Corporate Insights Managing the multiple:
Weighing growth against profitability

Managing the multiple:
Weighing growth against profitability

(1st Quarter 2016)

Themes

  • The role and importance of market multiples
  • The relationship between market multiples and company fundamentals today
  • The relationship between market multiples and company fundamentals over time
  • The influence of systemic factors on market multiples
  • Does higher growth always mean a higher multiple?
  • The trade-off between growth and returns on capital – which drives more value?
  • The trade-off between growth and returns on capital – which lasts longer?
  • Returns on capital are "stickier"… and the market is willing to pay more for them

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Introduction

The world's public equity markets gyrated wildly during the second half of 2015 and into early 2016. Companies in some industries saw billions of dollars of value added to or subtracted from their equity values in the course of weeks or even days. Yet, by and large, we have seen that market multiples have continued to expand in the years since the 2008 financial crisis. And when we look at the markets as a whole, growth expectations have remained stable and in fact are somewhat lower than prior to the 2008 financial crisis. So, what do market multiples really tell us?

Market multiples are widely accepted as a barometer for value and, more importantly, they influence a wide range of strategic decisions as corporate clients benchmark themselves to their competitive landscape and evaluate potential M&A opportunities. Such a reliance on multiples in decision-making increases the importance of dissecting – and understanding – market multiples for what they truly are – a shortcut to relative valuation.

This paper, the second in our Credit Suisse Corporate Insights series, explores the relationship of market multiples to fundamental drivers of value. We find that – at their core – market multiples reflect the market's discrete expectations about company growth and profitability (as measured by return on capital). The value paid for growth and returns varies; in the markets right now, higher multiples are being paid for returns on capital than for additional growth.