Amortized market multiple

What Is Amortized Market Multiple?

The amortized market multiple refers to a valuation approach where traditional market multiples are adjusted or analyzed in the context of amortization expenses, particularly those related to Intangible Assets. While not a standalone, universally defined financial ratio, this concept is rooted in the broader field of Financial Valuation and aims to provide a more nuanced view of a company's worth by accounting for the non-cash impact of amortization on reported earnings or book values. It highlights how the accounting treatment of certain assets can influence a company's apparent Financial Performance and, consequently, the multiples derived from its financial statements.

History and Origin

The concept of market multiples for company valuation has a long history, serving as a fundamental tool in Relative Valuation by comparing a company to its peers or industry averages. Concurrently, the accounting treatment of Intangible Assets and their amortization has evolved significantly over decades. For instance, in the United States, the Financial Accounting Standards Board (FASB) issued Statement No. 142 (now codified primarily under ASC 350) in 2001, which fundamentally changed the accounting for Goodwill, moving from systematic amortization to an impairment-only model for public companies. However, certain types of goodwill, such as equity method goodwill, can still be amortized over a period not exceeding 10 years, and private companies may elect to amortize goodwill¹¹. Similarly, International Accounting Standard (IAS) 38, issued by the International Accounting Standards Board (IASB), outlines the accounting requirements for intangible assets, including when they should be amortized over their useful lives⁹, ¹⁰.

The discussion around an amortized market multiple arises from a desire to neutralize the impact of these differing accounting treatments when comparing companies. Analysts recognized that a company's reported Earnings Per Share or Book Value could be significantly affected by amortization expenses, particularly if a company had acquired substantial intangible assets through acquisitions. This led to a focus on analyzing multiples both with and without the amortization effect to gain a clearer comparative perspective, especially when dealing with companies under different Accounting Standards or those that have made different accounting elections for certain assets.

Key Takeaways

• An amortized market multiple is not a specific ratio but an analytical approach to adjusting standard market multiples for amortization.
• It primarily addresses the impact of non-cash amortization expenses, especially from Intangible Assets like goodwill.
• This approach aims to enhance comparability between companies with varying amortization policies or acquired intangible asset bases.
• Adjustments often involve re-adding amortization expenses back to earnings or modifying book value figures.
• The relevance of an amortized market multiple depends on the significance of amortization to a company's reported financial metrics.

Formula and Calculation

Since "amortized market multiple" is a concept of adjustment rather than a single formula, it typically involves modifying the denominator of standard market multiples. For instance, to calculate an "amortization-adjusted" Price-to-Earnings Ratio, an analyst might re-add amortization expense (especially non-cash amortization of acquired intangibles) back to net income to derive a modified earnings figure.

The general concept can be expressed as:

Or, for enterprise value multiples:

Where:

• Market Price per Share: The current trading price of a company's stock.
• Enterprise Value (Enterprise Value): The total value of a company, including its equity and debt, less cash.
• Adjusted Earnings per Share: Earnings per share after adjusting for the amortization expense. For example, reported net income could be increased by the after-tax amortization expense related to certain intangible assets to arrive at an "amortization-adjusted net income" before calculating the per-share figure.
• Adjusted Operating Metric: An operating performance measure (like EBITDA or EBIT) adjusted to exclude or include the impact of amortization as desired for comparative purposes.

It's crucial to define precisely which amortization components are being adjusted for, as this will directly affect the calculated multiple.

Interpreting the Amortized Market Multiple

Interpreting an amortized market multiple involves understanding what the adjustment reveals about a company's underlying profitability and valuation. By "normalizing" earnings or other financial metrics for the effects of amortization, analysts can gain insights into how a company would be valued if certain non-cash expenses were treated differently or if comparisons were made to companies with different amortization profiles.

For example, if a company has significant amortization expenses from a large acquisition, its reported Earnings Per Share might appear low, leading to a high Price-to-Earnings Ratio. By adding back amortization to create an "amortization-adjusted" earnings figure, the P/E ratio would decrease, potentially making the company appear more attractive or more comparable to peers that did not incur similar acquisition-related amortization. This type of adjustment helps in evaluating the core operational Financial Performance of the business, independent of certain non-cash accounting charges that can distort valuation metrics.

Hypothetical Example

Consider Company A, which recently acquired a competitor, resulting in a significant amount of recognized Intangible Assets subject to amortization. Company B is a direct competitor but has grown organically and has minimal amortization expenses.

Company A (with Amortization):

• Market Price per Share: $50
• Reported Earnings per Share (EPS): $2.00
• Amortization Expense per Share (after-tax): $0.50

Company B (without significant Amortization):

• Market Price per Share: $40
• Reported Earnings per Share (EPS): $2.50
• Amortization Expense per Share: $0.05

Standard P/E Ratio:

• Company A: $50 / $2.00 = 25x
• Company B: $40 / $2.50 = 16x

Based on the standard P/E, Company A appears significantly more expensive.

