What is Forward Multiple?
A Forward Multiple is a valuation ratio that reflects a company’s value on the basis of an estimated financial metric, i.e. forecasted earnings performance.
How to Calculate Forward Multiple (Step-by-Step)
The forward multiple is most often used to determine the valuation of a high growth company that is either unprofitable as of the present date, or the market is valuing the company based on its expected earnings in the future.
Given this context, it can be reasonable – or sometimes the only choice – to value a high-growth, unprofitable company based on its expected future profitability as opposed to its actual historical performance.
- Unprofitable (or Limited Profitability): If a company is currently unprofitable, usage of traditional valuation multiples, such as EV/EBITDA and EV/EBIT, can be out of the question because the negative denominator causes the multiple to be impractical, i.e. “not meaningful”.
- Forward-Looking Market Pricing: For companies exhibiting high growth and operating in hyper-competitive markets, the priority must be on revenue growth in lieu of profitability. Of course, the company must eventually become profitable to sustain operations, however, the competition in certain industries can force participants to prioritize growth, including acquiring more customers, securing long-term contracts, and running effective sales and marketing campaigns, which are each costly endeavors that can erode a company’s margins.
Learn More → Valuation Multiple
Forward Multiple Formula
The formula to calculate a forward multiple is as follows.
- Value Measure: Enterprise Value (TEV) or Equity Value
- Value Driver: Forecasted Financial Metric (e.g. EBIT, EBITDA, Net Income)
The rule for all valuation multiples, whether on a historical or forward basis, is that the numerator and denominator must match in terms of the capital providers represented.
- Enterprise Value: e.g. EBIT, EBITDA, FCFF, NOPAT
- Equity Value: e.g. Net Income, Book Value of Equity (BVE), FCFE
Valuation Multiple: Forward Multiples vs. Historical Multiples
- Historical Multiple: The traditional valuation multiple is based on historical performance, such as LTM EBITDA or LTM EBIT. Historical multiples, or “trailing multiples”, portray how much investors are willing to pay for a dollar of past earnings.
- Forward Multiple: In contrast, a forward multiple reflects the amount that investors are willing to pay for a dollar of future earnings. The benefit to using a forward multiple is that in reality, market valuations price in future expectations more than historical performance, albeit the two are closely intertwined. For instance, if a financially sound, profitable SaaS company trading at a premium were to suddenly announce that its future growth outlook seems unfavorable and its profit margins should reduce substantially in the coming years, the company’s share price would plummet post-announcement, regardless of its past profitability and historical margins.