Comments (11)

Dec 7, 2008

(1) The advantage of using the EBITDA or EBIT multiple is that it allows you to compare firms with different capital structures as you are analyzing the cash flow to all providers of capital.

My one beef with using EBIT is that it assumes that capex = depreciation, which is not necessarily the case. If you would like to take capex into account, I would suggest using EV / (EBITDA - Capex).

(2) Sales multiples come in handy when you are looking at companies with no earnings (i.e. early tech). But that being said, I think its useless for mature companies as you are ignoring how the efficiency of each company (i.e. converting sales into cashflow to capital providers).

(3) P/E multiples are important (& is a mainstay) as they measure the price paid for a share relative to the profit earned per share. Higher P/Es indicate strong growth possibility. You can't really use this multiple for firms with negative earnings. Also, my opinion is that if you are looking at companies with widely divergent growth rates, then using a P/E multiple is going to give you distorted information. Rather, I would use a PEG ratio as it discounts the effect of growth. Still, regardless of its many drawbacks, P/E multiples are used widely.

Dec 7, 2008

Another drawback of the P/E multiple is that it includes the effects of capital structure. Makes comparing companies with different capital structures difficult.

Dec 7, 2008

Just to make sure I understood it right. For (1), because EBIT is the profitability of a firm before the effects of capital structure, EBITDA and EBIT multiples let you come up with EVs that disregard the capital structure of the comps? And this is important because each firm has a different cap. structure and we don't want those to influence our EV? But then in the end, the capital structure of a firm does influence its value, right? So for a multiples analysis using EBITDA or EBIT how do we adjust our EV for our own capital structure?

And for EBIT multiples, why do you assume that capex=depr.?

Thanks a bunch for your answers, they really made it a lot clearer!

Dec 9, 2008

1) correct, it gives a relative firm value to cashflow. Remember, EBITDA and EBIT are considered "Rough" cashflow metrics as they add back in and adjust for non-cash items such as stock compensation, etc. In LBO's the current cap structure is unimportant as it will get replaced anyway after acquisition, therefore we need to know the company's true earnings potential compared to its value.

Look into LBO's if you want to see adjustments for your own capital structure. What happens is that you decide a company is worth $100m ie EV = $100 proposed, therefore you choose a capital structure according to this valuation. This maybe different from the current capital structure of $75m, and therefore it gets replaced by the new one, the acquiring one. EV just tells us that in order to acquire all the assets of the company, we need to buy not only the equity used to purchase the asset, but also the debt. So the more debt/equity the company takes on, the more assets it should acquire, in theory.

capex=depreciation because you assume that you replace the utilization rate lost with the depreciation. An assets production capability is less in year two than in year one, etc. It's a maintenence capex assumption. This is really important for capital intensive businesses, not important for labor/human capital intensive businesses.

Dec 8, 2008

this is a majorly basic ib interview question... if you don't know this by now then you're hurting. and what school do you go to that doesn't teach you this?

enterprise versus equity multiples....

for enterprise... move up the income statement until you get a good (positive) number.

Aug 3, 2009

need help on this topic

1) sorry can someone give a bit more insight on the capex=depreciation assumption for using ebit multiples?

I thought one reason to use ebit instead of ebitda is because da matters, in that case shouldn't capex not equal depreciation. isn't the assumption using ebitda multipe that the business is in steady state and hence capex = depreciation.

2) why use trailing ebitda for ev/ebitda multipes and forward e for p/e multiples?


Aug 5, 2009

In an LBO, firms are purchased based on LTM EBITDA numbers, not forward numbers. In equity markets, stocks trade based on forward earnings. Stocks don't really trade on forward EBITDA.

Aug 5, 2009

But why don't you look at forward EBITDA in LBO situations and why don't stocks trade on forward ebitda?

Aug 4, 2009

no one can help?

Aug 5, 2009

Capex should not really equal depreciation. I guess you can assume that every year you depreciate your existing PPE and any new capital expenditures, which is a really bad proxy for capex. If you want to include capex into your EBITDA, you want to just do EBITDA - Capex.

The reason you look at historical EBITDA rather than forward is because investors are going to value your company off what you have accomplished. If you generated LTM EBITDA of $100mm, you are going to be valued off that number because that's what you've earned for sure. If you project $250mm in 2 years, it doesn't make sense to value off that number because no one knows if you will hit that number.

Aug 5, 2009