Multiples analysis: Industry labels don’t matter, performance does

We hear executives theorize all the time about whether a change in industry classification1 could boost their companies’ valuation, even if underlying performance didn’t change very much. For instance, if an insurance company were classified as a “wealth manager” rather than an “insurer,” it could trade at higher multiples, and its valuation would increase. Right?

Not so fast.

Our research underlines the degree to which corporate performance and multiples are inextricably linked. Companies in the packaged-food-and-meat industry, for instance, generally trade at multiples lower than 15 times EV/EBITDA.2 But the higher performers—those companies that consistently deliver superior returns on invested capital and revenue growth—steadily trade at a multiple of more than 15 times EV/EBITDA (Exhibit 1). What’s more, multiples are highly variable within industries themselves, reflecting the differing growth rates and profitability of different parts of the economy (Exhibit 2).

Underlying performance drives variation in multiples.
Multiples vary significantly within different sectors.

Why bad multiples happen to good companies

The numbers suggest that there are no shortcuts to higher valuation. For a company to realize the industry-average multiple, it must match the industry-average expected performance. There’s not much executives can do to directly affect industry classifications and market variability, but they can control their companies’ efforts to create more growth, higher margins, and greater capital productivity. Business leaders must do the hard work of revising business strategies, reallocating resources, monitoring outcomes, and otherwise enhancing corporate performance over the long term. Doing so will steadily improve a company’s share price, even if it doesn’t immediately result in higher multiples.

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