Why use EV/EBIT multiple when compared companies in the asset intensive industry?
Hi, can anybody explain me that Why use EV/EBIT multiple when compared companies in the asset intensive industry?
I've read a interview question about this:
Question:'TheEV/EBIT,EV/EBITDA,andP/E multiples all measure a company’s
profitability. What’s the difference between them,and when do you use each one?'
Answer: P/E depends on the company’s capital structure whereas EV/EBIT and EV/EBITDA are capital structure neutral. Therefore, you use P/E for banks, financial institutions,
and other companies where interest payments/expenses are critical.
EV/EBIT includes Depreciation&Amortization whereas EV/EBITDA excludes it – you’re more likely to use EV /EBIT in industries where D&A is large and where capital expenditures and fixed assets are"important"(e.g."manufacturing), and EV/EBITDA in industries where fixed assets are"less"important"and where"D&A"is comparatively smaller(e.g."Internet"companies).
I know the difference between P/E and EV/EBIT (EV/EBITDA), but I don't know why we use EV/EBIT in asset intensive industry, rather than EV/EBITDA?
Can anyone help me with this?
Thank you very much (This question bother me for a long time)...
because the tooth fairy doesn't pay for Cap Ex, and in capital intensive industries, you are more likely to see EBITDA consumed by D&A. Look at Five Star Quality Care, Inc. They are trading at a super low EBITDA multiple (5.0x) , but all of their EBITDA is locked in D&A.
Thanks for your response, and I have further question about it. When we compared the companies in the same industry (Asset intensive industry). Every company has huge D&A at the same time, so I think this situation may makes the EBITDA multiple still useful for comparing?
THANKS
not that it isn't useful. Just some metrics are more useful than others. Say Company A more efficiently utilizes its asset than Company B. Assuming both are in the same industry, and EBITDA is equal, earnings in company A are more valuable because less is locked in D&A.
OK, I got the point here... So, you were saying that because D&A is so important in this kind of industry, so the effect from the D&A should be eliminated when we compare the companies profitability.
Is that right?
D&A is a proxy for capex. Ideally, you would want to do EV / EBITDA - Maintenance Capex, but most company don't break down capex between growth and maintenance so D&A is the best proxy. So if a company is able to get more out of its assets, it will be spending less in capex (and therefore D&A) and be more profitable, hence why there can be a disconnect between EV / EBITDA and EV / EBIT and why EV / EBIT is more appropriate for capital intensive firms.
Can you give an example ? Appreciate it
2 firms trade at 10x EBIT, are in the same industry and have the same EBITDA
Firm A: EBITDA: $100mm D&A / Capex: $20mm EBIT: $80mm EV: $800mm Implied EV / EBITDA: 8x
Firm B EBITDA: $100mm D&A / Capex: $40mm EBIT: $60mm EV: $600mm Implied EV / EBITDA: 6x
Firm A is more efficient with its assets (ie. it's able to generate the same EBITDA as firm B with half the annual capex spend) and therefore trade at a premium on an EV / EBITDA basis.
Et facilis ut dignissimos assumenda deserunt aut. Neque cum tempore asperiores facere. Laborum dolores dolore et dolor quasi et veritatis. Illo ducimus et possimus odio. Soluta nihil est id quis doloremque ipsum asperiores. Molestias mollitia natus cum qui dolores rerum ad soluta. Voluptas dolorem quidem odit dolorem iure laudantium laudantium sapiente.
Similique quisquam maxime neque. Sed itaque libero fugiat consequatur in veniam quasi. Quia voluptate aut iusto non.
Molestiae autem quos eos odio fugiat exercitationem. Corrupti fuga incidunt officia doloribus. Quia esse adipisci provident recusandae voluptates ut. Sunt blanditiis qui dolores et.
Mollitia quo sunt magnam sed. Aut impedit aliquam velit. Exercitationem quod qui provident voluptas minus est dolorem. Adipisci deleniti nisi doloribus facere expedita quidem. Quo illo cupiditate totam accusantium.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...