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Hedge Fund · Topic lesson

Valuation Multiples

How a buy-side analyst prices a stock: EV/EBITDA against P/E, free cash flow yield, growth-adjusted multiples, sum of the parts, and where a stock's return comes from.

5 chapters About 53 minutes0 of 5 complete
Start chapter 1

A multiple is a shortcut: the price of a business divided by something it earns. Hedge fund interviews test whether you know which shortcut fits which question, how to walk from one to another, and what a multiple quietly assumes about growth and risk. This lesson goes from the two standard multiples to the return a valuation view implies.

  • Two multiples. EV/EBITDA prices the business; P/E prices the equity.
  • Cash. Free cash flow yield asks what the owner actually receives.
  • Growth. The PEG ratio adjusts the P/E for how fast earnings grow.
  • Several businesses. A sum of the parts values each at its own peers' multiple.
  • Return. The multiple bridge splits a return into growth, re-rating and dividends.
The rule that solves every question

Match the top of the multiple to the bottom. Enterprise value goes with earnings before the lenders (EBITDA, unlevered free cash flow); equity value goes with earnings after them (net income, levered free cash flow). And pick the multiple that fits the business: for banks and insurers, where debt is raw material, use price to book and return on equity.

From a multiple to a return

Each step points to the chapter that practices it.

  1. 1
    Price the business and the equity

    EV/EBITDA, P/E, and the walk between them.

    Chapter 1
  2. 2
    Check the cash

    Free cash flow yield, levered and unlevered.

    Chapter 2
  3. 3
    Adjust for growth

    PEG, and the growth a price implies.

    Chapter 3
  4. 4
    Split the company

    Segment multiples, head-office costs, the discount.

    Chapter 4
  5. 5
    Turn it into a return

    Growth, re-rating and dividends.

    Chapter 5

Chapters

1

EV/EBITDA versus P/E

11 min

One multiple prices the whole business before anyone is paid; the other prices what is left for shareholders. Walk from one to the other.

  • Turn an EV/EBITDA multiple into a P/E, line by line
  • Say how D&A, debt and tax make the two multiples disagree
  • Find the EV/EBITDA that a peer P/E implies
  • Choose the fairer multiple for a comparison
2

Free cash flow yield

11 min

Earnings are an opinion; cash is a fact. What the business actually hands its owners, as a yield on what they pay.

  • Build levered free cash flow from EBITDA
  • Calculate the equity and unlevered free cash flow yields
  • Find the market cap and multiple that a target yield implies
  • Show what a buyback at that yield does per share
3

PEG and growth-adjusted multiples

9 min

A high P/E on fast growth can be cheaper than a low P/E on none. The PEG ratio puts the two on the same footing.

  • Calculate the forward P/E and the PEG ratio
  • Find the P/E and share price that a target PEG implies
  • Back out the growth a share price assumes
  • Show how a stock grows into its multiple
4

Sum of the parts

11 min

When one company runs businesses the market values differently, value each at its own peers' multiple, then ask why the market will not.

  • Value a company segment by segment, net of head-office costs and debt
  • Measure the market's discount to the sum of the parts
  • Back out the multiple the market puts on one segment
  • Show why leverage magnifies a conglomerate discount
5

The multiple bridge

11 min

A share price is earnings times a multiple, so a return comes from earnings growth, a change in the multiple, or dividends.

  • Split a stock's return into earnings growth, multiple change and dividends
  • Annualize a total return over several years
  • Find the exit multiple a target return needs
  • Separate what the company controls from the market's mood