366  Analyzing the Results
Creating scenarios also helps you understand the company’s key prior-
ities. In our example, reducing costs or cutting capital expenditures in the 
downside scenario will not meaningfully affect value. Any improvements in 
the downside scenario whose value is less than $531 million ($2,800 million 
in face value less $2,269 million in market value) will accrue primarily to the 
debt holders. In contrast, increasing the odds of a successful launch has a 
much greater impact on shareholder value. Increasing the success probability 
from two-thirds to three-fourths would boost shareholder value by more than 
10 percent.
The Art of Valuation
Valuation can be highly sensitive to small changes in assumptions about the 
future. Take a look at the sensitivity of a typical company with a forward-
looking price-to-earnings ratio of 15 to 16. Increasing the cost of capital for this 
company by half a percentage point will decrease the value by approximately 
10 percent. Changing the growth rate for the next 15 years by one percentage 
point annually will change the value by about 6 percent. For high-growth 
companies, the sensitivity is even greater. Considering this, it shouldn’t be 
surprising that the market value of a company fluctuates over time. Historical 
volatilities for a typical stock over the past several years have been around 25 
percent per annum. Taking this as an estimate for future volatility, the market 
value of a typical company could well fluctuate around its expected value by 
15 percent over the next month.4
We typically aim for a valuation range of plus or minus 15 percent, which 
is similar to the range used by many investment bankers. Even the best profes-
sionals cannot generate exact estimates. In other words, keep your aspirations 
for precision in check.
4 Based on a 95 percent confidence interval for the end-of-month price of a stock with an expected 
return of 9 percent per year.

367
18
Using Multiples
While discounted cash flow (DCF) is the most accurate and flexible method 
for valuing companies, using a relative valuation approach, such as juxtapos-
ing the earnings multiples of comparable companies, can provide insights and 
help you summarize and test your valuation. In practice, however, multiples 
are often used in a superficial way that leads to erroneous conclusions. This 
chapter explains how to use multiples correctly. Most of the focus will be on 
earnings multiples, the most commonly used variety. At the end, we’ll also 
touch on some other multiples.
The basic idea behind using multiples for valuation is that similar assets 
should sell for similar prices, whether they are houses or shares of stock. In the 
case of a share of stock, the typical benchmark is some measure of earnings, 
most popularly the price-to-earnings (P/E) multiple, which is simply the eq-
uity value of the company divided by its net income. Multiples can be used to 
value nontraded companies or divisions of traded companies and to see how 
a listed company is valued relative to peers. Companies in the same industry 
and with similar performance should trade at the same multiple.
Valuing a company by using multiples may seem straightforward, but 
arriving at useful insights requires careful analysis. Exhibit 18.1 illustrates 
what happens if you don’t go deep enough in your multiples analysis. The 
managers of Company A, a producer of packaged foods, looked only at 
P/Es and were concerned that their company was trading at a P/E of 7.3 times 
while most of their peers were trading at a P/E of about 14, a discount of 50 
percent. The management team believed the market didn’t understand Com-
pany A’s strategy or performance. In fact, management didn’t understand the 
math of multiples. If the managers had looked at the more instructive multiple 
shown in the exhibit—net enterprise value to earnings before interest, taxes, 
and amortization (EV/EBITA)—they would have seen that the company was