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CFA Level II · CFA Level II Exam

Market-Based Valuation: Price and Enterprise Value Multiples Explained

Market-based valuation estimates a stock's value by comparing its price or enterprise value to a fundamental such as earnings, book value, sales, cash flow or EBITDA. You solve it by picking the right multiple, adjusting the inputs, and applying a benchmark from comparable firms or a peer group.

What this chapter covers

This chapter covers valuation with multiples. A multiple is a ratio of market value to a fundamental. Price multiples include P/E, P/B, P/S and P/CF. Enterprise value multiples include EV/EBITDA. You also meet dividend yield and the dividend payout link to value.

The chapter has two parts. The first part teaches each multiple: how to compute it, what drives it, its strengths and weaknesses, and how to adjust it. Trailing and forward P/E, normalised earnings, and the treatment of non-recurring items belong here. The second part teaches how to use the multiples: the method of comparables, valuation against benchmarks, and the use of cross-sectional regression and momentum indicators.

It connects to the rest of the paper. Equity valuation builds on discounted cash flow models, and multiples are the quick cross-check on those models. Financial statement analysis supplies the earnings and book value quality you must adjust. Corporate finance supplies enterprise value ideas such as net debt. In the exam, a multiple question sits inside an item set, so you must find the numbers in the vignette and exhibits and apply the right model.

Equities carry a large share of Level II, and multiples are used in many equity item sets, often alongside DCF work. The questions are mostly applied: you read an exhibit, compute or interpret a multiple, and judge whether a stock looks cheap or dear. The maths is light, so marks are won by knowing which multiple fits which situation and which adjustment the vignette hints at. Because there is no penalty for wrong answers, you should always answer, but a clear framework for each multiple lets you reach the correct choice rather than guess.

Market-Based Valuation: Price and Enterprise Value Multiples: topics in the order to study them

  1. 1Price and Enterprise Value Multiples OverviewIt gives the shared vocabulary of price multiples, enterprise value multiples and the fundamental in the denominator, which every later topic uses.
  2. 2Price to Earnings (P/E) RatioP/E is the most tested multiple, and it teaches trailing, forward and normalised earnings, which carry over to other multiples.
  3. 3Price to Book Value (P/B) RatioIt builds on P/E and ties valuation to ROE and book value quality, so study it right after you know earnings-based multiples.
  4. 4Price to Sales and Price to Cash Flow MultiplesThese are used when earnings or book value are unreliable, so they make sense once you know the limits of P/E and P/B.
  5. 5Enterprise Value and EV/EBITDA MultipleIt moves from equity value to the whole firm, so you need the price multiples settled before adding debt, cash and capital structure.
  6. 6Dividend Yield and Dividend-Based Valuation MultiplesIt links payout and growth to value and ties back to the dividend discount model you already know.
  7. 7Comparables Approach and Valuation Using BenchmarksIt applies all the multiples learned so far to a peer group, an industry or a historical average.
  8. 8Cross-Sectional Regression and Momentum IndicatorsIt is the most advanced use of multiples, so it goes last, when you can read regression output against the earlier ideas.

How to prepare Market-Based Valuation: Price and Enterprise Value Multiples

Treat this chapter as a toolbox. For each multiple you need the same short set of facts, and you practise them on vignettes, not from memory lists.

  1. Make one summary card per multiple with four lines: definition, what drives it, when it suits, and its main weakness.
  2. Practise the adjustments: trailing versus forward, normalised earnings, removal of non-recurring items, and net debt in enterprise value.
  3. Learn the links between multiples and fundamentals, such as P/B and ROE, and P/E and payout, growth and required return, and work a few numbers by hand.
  4. Do vignette-style practice for the comparables approach: pick peers, compute each multiple from the exhibit, take the benchmark and state whether the stock looks over or undervalued.
  5. Read regression output slowly: identify the dependent and independent variables, the coefficients, and what a predicted multiple means for a stock above or below the line.
  6. Finish each study session by writing, from memory, which multiple you would use in three different situations and why.

Common mistakes in Market-Based Valuation: Price and Enterprise Value Multiples

  • Using the wrong earnings for P/E, such as including one-off gains.

    Fix: Scan the vignette for non-recurring items, restructuring and cycle comments, and adjust before computing the multiple.

  • Leaving out debt, cash or other claims when computing enterprise value.

    Fix: Write the EV formula first, then fill each term from the exhibit, including non-controlling interest and preferred stock.

  • Comparing multiples that are defined differently across firms or time.

    Fix: Check the definition and period for each figure before taking an average or median, and say so in your reasoning.

  • Calling a stock cheap because its multiple is low, without asking why.

    Fix: Compare growth, risk and profitability with the peers, then decide whether the discount is justified.

  • Misreading regression output in the cross-sectional section.

    Fix: Name the dependent variable, plug the firm's inputs into the equation, and compare the predicted multiple with the actual one.

  • Treating dividend yield alone as a measure of value.

    Fix: Link yield to payout ratio and growth, and ask whether the dividend is covered by earnings and cash flow.

Last-day revision: Market-Based Valuation: Price and Enterprise Value Multiples

  • A multiple is a market value divided by a fundamental, and the benchmark must be built on the same definition.
  • P/E = price ÷ earnings per share, and trailing uses past earnings while forward uses expected earnings.
  • Normalise earnings for cyclical or one-off effects before using P/E.
  • P/B = price ÷ book value per share, and it suits asset-heavy firms such as banks when book value is reliable.
  • P/S is usable when earnings are negative, but it ignores margin differences.
  • P/CF is harder to manipulate than earnings, but define cash flow the same way across firms.
  • Enterprise value = market value of equity + debt + preferred stock + non-controlling interest − cash and short-term investments.
  • EV/EBITDA suits firms with different leverage, and it works when earnings are negative.
  • Dividend yield = dividends per share ÷ price, and it only tells the full story with payout and growth.
  • In a comparables valuation, check that peers share business, growth, risk and accounting before applying their multiple.
  • In a cross-sectional regression, a stock priced above the predicted multiple looks relatively overvalued.
  • Momentum indicators use price or earnings trends, and they complement rather than replace fundamental multiples.

Market-Based Valuation: Price and Enterprise Value Multiples in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Market-Based Valuation: Price and Enterprise Value Multiples: frequently asked questions

Which multiple is tested most in this chapter?

P/E is the core multiple, and the ideas behind it carry across the others. EV/EBITDA and P/B also appear often. You should be able to compute each from an exhibit and explain when it suits.

Do I need to memorise many formulas?

Not many. The key ones are the multiple definitions and the enterprise value build-up. Most marks come from choosing the right multiple and adjusting inputs in the vignette.

How is this chapter tested at Level II?

It appears inside item sets. A vignette gives company data and exhibits, then four questions ask you to compute, adjust or interpret multiples. All answers must come from the vignette.

Why is EV/EBITDA used instead of P/E for some firms?

EV/EBITDA is not affected by capital structure, so it compares firms with different debt levels more fairly. It also works when net income is negative. You must still check that EBITDA is defined consistently.

How should I read a cross-sectional regression for valuation?

Identify the dependent variable, usually a multiple, and the explanatory variables such as growth or risk. Use the fitted equation to find the predicted multiple for the stock. If the actual multiple is higher, the stock looks relatively overvalued.