Pricing with Performance-controlled Multiples

This study presents and tests an approach for estimating the potential price of equity investments, which are not (yet) traded in a market. In practice, multiples derived from comparable companies that are traded and priced in the market are frequently used as a point of reference. The accuracy of those multiples can be empirically assessed by comparing the pricing result for a company with an observable market price (eg. a market capitalization) for this specific company. In most empirical studies conducted so far, comparable companies are selected on the basis of industry membership. The innovative aspect of the approach presented in this article is that we use specific control factors such as growth and profitability to select “comparable assets”. We identify these factors on the basis of a simplified valuation model. In contrast to the earlier work, we avoid using multiple regressions to aggregate the factors because the prerequisites for this statistical approach are not fulfilled. We investigate the accuracy of our approach vis-à-vis other approaches using a multi-year sample of American and European firms. The empirical results strongly suggest that a selection of comparable assets based on control factors – especially expected earnings growth rates and rates of return on capital – is superior to a selection based on SIC industry codes. Furthermore, the additional control of industry membership does not significantly increase accuracy. Findings are robust against variations of the basis of reference, the country of origin, the relevant industry as well as the year under observation. Additionally, the study offers some guidance with respect to the reliability of different bases of reference as well as diverse methods of estimating multiples from comparable sets.