Same EV/EBITDA multiple different P/E
If two companies have the same EBITDA multiple but different P/E multiples, is the one with the higher P/E multiple the more highly levered (ie. because net income is lower)?
On the other hand, if two companies have the same P/E multiple, but different EBITDA multiples, is there any way to tell which company is more levered?
Differences in: tax rate, capital intensity, operating vs capital lease classification, leverage
ya but how do you know which company is which. A lower tax rate implies comparatively higher earnings, so mathematically the P/E should be lower.
But intuitively, a company with lower tax should trade at a higher p/e?
A company with a lower tax rate will have higher earnings (larger denominator) and thus a lower P/E multiple, assuming constant price. EBITDA is earnings before interest, tax, and depreciation/amortization, so changes in tax rate won't affect EBITDA and thus won't affect EBITDA multiple assuming constant enterprise value.
EBITDA multiples are capital structure neutral - so you won't be able to tell which is which.
Optimal capital structure vs non-optimal could imply lower WACC and higher EV. Lower tax rate is after EBITDA but there is value to be captured which would mean the EV should be higher and thus different EV / EBITDA multiples. As for the impact on the PE multiple, you might argue that the PE ratio of the company with a higher tax rate should trade higher because there could be more opportunity for their tax rate to come down in the future.
Kind of a silly argument - it’s like saying you’d expect a company with lower profitability to trade at higher P/E multiples because they can always cut costs in the future.
Two firms, same EBITDA multiple, different PEs--what are the drivers? (Originally Posted: 02/08/2014)
Hi all,
Getting this question repeatedly in private equity SA interviews, and every interviewer seems to have a different take. What are your thoughts? Leverage will drive PE higher, but at the same time a) increased interest expense and b) more debt --> smaller EV. I've said leverage increases the multiple and that worked for two interviews, but got ripped apart by a third for thinking that. Any insight would be helpful!
Wouldn't an easier way to think about it be to look at what happens below EBITDA (i.e. how do you get from EBITDA to Net Income)? There are a lot of "discretionary" adjustments such as D&A, and also other business factors such as taxes that could get you very different net income figures from the same EBITDA figure.
Leverage could be an answer too, but you have to be careful because there are multiple impacts of taking on debt with regard to valuation and earnings (as you point out).
... lol. this is like asking how you calc P/E
More leverage won't decrease EV until you reach an inflection point where the company cannot service it's interest and is subject to financial distress.
P/Es can also differ because of nol tax usage and other tax benefits.
Came back to this thread after a few years of having had people ask me this question, with everyone expecting a different answer.
IMO the right way to answer this, is to say that it depends on which is greater: 1/EBITDA multiple or the interest rate (assuming interest rate and tax rate are same for both) since this is the point that flips the P/E.
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