Choosing the right Valuation Multiple
This seems to be one of the most asked interview questions in investment banking as well as principle investment roles. When do you use a specific valuation multiple over another?
There are a lot of threads in the WSO forum but none of them actually nails this down - in my opinion.
In what situations will you use the following multiples:
EV/EBITDA
EV/EBIT
In investment banking interviews I have heard a lot of people leaning towards the EV/EBITDA multiple, but in principle investment roles - such as a hedge fund interview - majority prefers EV/EBIT.
When do you use one over the other.? Which is best to look at from an investors point of view? What should you take into consideration when choosing the right multiple to look at?
Don't segment them based off this preconceived notion that one is used more in IB, and the other is used more in HFs.
Actually think about the difference between EBIT and EBITDA. What's the difference? One has depreciation and amortization added back into it.
In what instance is D&A relevant? When there's a lot of it. In what instance would you have a lot of D&A? When your operations are capital-intensive.
My sense is the opposite. For capital-intensive (think manufacturing), you use EBIT since EBITDA takes out the D&A which is linked to CapEx. For less capital-intensive industry, you will see EBITDA more often (think internet/software)
This comment was edited so that it would get less poops thrown at me, sorry for the disinformation
NTinNY is right. You look at EV/EBIT for CapEx-intensive industries because CapEx is so critical to operations. I.e., companies are going to be valued on their ability to generate cash flow in excess of capex, which is reflected in D&A
How to select which valuation multiple to use? (Originally Posted: 11/18/2017)
Hi,
How do we select the correct multiple for a target price calculation?
Equity research reports often say our target price of X is based on a 50:50 combination of P/E and EV/EBITDA (This was for a European Utility Stock)...
How is that ratio determined?
When should we use P/E, EV/EBITDA?
Would REALLY appreciate inputs...
This comment deserved the 2 poops that it got
Does this guy have his EBITDA and EBIT mixed up or am I going crazy?
Lol no you're confusing yourself. In capital intensive industries, we WANT the value of EBIT to dramatically depart from EBITDA. Like in manufacturing, everyone who operates in this space has significant CAPEX and anyone who can find a way to make this CAPEX more efficient trades at a premium to their peers. Thus, you would use EBIT to see who is more profitable after CAPEX. If you use EBITDA, you can't tell who has the more efficient CAPEX. In other words, in CAPEX intensive industries, CAPEX is part of the operations of the business so to speak so we can't just ignore it.
In technology industries, investors don't care about how efficient your CAPEX is because more often than not it is not related to the fundamental aspects of your business. Since CAPEX is not an integral part of the operations of the business, being able to lower/increase it is not directly correlated to a more/less valuable business (contrary to the manufacturing industry where if you have a less capital intensive factory that's worth something to investors) we will use a metric like EBITDA to eliminate it. In other words, it doesn't really matter how cheaply Uber can buy a factory that makes Uber stickers for, since that type of CAPEX (according to how accountants classify CAPEX nowadays) is totally unrelated to what drives revenue for Uber, whereas in manufacturing its pretty fucking important.
The avg of the peer group
EV/EBITDA is probably a more appropriate multiple (than P/E) to use if you're comparing companies with different capital structures. At the same time, for some industries, some investors focus almost exclusively on P/E multiples. Using a blended valuation may be an attempt to straddle the two concerns and/or make the TP determination look more robust than just the forecast for one year's net earnings.
I think reading this thread made me understand finance less lol.
EV-EBITDA is a cash flow metric, EV-EBIT is profitability. Jesus.
Multiple Selection (Originally Posted: 02/25/2016)
Hi all,
Just wanted to hear your opinions on a relatively simple subject that has been bugging me lately. Specifically the multiple selection criteria for private company valuation.
So I came across many different private company valuation reports in which the thought process with respect to multiple selection is different. I guess there is always some sort of subjectivity when it comes to multiples, but I wanted to elaborate further on this topic.
So let's say I have a private company with good growth prospects and healthy EBITDA margins. Lets assume my revenue growth is higher (1-2 years into the future) than than the median growth rate of peers but my EBITDA margin is lower (currently and also in going forward). Let's assume I have 2 multiple criterias: EV/Revenue and EV/EBITDA
So just by looking that my revenue growth is higher than those of peers should I assume a Revenue multiple in the high range (of peers)?
Or my thought process should be, well I am growing more but my EBITDA margins are lower so I should be paying less for each dollar of revenue growth (since that revenue is turned into profits relatively less efficiently)
But on the other hand, should I be attributing a lower EBITDA multiple because my margins are lower, or should I be thinking, my EBITDA margin is less, but ceteris paribus my revenue growth is higher so I should be paying more dollars for a given EBITDA margin.
