Why are EBITDA Multiples Different for Similar Companies?

wamartinu:

good question. a few weeks ago, I was looking at 2 companies within the industrials sector and both of them had exactly the same sales growth, margins, market share, etc. One was trading at 6x EV/EBITDA and the other one was trading at 11x EV/EBITDA. after some footnote reading I realised why: the 2nd company had some exceptional increase in COGS (long story short, it had exposure to a certain commodity whose price went up and the company didnt hedge properly, 1st company didnt use that specific commodity in their COGS). Therefore investors realising this COGS increase/ EBITDA Decrease is just a one-off event that happened in 2010 didnt penalise the company, realizing that next year, EBITDA would go back up to its historical level. So the reason EV/EBITDA was 11x was not because of some growth/margin/market share story but simply because EBITDA dropped massively during 2010. Debt stayed the same, market value of equity stayed the same (as a consequence of investors realizing the the exceptional nature of the EBITDA decrease), only thing that changed was the drop in EBITDA which caused the multiple to go up substantially. A good way to detect this is to look at HISTORICAL ev/ebitda multiples and see how they evolved over time. if 2, 3 companies have historically traded at same multiples and you see a SUDDEN spike amongst them, that might be caused by some exceptional, one off event. On the other hand, if the historical multiples show a PERSISTENT difference between them, then one is simply better than the other (higher sales growth/margins/market share/lower capex, ...etc). Lacking these exceptional events, I find it impossible for 2 companies (within the same industry) with exactly the same growth/margins/share/capex to trade at significantly different multiples (by significantly different I mean >2x). An up to 2x difference is acceptable in my opinion even if they have very similar characteristics like the ones mentioned above, because there might be some structural factors that justify that (in reality no 2 companies are EXACTLY the same) : size of 1 vs the other (small cap vs large cap), free float on the market of 1 company vs the other), which in turn affects how liquid the stock is, etc etc.

Don't you normalise / add back extraordinary items to earnings etc purely for this reason?

All of this can be circumvented by looking at forward multiples instead of historical.

There are two variables here. If one variable is exactly the same, then the other must be different, which is EV. The answer is: two companies have two different enterprise values. Therefore, their EV/EBITDA multiples are different.

For example:

Company A: EV: 100 EBITDA: 10 EV/EBITDA: 10x

Company B: EV: 200 EBITDA: 10 EV/EBITDA: 20x

Hope this helps.

Actually, a very complicated question. The answer could be company specific, industry specific, etc. An industrial with a very predictable $300M of EBITDA would never trade at the same multiple as a high-growth tech company who just reached $300M of EBITDA this year, but is expected to achieve $400M of EBITDA next year.

And outside of actual company performance, there are market dynamics. The market may assign a premium to certain names because of management team, liklihood of being a take-out target, etc.

Just think about what a company's stock price represents in theory. It's the NPV of all future cash flows. So, a stock trading at a higher multiple is either expected to grow earnings (and thus cash flow) at a higher rate than comparable companies with lower multiples.

There should be a comprehensive summary in your Corp. Fin. text book. Or, take a look at the Vault Guide.

EV= Market Cap+Debt (can vary on how its computed)+minority interest+Preferred Stock-Cash & Cash Equivalents

Anything that may vary within the computation of EV will throw the multiple.

I'm sure the OP knows better than "The EV must be different"

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Different margins. While EBITDA and EBIT might be negative, one might be more negative than the other, and they are likely to be projected to eventually turn positive if the companies are worth anything.

You're thinking about it backwards. Every multiple whether it's off of sales, EBITDA, earnings is just a proxy for valuing a company based on its conversion to FCF and the visibility / predictability of that FCF.

one company is more levered than other and has a higher wacc.

C. You would want the higher multiple to decrease because that would most likely imply rising EBITDA. This in turn could imply higher bottom line growth and thus a better investment.