Multiples are really just a means to establish a relative market valuation for one thing based on how another thing is valued. We use the framework every day:
- House Price – Price per square foot
- Stock market – Price per earnings
The advantages of using multiples to value something:
They are market–based. Comparing a home sold in your neighborhood yesterday to your house will reflect the current market. However, there is a limit to comparability over time. Comparing a home sold in your neighborhood 10 years ago, to a home for sale today may not reflect the current market.
They are relatively simple to understand and calculate. Far simpler than the Income method, or other veterinary clinic appraisal valuation methods. There is only one input variable: Normalized EBITDA* (in the case of veterinary practices). The market tells you the multiple.
*EBITDA stands for (Earnings Before Interest Taxes Depreciation and Amortization)
Of course, there are weaknesses:
You need to have access to clean comparative deals (comps) to make a quality comparison. With a house, you can find data on thousands of different sale prices. This can be more difficult for other items, such as selling your island, or selling a unique business such as Facebook.
Veterinary practice sale prices are private so there is no publicly available data. Most appraisers, unless they are affiliated with a broker, will have limited access to any vet practice comparables.
Not all multiples are appropriate for all businesses. Banks, for instance, aren’t valued with EBITDA but with price to book value. One single type of multiple won’t allow for that comparison. You have to know what the multiple doesn’t tell you, as much as what it does tell you. Veterinary practices are generally valued by buyers using an EBITDA multiple.
A good source of context on multiples is the S&P 500.
The index contains 500 companies with 500 valuations established by millions of market participants doing research and transacting everyday. The price of any one stock is a reflection of the market’s view on the valuation of that company.
Now suppose I calculate the revenue to valuation multiples for every stock in the S&P 500. I would get a multiple for every stock and note right away that there is a broad spectrum of values.
The question is why?
Why does the market think one stock should be worth 3x revenue, and another 10x? There are many different reasons. There are good industries and bad industries, high or low profit margins and dozens of other factors. However, the best predictors of the multiple are expected growth and company size.
A professional investor thinks of a multiple as a price paid for growth. If she calculates trading multiples and growth rates, she can compare the “prices” of stocks across or within industries. With thousands of market participants applying this intuition to thousands of stocks, money will move from one industry to another and one company to another as investors determine which opportunities offer the best “Deals” for the price. Multiple evaluation starts at this level, with millions of investors assessing these “prices” and selling or buying according to what they find.
Industry multiples in veterinary services are impacted by market multiples in other industries
The price of VCA stock (when it was public) was impacted by the valuations at which U.S. Hospital companies traded. Investors could look at hospital stocks and evaluate whether an investment in veterinary hospitals was a better deal for expected growth.
Multiples across the market are also impacted by “macro” factors: interest rates, the economic climate, risk tolerance, availability of financing, and many more.
The multiple for an individual veterinary practice is impacted by how that practice compares to others. Practice size and revenue / EBITDA growth are the most important.
Combining these concepts creates a range that moves based on the market, and a cursor that moves within the range. If the whole range moves, the cursor moves, but the cursor can move along the range while the range remains fixed.
Certain valuation factors impact the valuation of all practices, some impact the value of your practice
Intuitively based on experience, this concept makes sense.
If you sell your practice today, it will likely sell for a higher valuation than a similar practice sold in 2009 because an economic recovery has increased multiples in veterinary services. You can see that with some of the big deals recently announced such as JAB buying NVA, or Mars buying VCA.