Valuation multiples question
Company A and Company B are in the exact same industry and exact same country. They sell the same products and have the same Revenue and EBITDA. And yet, Company A is trading at 15x EV/EBITDA while Company B is trading at 10X EV/EBITDA. What can cause this to happen?
Apparently the answer focuses on growth prospects going forward. I don't get it though. So I have three questions
1. How does future growth / earnings / outlook affect valuation multiples? If we're looking at EV / EBITDA today, how does this determine whether one trades at a cheaper price than other?
2. Are there any other reasons why companies can trade at different multiples if they have identical operational performance and operate in the same industry?
3. I read that valuation multiples are affected by three things: risk, growth and leverage. Is this true? And if so, how?
Thanks all!
Couple items.
1. Same Revenue / EBITDA today. Could mean that Company A has grown historically at 50% CAGR, while Company B has declined.
2. Future growth. Company B is projected to decline. Company A is projected to gain share
3. B/S & Leverage profile
4. Management team
5. Legal risk
6. etc etc etc
Many thanks! From what I understand about point 2 on growth, a higher earnings outlook will be driving higher prospective cash flows and therefore we expect a greater multiple, thanks to EV. Am I right in understanding that?
And on your leverage point, it's tied to the cost of capital. The lower our cost of capital, the higher the potential to realise our returns (and of course, cost of capital affects our cash flows when discounting). So really, if two companies have the same EBITDA and Revenue, the underlying fractional change is EV...right?
Finally, why would the management team affect things?
Keep it simple. If the companies are the same today, the one with higher growth prospects will be valued higher.
Leverage. I don't care about the cost of capital. Higher leverage = 1) higher interest payments / lower cash flow and 2) more risk.
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