The investment banking interview question we’re going to go over today is “Should we use forward multiples or trailing multiples?” Forward multiples are based on future financials while trailing multiples are based on past financials. In other words, the former is forward-looking while the latter is backward-looking. We’ll walk you through exactly how to phrase your answer to this interview question. Here’s what you can say for your answer to our question today.
“It depends. In general, when we’re valuing companies on a standalone basis, we usually want to use forward multiples. That’s because by using the forward multiple, we can take future growth into account. And growth is very important for equity investors.
However, when we are using the multiple to calculate the purchase price in a merger model or a LBO model, we usually want to use it on a trailing basis. That’s because the transaction will likely require debt financing and debt investors would want to look at multiples on a trailing basis because they don’t benefit from future growth. They care more about sustaining what the company is currently earning. And so to be on the same page as the creditors, we use trailing multiples for these transactions.”
In short, that’s how you answer the question: “Should we use forward multiples or trailing multiples”. Remember, equity investors want the business to grow because they can get unlimited upside. So they care more about the future. Credit investors just want the business to sustain itself. They don’t benefit from the growth. What the company has already accomplished is more important to them so they care more about the past.