Why low multiples matter?
Hi :)
I am preparing interviews in private equity and I have a question.
How come a company with a lowest valuation multiple ( say EBITDA for ex) will be more attractive that a company with a higher valuation multiple?
I dont understand because multiple are relative.... So i dont see the point/logic behind this...
In general, a lower multiple means you're spending less money for a $1 of earnings.
Another point you should consider is that a company which trades at a lower multiple than the industry average may be undervalued.
But - a company with the lowest valuation multiple will not always be more attractive than a company with a higher valuation; a lower multiple can come from an increased risk, cyclical business, etc.
Thank you very much for your answer :)
Why would it be undervalued ? Can't it be that the firm has a very strong ebitda, hence the lower multiple?
The multiple is an implied measure, not the explicit one. In a transaction you know the price and the various figures from the financials of the company.
So, assuming no cash/debt, you can buy a $20m EBITDA business at $200m (10x multiple) and then you sell it for $300m with a $25m EBITDA at a 12x multiple a year later. You make a profit for the combination of the increased multiple (so called multiple expansion) and EBITDA growth. But you might also face a loss for a business with a increasing EBITDA which is selling at lower multiple (e.g. $180m with a 7,2x multiple). Given that you don't know the multiple you are going to get when you sell the business, the lower the better.
Buy low
sell high
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