Learn Everything about the Valuation using Multiples: CCA & CTA

If you are an investor in an organisation and want to understand the methods of the valuation multiples so that an accurate value of the business can be drawn upon to guide you to make better decisions then you must go through this piece. So, let’s understand about it in more detail. 

What is Valuation Using Multiples?

Valuation using multiples is a kind of business valuation. There are three types of approaches for valuing the business and valuation using multiples is one of the kind. Valuation using multiples is also known as the market-based approach.

In this method of valuation, it is assumed that similar companies shall be valued in a similar way by using the financial data from the other comparable companies to help in determining the value of the target company.in this process of the valuation of the company obtain ratios to determine the value of the business. This method uses two approaches respectively Comparable Company Analysis (CCA) and Comparable Transaction Analysis (CTA)

What is the major assumption of the Multiple Approach?

The major assumption of this multiples approach is that in order to value a company one must compare it with the value of other similar companies.in other words, similar assets or similar companies are set at similar prices which is valid to make a good comparison between the companies.

What are the Advantages and Disadvantages of the Multiples Approach?

Advantages

• Estimation Value: It helps in the quicker estimation of a company’s value.
• Easiest Approach: It is one of the simplest approaches to valuing a company
• Observation of the Multiples in the Public Domain: The approach is easily defended as multiples are observed in the public domain.
• Easy extraction of the data: By using the comparable company analysis the data will be easily derived from the annual reports of the companies.

Disadvantages

• Reliability on the Past Data: The multiples are oriented to the past only and this is why of only reflect the future with a bit of difficulty.
• Unavailability of the Data: Sometimes the necessary data is not publicly available while conducting a precedent transaction analysis.
• Difficulty in addressing the correct data: Comparing SMEs with large publicly listed companies is a bit difficult and determining the correct discount is subjective.

Understand the Two Approaches in Detail

Comparable Transaction Analysis

It is a method of valuing a company that is based on the prices paid for similar businesses in their recent deals. This method is also known as the precedent transaction analysis. This method is useful for valuing the stocks as it reflects the true market reality as to what investors are willing to pay for an industry. At the same time, CTA captures the premiums and synergies involved in the deal which is not true in the case of the discounted cash flow or the market multiple.s

What are the steps involved in the CTA process?

• Identifying the target company: The first step involved in the CTA process is the identification of the target company and its key characteristics like industry, size, growth; risk profile, and profitability.

• Selecting the relevant transactions: The next step in the process is to select the comparable transactions and these transactions should be similar to the target company in areas of industry, size, growth, risk profile and profitability.it is also a requirement that these transactions should have occurred in a reasonable time frame.

• Gathering and analysing the data: It is of utmost importance that the data should include the deal value, the structure of the deal financial information of the target company and the acquirer. These data sets are required to be adjusted for any kind of differences between the comparable transactions and the target company. The data is also required to be adjusted for any kind of accounting or reporting differences.

• Calculating the valuation multiples: These valuation multiples are the ratios that compare the value of the deal to the financial metric of the target company. These valuation multiples may be calculated on a historical basis by using the financial data of the target company before the deal. The valuation multiples used in CTA are: 

• EV/EBITDA: As the name suggests this type of multiple uses the enterprise value of a company to its earnings before taxes, interest, amortisation, and depreciation. This multiple measures how many times a company’s operating cash flow can cover the total value of the organisation.

• EV/ Revenue: This multiple compares the enterprise value of the company to its revenue. This multiple measures how much the market is willing to pay for each piece of the company’s sale.

• P/E: This multiple makes the comparison of the equity value of the company to its earnings. This multiple use the measurement to gather how many times the company’s net income can cover its market capitalisation.

By using any of these approaches the business value can be tracked down by using the Comparable Transaction Analysis.

Advantages of CTA

• Current market conditions: As it uses the ratios of the comparable companies it helps in drawing the market conditions.

