Bias and Efficiency of Equity Valuation Using Multiples
Asian Tax Journal Vol. 14 No. 1 (2013), pp. 31-62
Abstract
In this study, I analyze the factors that determine the proximity to stock prices of valuations generated by multiplying a value driver by corresponding multiple, which is calculated with the ratios of stock prices to that value driver for a group of comparable firms. First, I compare validities of projected prices from the three methods for averaging multiples (arithmetic mean, harmonic mean, and least squares estimators), based on mean percentage errors(MPE) and mean squared percentage errors(MSPE). Second, a critical determinant for the accuracy of equity valuation using multiple is the dispersion of each price－to－value driver among comparable firms. With the concept of MPS(Mean Preserving Spread), I prove the effect of a change in dispersion of multiples among comparable firms on the accuracy of valuations. Third, the relation between the dispersion of multiples among comparable firms and the valuation accuracy using multiples indicates that a good multiple valuation procedure should be designed to render smaller dispersion of each price－to－value driver among comparable firms, when I consider the criteria for selection of comparable firms and when I make a choice among value drivers. Fourth, setting up a selection criteria for comparable firms is analogous to separate a population into distinct subpopulations in the regression analysis for the purpose of estimating parameters more accurately. Fifth, Too elaborate selection criteria might have the sample size become too smaller and cause to increase the sampling error. So, screening a small number of comparable firms using various elaborate criteria is not so good a statistical approach.
Keywords
- the comparable valuation method
- the complementary valuation method
- valuation multiple