Where the exit multiple comes from

In any multiples-based valuation, the number by which the terminal-year metric is multiplied decides much of the result. It is also the assumption most often chosen by eye or copied from the market. We derive it: every business belongs to a category with a reference band, and its position inside that band comes from its own fundamentals.

The four anchors, in order

First, the type of business fixes the band and the correct metric: a platform business, a capital-intensive industrial, a lender and a real estate trust are not valued alike. Second, growth in the terminal year — not today's — moves the position inside the band: a business still growing at the end of the horizon deserves more than one that has already stopped. Third, the return on capital and how durable it is. Fourth, cyclicality, leverage and predictability, which push downward.

A sanity check closes the calculation: the inverse of the multiple is the earnings yield. For a business without growth, that yield should exceed the opportunity cost of simply owning the market. Twenty times equals 5% and therefore presupposes continued growth; if the business does not have it, the multiple is wrong.

Multiples compress, they do not expand

The exit multiple should be at or below the entry multiple of a comparable mature competitor. As growth fades, the multiple compresses — that is the normal path of a maturing business, not a penalty. For the same reason the three-year multiple is higher than the terminal five-year one: at three years there is more growth still ahead.

The adverse and favourable scenarios move the multiple, but never punitively. An adverse scenario that compresses the multiple and also worsens the business and also cuts capital returns is stacking three penalties, each of which looks reasonable on its own.

Both sides are forbidden

That a multiple cannot be set above the band is obvious. What gets forgotten is that setting it below the floor, out of caution, is also a mistake: it puts risk inside the base, when risk is already charged in the required return and in the adverse scenario. Competition, leverage and a narrow moat already entered once when determining the position inside the band; discounting them again counts them twice.

If the business genuinely does not belong to that band, the correct answer is not to force the number: it is to change the category, justifying against the filing why it fits another one better.

When the market trades far below the band

If a company trades far below the floor of its category there are exactly two readings, and they are mutually exclusive. Either the market is wrong, in which case it is an opportunity and the multiple returns to the band. Or the market is right, in which case the business no longer belongs to that category.

Forcing the band without deciding which produces the value trap shaped like a thesis: a floor multiple bakes in a fifty or seventy per cent re-rating that carries the entire return while earnings stay flat. The test is direct: if for the thesis to work the multiple has to expand a great deal and earnings also fail to grow, there is no thesis — there is a bet on re-rating. It is either declared as such, or the category changes.

That is why, when one of our verdicts is aggressive, the analysis decomposes where the return comes from: how much comes from earnings growth, how much from buybacks and how much from multiple expansion. If removing the expansion collapses the return, the thesis depended on the multiple, and that has to be said.