• Capture different values: CTA captures different values of the synergies and other strategic benefits. With the help of the CTA the synergies from a merger or acquisition can be captured by using the transactions involving similar sellers and buyers of the target company. In simpler terms, synergies are the benefits that arise by combining two or more companies ranging from cost savings, operational improvement, and revenue enhancement. While on the other hand premium stands for the excess amount paid by a buyer over the market value of the target company. Premiums are mostly influenced by factors such as the competitive landscape, strategic fit, bargain power etc.

• Cross-checking of other valuation measures: With the help of this valuation measure the authenticity of the genuineness of other valuation measures can be measured.

• Helpful for the Investors: CTA helps the investors to find the undervalued or overvalued stocks generally based upon the perception of the market.

Disadvantages of CTA

• Reliability of the Data Type: The biggest drawback of the CTA is the total reality of the available data which sometimes makes it difficult to capture the unique characteristics of the target company.
• Influenced by other factors: The results drawn from CTA are influenced by the deal structure – financing, speculation and other market sentiments.

Comparable Company Analysis (CCA)

CCA is a method that is used to evaluate the value of a business by using the metrics of other companies of similar size and working in the same industry. This method works under the same assumption that similar companies have similar multiples. CCA uses the same multiples as used by the CTA the most common ones are EV/S, P/E, P/B P/S etc.

The steps involved in the CCA

• Identifying the Target Company: The first step involved in the CCA process is the identification of the target company and its key characteristics like industry, size, growth, risk profile and profitability.

• Gathering and analysing the data: The second step is to gather and analyse the data. It is of utmost importance that the data should include the deal value, the structure of the deal financial information of the target company and the acquirer. These data sets are required to be adjusted for any kind of differences between the comparable companies and the target company by using different valuation multiples.

• Calculating the valuation multiples: These valuation multiples are the ratios that compare the value of the target company with the comparable company.

Advantages and Disadvantages of the Comparable Company Analysis

Advantages

• With his method, optimistic assumptions can be obtained as it is based upon the real market data which is not far in the future.

• This method or approach is easy to understand and quicker to calculate.

Disadvantages

• There might be a possibility of no availability of truly comparing companies.

• This analysis or approach is less effective for volatile companies and thinly traded stocks.

• The comparable market could be different or wrong.

• With this approach, the long-term potential of the company can be undervalued.

What is the Comparable Company Analysis Formula?

Valuation of the company using the multiples is based on the below-calculation:

The financial metric is taken from the valuing company

• Company value = P &L x multiple

This multiple might be the median taken down from similar companies working in the industry.

What is the underlying logic behind Valuation using Multiples?

The main way his approach works is by looking at the financial performance of the other companies but not directly neck to neck comparing by using the main metrics such as sales, or EBITDA.

In this approach, it is always assumed that similar companies shall be able to apply the ratios from one to another and return a valid valuation estimate because they are totally limited in the business environment and operations which is valid to do so.

Choosing the Correct Multiple Approach

Different Multiples are obtained from different financial metrics such as EV/sales or EV/ EBITDA and then these will be applied to the related metric of the valuing company.

For instance, obtaining the multiple (ratio) and then multiplying it with the valuing company EBITDA to give the enterprise value.

What are Transaction, Trading and Experience Multiples?

Valuation multiples are used in different methodologies either in the trading comparable analysis or in the transaction comparable analysis. Sometimes practitioners use the experience multiples and the differences are as:

Trading Multiples (also known as the Comparable Company Analysis)

• This multiple is based on the market prices of comparable listed companies.
• It is assumed that the there prices are an accurate reflection of fair market value.
• Adjustments are necessary for this multiple.
• This reflects investor patterns in the market and sector.

Transaction Multiples (also known as Comparable Transaction Analysis)

• The comparable data is based on the purchase prices in the transactions with similar companies.
• Control premiums and strategic premiums are also included in the value of the transaction.

Experience Multiples

• This multiple is based on industry estimates.
• Surveys of the market participants.
• This multiple is used for early-stage companies and small businesses.

