SOTP) valuations.

Cash-flow based valuation

In discounted cash-flow (DCF) models, a company's forecast future free cash-flows are discounted by its weighted WACC. Due to the uncertainties involved in forecasting long-term cash-flows, analysts use a number of different DCF models.

Other valuation techniques

In some instances, other valuation metrics may be used. For instance, enterprise value per tonne of installed capacity may be used in capital-intensive sectors or in the earlier stages of a company's development.