The Purpose of Multiples

Multiples have several purposes. Let’s explore the two primary ones.

To Compare Investments

One of the primary purposes of multiples is to easily facilitate comparisons with other investments. Investors attempt to maximize their returns and will always seek out investments that generate the highest returns relative to the amount of risk. Using a simple metric to calculate potential returns on various investments simplifies this process.

Quick Valuation Method

Multiples are also used as a quick calculation before other more thorough measures of return are employed, such as the internal rate of return (IRR) or discounted cash flow (DCF). Multiples allow you to quickly evaluate and rank potential investments before deciding which ones to pursue. Multiples can differ dramatically from business to business and from buyer to buyer for the same company, which is one of the reasons the range of values can be so broad for a business.

For example, if a business is priced at $10 million and generates $1,000,000 in EBITDA, you can run some quick calculations and determine that other investments may be more attractive than one that only offers a 10% ROI. Few investors would invest in a business that offers a 10% ROI when other lower risk, absentee investments are available, such as real estate or stocks. The exception is if the business offers some unique advantage that’s difficult for the acquirer to replicate and the buyer can take advantage of these synergies and earn a higher return. Multiples are a handy tool to use before deciding to dig deeper into the merits of an investment. 

The purpose of calculating the ROI and multiples is to facilitate comparison with other investments.