What are your thoughts on this subject? If a company has both high growth and high margins then both multiples naturally trade higher, but with differing revenue/margin prospects how should I approach to each of these multiples?
Additionally there is the discount on the multiples that I've come across a few times. Frequently the rationale is that "given the size of the company is smaller than that of peers.." well is that a reasonable argument? Again, should not we view multiples from a relative perspective rather than absolute amounts? As the absolute amount in revenues or EBITDAs are captured in the purchase price, the multiple itself should not be dependent of my size, or not? In other words 1,000 Revenue Company vs 10,000 Revenue company will obviously differ in purchase price, but it should not be reflected in the multiple selection as the absolute figure is already capturing that.
Would really like to hear your opinions on multiples - as I come across more and more on valuation studies I would like to have a more fundamental understanding on this.
Because @lakesoup has written half of the posts and doesn't know what he's talking about.
Bump. Any thoughts?
You're not trying to come up a specific EBITDA or Revenue multiple when you run comps - you want to come up with a range of valuations (i.e. 8x-9x EBITDA, then do it independently with revenue and you can compare the two). So if growth is higher and margins are lower then in theory these should somewhat net out against each other. In practice, that may or may not be true. In general, err on the side of conservativism since it'll give you more room for error if you're wrong and juice your returns if you're right.
" In other words 1,000 Revenue Company vs 10,000 Revenue company will obviously differ in purchase price, but it should not be reflected in the multiple selection as the absolute figure is already capturing that."
Size absolutely does matter. In general, larger companies are more entrenched, have better business processes and management, and better relationships than smaller ones (and as a result of all these factors, more financial flexibility). If nothing else, think of it from a failure standpoint: which is more likely to fail: a BB bank or a small 3 man boutique?
Thanks for your reply. I am valuing a private company and if the market approach is the only thing I can look at, then I have to attribute specific multiples to the subject company right - I mean a range is fine but essentially you have to find that range with some fundamental thinking.
If my company starts with 100 revenue and grows each year by 10% against a peer group with much higher revenues say 100,000 but less growth 5%, the multiples should reflect that right - the absolute amount should not really matter.
With that in mind, when selecting my revenue multiple, should I care more about the revenue growth or also look at my EBITDA margins as well? So do I attribute a higher revenue multiple because of my high growth, or not so high multiple since my margins are lower.
Same thing with EBITDA multiple. Should i just care about EBITDA margins and attribute a lower one since my margin is lower, or attribute a higher one since my revenue growth is higher and everything else constant that revenue growth will turn into more profits.
I agree with your point on size. When using a discount rate we can always attribute a small stock premium but with multiples I thought this would not be necessary due to relativity. But it makes sense.
First of all think of EV as the Pv of all future FCFF . Now assuming EBitda margins remain co stant , whatever they are right now , the FCFF growth would be in line with the Revenue growth . Hence, the company with the higher revenue hence ebitda growth should be the one with higher Valuation ratios . The Absolute level of EBitda or margin does not matter much . Hope that answers your questoio
Would encourage anyone that's confused to ignore lakesoup's posts
Multiples....which one?? (Originally Posted: 04/09/2011)
I am wondering which multiple is best to use for a company with no long term debt.
I am working on valuation analysis for Boston Beer Company (SAM) which has no debt, the multiples I am using are:
Enterprise Value P/E Forecast P/E Enterprise Value/Sales Enterprise Value/Book Value of Assets Enterprise Value/EBITDA Enterprise Value/EBIT Book-to-Market
but I suspect that certain multiples won't reflect the appropriate value, this is because Boston Beer are not leveraged like the other firms.
What kind of multiple will be the best estimator for this kind of company ?
Thanks!
EV/EBITDA is pretty much always used, though with no leverage I believe the EV multiples become less relevant (since net debt is the diff b/w EV and market value). Book value of assets is only relevant in a few industries (financials) where assets are rolled over frequently enough to roughly reflect market value, and your returns depend very directly on asset base (e.g. interest rate on your loans)
Whether P/E matters also depends on how stable E is for companies in that sector.
So yeah, not completely usre of the answer (P/E or EV/EBITDA), but some things to think about...
You can probably check analyst reports for similar companies to find out what they use.
yup just check sell-side reports. ev/ebitda is meh for non ib/pe guys.
always use forward estimates.
Generally agree with what's been said above. You're probably best off using a forward P/E multiple if earnings are pretty stable. If not, I'd probably use EV/Sales as a second way to value the company.
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