For public comps analysis, there are 2 categories of multiples to use from. Equity multiples & EV multiples.
- Under what circumstance should we use either of them?
- What are the differences between the 2? Eg. PE multiple vs EV/EBITDA multiple
Thanks!
Which Multiples to Use for Comps Analysis?
To build comps you could pull data from Capital IQ, Factset, etc., but it’s important to get the numbers right. The best source is direct from the 10Q and other filings. Once you have the data, you’ll need to scrub the comps by normalizing earnings and adjusting for different financial periods.
While there are the standard multiples - P/E, EV/Sales, EV/EBITDA, EV/EBIT, Price/BV, ROE, 5 year CAGR, PEG – you may need to focus on different multiples depending on the stage and industry of the company/industry. For example?
- If you are comparing firms with different capital structures, then using EBITDA or EBIT multiples can be helpful because you are analyzing the cash flow to all providers of capital
- If you are looking at companies with no earnings (ex: early tech), sales multiples can be helpful
- P/E multiples are widely used, however you can’t really use this multiple for firms with negative earnings or widely divergent growth rates
The following posts provide great information on how to perform a comps analysis including which multiples to use:
To better understand the different multiples, you can check out:
P/E = Price / EPS. This reflects value of company for equity shareholders. The P/E however, does not take into account different capital structures.
EV/EBITDA better approximates the value of company for both equity shareholders and creditors. EV = equity value + net debt, and EBITDA is a rough approximation of FCF. THis allows you to roughyl compare two companies with significantly different capital structures.
Anyway, I'm not a finance major nor have i taken a finance class. perhaps someone who has can elaborate more
[quote=ibhopeful532]P/E = Price / EPS. This reflects value of company for equity shareholders. The P/E however, does not take into account different capital structures.
This is incorrect. P/E does indeed take into account a firm's capital structure; EPS is an after-interest metric and a firm's share price represents its value to equity holders only, after creditors have been paid. P/E is thus a levered multiple (it is capital-structure-dependent).
EV/EBITDA, on the other hand, is unlevered, as it allows you to look at the value of a company's earnings before the impact of debt/capital structure.
uhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhh..... if you're going to give an answer like that, preface it with... "i have no idea, but this is what i think". don't just merely say that you are not a finance major.
P/E does take into cap structure as you are using net income, which takes into account interest expense
EV/EBITDA does not take into account capital structure (hence earnings before INTEREST taxes D&A).
Use P/E when interest income & expense is a large component of operations... i.e. banks.
You might wanna check out dosk's (Mergers and Inquisitions) interview guide if you have IBD interviews coming up. It answers all these types of questions, and I beleive he released a new version just this week.
P/E ratio does not take into account capital structure, because earnings is after interest expense and minority interest expense, the residual can therefore only be used for dividends and retained earnings. Why this ratio is used for banks is because there is no EBITDA available (price to book or DDM are most common).
EV/EBITDA however does take into account capital structure, because it is before interest expense. EBITDA is a good measure for FCF because it takes into account capital structure and it is adjusted for different tax regimes and D&A methods.
This is wrong - did you care to look at the two posts above?
Here's a pretty basic way to think about it... The more debt you have in your capital structure, the more interest expense you have (assuming a flat interest rate for purposes of this discussion). Which metric would change if you were to bump up debt levels, thus changing the capital structure? Since EBITDA is BEFORE interest expense, it does not change. The items above EBITDA (revenue, COGS, opex, D&A) all remain exactly the same... But net income will change because of the greater interest expense. Since net income changes when the capital structure changes, it is the capital structure-dependent metric, which we like to call "levered" (EBITDA and other enterprise value metrics are considered "unlevered").
Hope this helps. If you are going for an interview any time soon, or are planning on it, I'd definitely suggest dosk's (M&I's) interview guide... it's loaded with technicals.
I agree the way you look at. I have a related question however. I was constantly asked in the interview that why EV/EBITDA is always lower than P/E. Do you have any clue on this?
cant believe idiots like hebbes84 even care to post ignorant post like this
EBITDA as a proxy of FCF represents both equity and debt holders (i.e. taking into account) while earnings only represents equity holders. EV/EBITDA is not distorted by capital structure while p/e is.
