Abstract
Although peer group selection is a key consideration when performing multiples-based valuations, there is a lack of theoretical guidance on an optimal peer group selection strategy in emerging markets. Principal Component Analysis-based biplots and correlation monoplots are used to assess the valuation performance of multiples whose peer groups are based on either industry classification or valuation fundamentals. The evidence suggests that multiples whose peer groups are based on valuation fundamentals outperform multiples whose peer groups are based on industry classifications, with a combination of valuation fundamentals Rg and RoE emerging as the optimal peer group variable. The evidence suggests that an optimal choice of peer group variable could secure an increase in valuation precision of as much as 41.77%.
Highlights
Multiples are arguably the most popular valuation approach used in practice (Bhojraj and Lee, 2002; Asquith, Mikhail and Au, 2005; Damodaran, 2006b; Roosenboom, 2007; Minjina, 2008; Dellinger, 2010; PwC, 2012)
It is hoped that a specific type of, and particular, peer group variables (PGVs) will emerge as the optimal basis for peer group selection purposes
In order to gain a clear perspective on the relative valuation performance of the 16 multiples, a PGV value chain is created, ranking, for each of the 16 multiples, the ten PGVs according to their respective valuation accuracies
Summary
Multiples are arguably the most popular valuation approach used in practice (Bhojraj and Lee, 2002; Asquith, Mikhail and Au, 2005; Damodaran, 2006b; Roosenboom, 2007; Minjina, 2008; Dellinger, 2010; PwC, 2012). Multiples are constructed by scaling market price variables with matching value drivers (Schreiner and Spremann, 2007; Damodaran, 2009). A peer group multiple is subsequently estimated for the company that is to be valued, i.e. the target company, and multiplied by the target company’s value driver to estimate the value of the target company or its equity. The greater the degree of similarity between the peer group of companies and the target company, the more accurate the valuation will be. The latter is the theoretical underpinning of a multiples-based approach to company valuations. If there is a lack of comparability between the peer group of companies and the target company, a multiples-based approach seems nonsensical
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