On the accuracy of equity value - multiples

Yong Keun Yoo, (Korea University Business School, Korea University, Sungbuk-Gu, Seoul, Korea) on:

The valuation accuracy of equity valuation using a combination of multiples

 

Abstract

 

Purpose 

Aims to examine a comprehensive approach to combine several simple multiple valuation, so as to improve the valuation, accuracy of the simple multiple valuation technique. 

Design/methodology/approach 

In order to combine several simple multiple valuations, the equity value is estimated by a weighted average of the valuation outcomes obtained from several simple multiple valuations. To calculate the weight of each valuation outcome, the out-of-sample price-deflated regression of stock prices on several simple multiple valuation outcomes is conducted. Next, the alternative hypothesis of whether the composite approach yields a higher valuation accuracy than the simple multiple valuation is tested, using the actual stock price of the valued firm as the benchmark to measure the valuation accuracy under the assumption of market efficiency. 

Findings 

It was found that combining several simple multiple valuation outcomes of a firm, each of which is based on a stock price multiple to a historical accounting performance measure of the comparable firms (historical multiple), improves the valuation accuracy of the simple multiple valuation using a single historical multiple. However, further analysis shows that the combination of the simple multiple valuation outcomes based on a stock price multiple to analysts’ earnings forecasts of the comparable firms (forward earnings multiple) and several simple multiple valuation outcomes based on historical multiples does not improve the valuation accuracy of the simple multiple valuation using a forward earnings multiple. 

Research limitations/implications 

One caveat of this study is that only the linear combination of the simple multiple valuation outcomes is considered. Non-linear combination of the simple multiple valuation outcomes based on both forward earnings multiple and historical multiples may be able to improve the valuation accuracy of the simple multiple valuation using a forward earnings multiple. This possibility is still an open question. 

Practical implications 

The findings imply that a historical multiple contains incremental information not captured by other historical multiples, which is useful for the improvement of the valuation accuracy. However, the historical multiples may have no incremental information beyond a forward earnings multiple. 

Originality/value

The forward earnings multiples as well as the historical multiples for the equity valuations of broader firms are considered. Given the previous finding that forward earnings multiple presents the highest valuation accuracy among the valuation multiples, it is further investigated whether the composite approach using forward earnings multiple and historical multiples can improve the valuation accuracy of the simple multiple valuation using a forward earnings multiple. In addition, the potential problem of selection bias in the previous study is addressed, which examines only the equity valuations in the tax court.

(Yong Keun Yoo, (2006) "The valuation accuracy of equity valuation using a combination of multiples", Review of Accounting and Finance, Vol. 5 Iss: 2, pp.108 - 123)