Jim Brown's explanation is pretty solid. I would agree you should take some time to look at guides. I have not seen the M&I guide but know the WSO guides provide the types of answers you will be expected to give in interviews. They are asking you questions like this to see if you have done your homework and prepared more than to see if you can give a 5 minute course on the difference between EV/EBITDA and P/E ratios. Don't over-explain things, if you keep it high level to begin, you are less likely to make an error, and if they want you to go into more depth they can always ask.
"earnings is after interest expense and minority interest expense"
That was good for a laugh.
Occasionally I ask "explain minority interest" in a interview - around 95% of the answers I hear are wrong. Surprising really for such a simple concept.
Forward or trailing P/E ?
relative basis - EBITDA is always a bigger number than EPS
I am not sure what you are saying. I was asking why EV/EBITDA is always lower than P/E - regardless of forward / trailing.
This answer is correct. EBITDA is always larger than earnings because EBITDA is before Interest, taxes, deprec, amort, so EBITDA > E. Meaning EV/EBITDA
PE is a levered metric - EV/EBITDA is not ...
Are there exceptional cases for using equityvalue/ebitda multiples and Price/Revenue multiples? (Originally Posted: 12/24/2015)
This question was asked in the one of the interviews: Would you ever use an equity value/EBITDA ratio to value a company?
Rationale is that Cash Flows of EBITDA go to Debt holders and equity holders, thus EV/EBITDA should be used.
However, are there exceptional cases, were a mismatch in the ratio metrics are used? For example, in one of the IB guides, it says that (Market Cap/Revenues) is used for High Growth Industries with No Earnings
Thank you
No -you would never use equity value/ EBITDA because its an apples to oranges ratio. Always use EV when the denominator of the multiple excludes interest income/expense and equity value (aka Market Cap) when the denominator includes interest income/expense.
Yeah sorry - basically read my 2nd reply - P/E is a levered metric - its essentially leveraged returns so its much higher
Difference between equity performance multiples and enterprise performance multiples (Originally Posted: 05/04/2014)
Equity performance multiples: Statistics applicable ONLY to equity shareholders - After interest expense, preferred dividends & minority interest expense - Common multiples: P/E, Market Value/Net Income, PE/Growth Rate
Enterprise performance multiples: Statistics applicable to ALL capital holders - Before interest expense, preferred dividends or minority interest expense - Common multiples: EV/Sales, EV/EBITDA, EV/EBIT
It makes sense that equity performance multiples are applicable only to equity shareholders because it is what they are left with after all the deductions from interest expense, dividends and minority interest expenses.
I am confused however on why enterprise performance multiples are applicable to all capital holders...
Why would debt holders be concerned with Sales, EBITDA, and EBIT? Is it because these metrics can show whether the company can adequately cover these obligations?
My book doesn't go into detail, so I was hoping you guys can help me make it more intuitive. Thanks!
^ Thanks. I understand leveraged means higher multiples. But I got confused when I think it this way, starting from P/E to get EV/EBITDA, we basically add the value of (debt+minority int.+ preferred) to the nominator and add (Int+D&A+Tax) to the denominator. Normally P/E should be higher than EV/EBITDA, meaning (Debit+minority int+preferred) / (Int + D&A +tax) would be lower than P/E. But looks like these two ratios are not dependent to each other. That’s the part I do not understand - I mean (Debit+minority int+preferred) / (Int + D&A +tax) not necessarily have to be lower than P/E.
Because ebitda is the earnings that are available to all investors (debt and equity). Think of ebitda as a proxy for cash flow. Ebitda is then essentially all the cash earned that can be paid out to all capital holders. NI on the other hand is an after interest figure and thus represents the earnings that are available to only the equity holders.
That makes great sense. Thank you!
Conceptually, EBITDA is a proxy for what earnings the business can generate before you look at how those earnings are split between equity and debtholders ie before the impact of financing decisions. That tells you what the underlying business is capable of (leaving aside debates on whether EBITDA is really that good a measure).
As a debtholder, I care about what the EBITDA (and capex) is because EBITDA - capex is the proxy for the cash generated that services my cash flow.
As an equityholder, I care about what the EBITDA (and capex) is because debt financing often changes. EBITDA - capex indicates how much debt the business can bear, hence how much leverage can be applied to beef up my equity returns.
For example, if I'm a PE firm looking at a business that has debt/EBITDA of 3x in today's market and would be a B2/B credit at about 6x, I'd be focusing heavily on the EBITDA, as I know that I can raise debt to around 6x net debt/EBITDA (if not more in today's market), hence reduce the size of the equity I need to invest and leverage up my equity returns.
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