370  Using Multiples
Use Forward Earnings Estimates
When you are building multiples, the denominator should be a forecast of 
profits, preferably normalized for unusual items, rather than historical profits. 
Unlike backward-looking multiples, forward-looking multiples are consistent 
with the principles of valuation—in particular, that a company’s value equals 
the present value of future cash flows, not sunk costs. When companies have 
recently acquired or divested significant parts of their operations, historical 
profits are even less meaningful. Normalized earnings estimates better reflect 
long-term cash flows by avoiding one-time items. For example, Warren Buf-
fett and other disciples of value-investing guru Benjamin Graham don’t use 
reported earnings. Rather, they rely on a sustainable level of earnings that they 
refer to as “earnings power.”2
Forward-looking multiples generally also have lower variation across 
peer companies. A particularly striking example is the stock market valua-
tion of the 20 largest pharmaceutical companies worldwide in 2019. The 
Exhibit 18.2  Sample Sum-of-Parts Valuation
EV/NOPAT, times
Value, $ million
NOPAT, 2014, 
$ million
High
Low
High
Low
Business Unit 1
410
16.0
14.5
6,568
5,952
Business Unit 2
299
13.9
12.5
4,165
3,749
Business Unit 3
504
13.1
12.5
6,597
6,306
Business Unit 4
587
9.7
9.4
5,681
5,533
Business Unit 5
596
9.0
8.0
5,365
4,769
Business Unit 6
116
8.0
7.0
931
814
Corporate
(542)
8.0
9.1
(4,339)
(4,917)
Net Enterprise Value
1,971
12.7
11.3
24,968
22,207
Value, $ million
After-tax net 
income, 2013, 
$ million
Book value, 
$ million
Earnings 
multiple, 2013 
times
Market value/
book value, 
times
High
Low
Joint ventures
157
675
12.0
2.5
1,879
1,688
Other investments
1,525
1,525
1,525
Cash and marketable securities
2,879
2,879
2,879
Gross enterprise value
31,251
28,298
Debt
(10,776)
(10,776)
(10,776)
Unfunded retirement liabilities
(2,907)
(2,907)
(2,907)
Noncontrolling interest
(45)
(296)
12.0
2.5
(540)
(739)
Other
(1,940)
(1,940)
(1,940)
Equity value
15,088
11,937
Shares outstanding, millions
500
500
Equity value per share
$30.18
$23.87
 
2 B. C. N. Greenwald, J. Kahn, P. D. Sonkin, and M. van Biema, Value Investing: From Graham to Buffett 
and Beyond (Hoboken, NJ: John Wiley & Sons, 2001).

Use Forward Earnings Estimates  371
­backward-looking ratio of enterprise value of last year’s EBIT ranged from 
about 10 to more than 70 times (see Exhibit 18.3). The ratio of enterprise 
value to the next year’s expected EBIT, based on equity analyst estimates, 
also showed significant variation, ranging from about 6 to 25 times. But when 
we extended the forecast window to four years, the variation across compa-
nies was significantly lower, with multiples for all but one company between 
about 7 and 12 times.
The convergence of multiples four years out in the pharmaceuticals in-
dustry is extreme. This is most likely due to the market’s ability to project 
near-term earnings well, because drug introductions and patent expirations 
are well known. By contrast, it is difficult to differentiate long-term success 
across companies because it depends on an individual company’s ability to 
discover or develop new drugs. No one has figured out a good way to do that.
Empirical evidence shows that forward-looking multiples are indeed more 
accurate predictors of value than historical multiples are. One empirical study 
examined the characteristics and performance of historical multiples versus 
Exhibit 18.3  Pharmaceuticals: Backward- and Forward-Looking Multiples, 
September 2019
PharmaCo 20
 17.0
 12.9
 17.6
 14.4
 17.9
 16.1
 58.2
 17.9
 18.6
 14.5
 11.2
 72.1
 12.3
 14.4
 27.4
 42.0
 14.6
 23.6
 10.5
 9.3
 13.6
 11.1
 14.7
 13.0
 14.9
 14.4
 18.9
 12.4
 17.3
 12.1
 6.3
 10.7
 11.3
 7.6
 19.8
 25.0
 11.3
 12.1
 7.5
 10.1
 10.9
 10.2
 10.9
 10.1
 12.1
 11.1
 9.6
 10.4
 13.1
 9.7
 3.7
 9.8
 9.9
 6.9
 7.9
 11.6
 7.3
 9.7
 6.6
 9.9
PharmaCo 19
PharmaCo 18
PharmaCo 17
PharmaCo 17
PharmaCo 16
PharmaCo 15
PharmaCo 14
PharmaCo 13
PharmaCo 12
PharmaCo 11
PharmaCo 10
PharmaCo 9
PharmaCo 8
PharmaCo 7
PharmaCo 6
PharmaCo 5
PharmaCo 4
PharmaCo 3
PharmaCo 2
PharmaCo 1
Enterprise value/
EBIT, 2018
Enterprise value/
expected EBIT,1 2020
Enterprise value/
expected EBIT,1 2023
1 Consensus analyst forecast.