Let me go through a EBIT multiple valuation method using Dell (NASDAQ:DELL). The free online calculator can be found here.

P/E multiples are thrown around a lot when talking about stocks, but there is a much better way to value stocks using multiples -- EBIT multiples. Don't be shocked. Just because I'm a value investor doesn't mean I do not look at multiples. I like to concentrate on value-based metrics such as P/FCF, which is a variation of P/E, and even EV/EBITDA, but the more tools I have and understand how and when to use them only helps me as an investor.

Given that most people use multiple valuation methods incorrectly, I will show you how to do it the proper way.

**How People Perform Multiples Valuation**

**The All Too Common Way**

You may have heard this sort of analysis before:

"DELL is trading at a P/E of 10.6x with a forward P/E of 8.7x. Its competitors are trading between 9x and 14x. If DELL corrects its problems, it should trade at similar multiples to its competitors. Therefore, DELL is worth $18."

**Problems Doing It This Way**

Right away, there are some fundamental flaws. I understand the importance of keeping things simple, but not so simple that it affects the whole underlying principle.

P/E is a broad metric that can vary greatly depending on adjustments to the income statement, such as:

- A goodwill charge can reduce earnings drastically, although it doesn't affect the business operation
- Income from discontinued operations can inflate P/E

**EBIT Multiple Valuation Is The Better Way**

You start with a normalized revenue estimate, enter a conservative, normal and aggressive operating margin to get the EBIT. Then decide what multiplier you want against EBIT, add cash and subtract debt to get a total equity value.

It's simple and doesn't remove everything just for the sake of keeping it simple. What's more, if you are looking at a company with several subsidiaries or operating segments that do vastly different things, you can apply the EBIT method for each segment and then add it up to get a sum-of-parts valuation.

**Valuing DELL With EBIT Multiples**

Let's jump straight into the numbers and see how this works. Here are the numbers and assumptions I am using for a normalized case:

- Over the past five to six years, I normalized the revenue to be $59 billion
- A normalized operating margin of 5.3% for a "normal" case
- A fair value EBIT multiple of 8x
- Add cash and subtract debt

Take a look at the image below to see how these assumptions are used to perform the EBIT valuation.

*The numbers for cash and debt came from the stock analyzer spreadsheet and are verified against the latest 10-K.*

DELL makes for an interesting case study because there are several big investors coming up with their own valuation targets, which we can reference.

- Michael Dell wants to buy out DELL at $13.65
- Carl Icahn has come out and said that he wants DELL to issue a $9 special dividend because he values it at $22.81
- Jim Chanos has revealed that he is short DELL going into the deal citing issues with the balance sheet and cash flow. (In other words, he doesnâ€™t think it is worth $13.65.)

Although Jim Chanos has not revealed his target price, I believe it will likely be closer to $10, which is the lower end of the range. Michael Dell is hovering over the normalized case to get a slightly cheaper deal than the fair value. Carl Icahn is the optimistic and aggressive investor.

The question now becomes: Who is right based on the business model? It's too early to say at the moment.

**Summary of the EBIT Multiples Method **

As you can see, the EBIT valuation gives you a much better picture of a company and helps you take a step-by-step approach to valuing companies. That's something a simple multiple or rule-of-thumb method does not allow you to do.