Calculating Amortization-Adjusted EPS for Company A:

• Adjusted EPS = Reported EPS + Amortization Expense per Share
• Adjusted EPS (Company A) = $2.00 + $0.50 = $2.50

Amortized Market Multiple (Amortization-Adjusted P/E Ratio):

• Company A (Adjusted P/E): $50 / $2.50 = 20x
• Company B (no significant adjustment needed): 16x

After adjusting for amortization, Company A's amortized market multiple (adjusted P/E) is 20x, making it more comparable to Company B's 16x. This indicates that while Company A's reported earnings are lower due to amortization, its underlying earnings power, when normalized for this non-cash expense, is closer to its competitor's. This type of analysis helps investors and analysts make better apples-to-apples comparisons of Financial Performance when assessing valuation multiples.

Practical Applications

The concept of an amortized market multiple is applied in several areas of Financial Valuation and analysis:

• Comparative Analysis: When performing Relative Valuation, analysts often compare a target company to a group of comparable firms. If these comparable firms have different histories of acquisitions or varying Accounting Standards that impact amortization, adjusting financial metrics for amortization can provide a more accurate basis for comparison. For example, comparing a private company that amortizes Goodwill (as permitted by certain FASB Accounting Standards Updates⁸) to a public company that does not amortize goodwill requires such adjustments.
• Mergers and Acquisitions (M&A): In M&A deals, the buyer often acquires significant Intangible Assets and goodwill, which will impact future financial statements through amortization or impairment tests. Understanding market multiples on an "amortization-adjusted" basis can help assess the true underlying value of the target company and the post-acquisition financial picture.
• Private Company Valuation: Private companies, under specific accounting alternatives, may elect to amortize goodwill, whereas public companies generally do not⁶, ⁷. When valuing a private company using public comparable multiples, analysts might adjust the public company's metrics or the private company's earnings to ensure consistent treatment of amortization, thereby creating a more meaningful amortized market multiple for comparison.
• Earnings Quality Assessment: Amortization, being a non-cash expense, can sometimes obscure the true cash-generating ability of a business. By analyzing an amortized market multiple, investors can assess earnings quality more effectively, distinguishing between accounting profits and the underlying cash profitability.

Limitations and Criticisms

While adjusting for amortization in market multiples can enhance comparability, the approach has limitations and criticisms:

• Subjectivity of Adjustments: Determining which amortization expenses to adjust for and the exact method of adjustment can be subjective. Not all amortization is the same; some relates to assets with a finite, discernible economic life (like patents), while others are more accounting-driven (like certain goodwill amortization). Arbitrary adjustments can misrepresent a company's true Financial Performance.
• Ignoring Economic Reality: Amortization, even if non-cash, represents the systematic expensing of an asset's cost over its useful life, reflecting the consumption of economic benefits⁵. Completely ignoring it can lead to an overstatement of underlying profitability and potentially an inflated amortized market multiple. For instance, critics of widely used multiples like EV/EBITDA sometimes point out that while they remove non-cash charges like Depreciation and amortization, this can overstate cash flow for businesses with significant capital expenditures required to maintain their assets⁴.
• Lack of Standardization: There is no universally accepted "amortized market multiple" ratio or standardized methodology for its calculation. This lack of standardization can lead to inconsistencies in analysis across different practitioners or firms.
• Market Perception: Public markets typically react to reported earnings and established multiples like the Price-to-Earnings Ratio. While an analyst may derive an adjusted amortized market multiple for internal analysis, the market's perception and pricing might still heavily rely on GAAP-reported figures, making direct application challenging³. Various market multiples, while simple, can disregard factors like growth, leverage, and risk, and may be easily misinterpreted due to different accounting policies¹, ².

Amortized Market Multiple vs. Discounted Cash Flow Analysis

The amortized market multiple approach primarily falls under Relative Valuation, while Discounted Cash Flow Analysis (DCF) is an intrinsic valuation method. The core differences lie in their methodology and focus:

While an amortized market multiple offers a quick and intuitive comparison by adjusting for specific accounting nuances, Discounted Cash Flow Analysis seeks to determine a company's inherent value based on its fundamental ability to generate cash, making it less susceptible to market fads or accounting policy differences, though it introduces its own set of assumptions.

FAQs

What is the primary purpose of considering an amortized market multiple?

The primary purpose is to enhance the comparability of market multiples across companies that have different accounting treatments or significant variations in amortization expenses, particularly from Intangible Assets or Goodwill. By adjusting for these non-cash charges, analysts can derive a clearer picture of a company's underlying operational profitability for valuation purposes.

Does FASB or IASB define an "Amortized Market Multiple"?

Neither the FASB nor the IASB officially defines "amortized market multiple" as a specific financial ratio or metric within their Accounting Standards. Instead, it's an analytical approach or a modification of existing market multiples that analysts use to account for the impact of amortization on reported financial figures, especially concerning goodwill and other intangible assets.

How does amortization affect market multiples like the P/E ratio?

Amortization is a non-cash expense that reduces a company's reported net income on the Income Statement and the value of assets on the Balance Sheet. A higher amortization expense will result in lower reported Earnings Per Share, which, for a given stock price, would lead to a higher Price-to-Earnings Ratio. By creating an "amortized market multiple" that adjusts for this expense, analysts aim to see the P/E based on earnings before the impact of certain amortization charges, potentially making it more comparable to peers.