Valuation with the EBITDA Multiples

Valuation using the EBITDA multiples opts as it disregards the differences between the debt costs of the companies, depreciation, taxes and amortisation. These are also excluded from the valuation and this approach assumes that the comparable companies have similar operating functions.

Which year is to be used?

At the time when the CIA approach is being used it is crucial that the same P&L metric for the comparable companies and the target company is to be used. For instance: if the P/E multiple is being used the earnings in such a case of the comparable companies will be similar to the target company.

Comparison of the CTA with other Methods and Multiples.

• Discounted Cash Flow: In this method the projection of the future cash flow of a company is done and then discounting it back to the present value by using a discount rate. This method is widely used by analysts and investors as of captures the fundamental value of a company based on the expected cash generation system.

• Leveraged Buy-Out: In this method it estimates the value of the company which is based upon the amount that an acquirer would pay to buy it by using both the debt and equity. With this method the acquirer aims to generate A higher return on the investment by paying a law amount and at the same time using the high level of debt and thereby improving the performance of the target company.

• Relative Valuation: This method-it involves the comparing the value of a company to he value of other similar transactions or companies using ratios or multiples which are based on the financial metrics.

Common mistakes to avoid for improving the accuracy and reliability of CTA

• Properly defining the criteria for selecting the Comparable Transactions: Properly identifying the set of transactions which are similar to the target company. The criteria can be in terms of size, growth, profitability and other factors.

• Collecting and verifying the data: Second step is to collect the proper data for the selected transactions which include the deal value, the deal date, the acquirer, the target company – the revenue, the multiples, the synergies, and the EBITDA. Various sources can be used for these datasets such as press releases, analyst reports, financial statements, industry publications, etc.
• Adjusting the data: Adjusting the data set for the comparable transactions for making them more comparable to the target company. This involves adjusting the deal value for debt, cash, minority interest, etc.

• Calculating and Analysing the Multiples: The next step is calculating and analying the multiples for the comparable transactions. Calculating the multiples for each transactions- the median, mean, minimum and the maximum values.it is also imperative that distribution and range of the multiples are analysed,and identifying any trend or patterns which can indicate the driver of the value in the industry.

• Applying ther Multiples: The last step in the process is analysing and lastly applying the multiples to the target company to estimate its value.

Conclusion

Valuation using multiples is considered the most feasible option rather than the discounted cash flow method. The ratio of the comparable companies is taken into consideration and then with the difference the exact valuation of the valuing company can be taken down.

Frequently Asked Questions

Q1. What is the CCA method of valuation?

Ans 1. CCA stands for the comparable company analysis method in which the valuation of the company is by using the metrics of other businesses of similar size in the same industry.

Q2. How to use multiples for valuation?

Ans 2. For determining the valuation of an enterprise the EBITDA of the business is required to be multiplied by the EBITDA of the comparable of the other companies.

Q 3. What are the five methods of valuation?

Ans 3. The five methods of business valuation are the profits residual, investment, cost-based, and comparative.

Q 4. What is the difference between CCA & DCF?

Ans 4. DCF stands for discounted cash flow this method is based upon the view of the company’s long-term prospects while CCA is a method that is based on the financial market of the industry.

Q5. What is the CCA method?

Ans 5. Current cost accounting is a method that values the assets of the organisation at their fair market value.

Q 6. What is EBITDA multiple?

Ans 6. This is the formula for calculating the financial ratio which compares the enterprise value to the annual earnings before taking into about the interest taxes, depreciation, and amortisation.

Q 7. What is the difference between CCA and depreciation?

Ans 7. There is a very thin line of difference between these two. The one difference is that CCA is also a version of depreciation.

Q8. What is the difference between multiples and DCF valuation?

Ans 8. DCF gives the intrinsic value of the organisation while multiples give the market relative perspective to the organisation.

Q 9. What is a good P/E ratio?

Ans9. A good P/E ratio is considered to be around 20 to 25.

Q10. Which method gives the highest valuation?

Ans 10. The DCF method gives the highest valuation.