Relative Valuation: Different Types, Usage, and Understanding Multiples in Detail!

In the previous article, we explained how one should choose the right equity valuation method, and if you haven’t already read that, here’s the link: Choosing the right valuation method!  Now that you have a basic understanding of what relative valuation is, in this article we’ll specifically talk deeper about Relative Valuation in which we’ll look at different relative valuation multiples and when to use them.

Types of Relative Valuation Multiples

Relative valuation is a widely used method to estimate the value of a company by comparing it to its peers. It assumes that similar businesses should trade at similar valuation multiples. Unlike intrinsic valuation, which involves forecasting cash flows and discounting them, relative valuation relies on market-based indicators, making it quicker and more adaptable to changing market conditions.

Earnings-Based Multiples

Price-to-Earnings (P/E) reflects what investors are willing to pay for each unit of earnings. Best suited for profitable, stable firms. EV/EBIT and EV/EBITDA is useful when comparing firms with varying debt levels. EBITDA strips out non-cash and financing items, offering a clearer picture of operating performance.

Revenue-Based Multiples

EV/Sales is applied when earnings are negative or volatile (e.g., early-stage tech or high-growth companies). It compares valuation to topline revenue but ignores margins and cost structures.

Book Value-Based Multiples

Price-to-Book (P/B) indicates the value placed on net assets. Best for financial or asset-heavy firms where book value reflects economic reality.

Cash Flow-Based Multiples

Price-to-Cash Flow / EV to Operating Cash Flow is useful in capital-intensive sectors like manufacturing or utilities. Cash flows are harder to manipulate than earnings, offering a more reliable measure of performance.

Industry-Specific Multiples

Used to capture sector-specific drivers:

• EV/Subscribers in telecom
• EV/Bed in healthcare
• EV/BOE (barrel of oil equivalent) in oil and gas
• EV/Assets Under Management in asset management

Trailing vs Forward Multiples

• Trailing Multiples use historical data (e.g., last 12 months - LTM) and are objective but may not capture future growth.
• Forward Multiples are based on forecasted earnings or revenues (e.g., next 12 months - NTM). They reflect market expectations and are more forward-looking but can be inaccurate if projections are flawed.

For example, a stock trading at 15x trailing P/E might trade at 12x forward P/E if earnings are expected to grow significantly.

When to Use Which Multiple?

Relative valuation is most effective when applied thoughtfully with the right peer set and the correct multiple. A combination of trailing and forward-looking multiples helps assess both current standing and future potential. Using multiple approaches together, while adjusting for differences in growth, risk, and accounting, provides a more balanced and realistic view of value.

What’s Next?

Now that you’ve understood what relative valuation is and know when to use which type of relative valuation multiple, in the next article we’ll look at some of the practical examples of using these multiples, so stay tuned as we work on the next article.