Technical Question - Why bankers prefer EV over PE?
Can anyone eloquently explain why bankers prefer EV/EBITDA over PE?
Can anyone eloquently explain why bankers prefer EV/EBITDA over PE?
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EV/EBITDA is not effected by the capital structure, which is much better to look at when you just want to see the business operation of the company.
Moreover, the EBITDA shows the true operating profitability of the business, before any extra-income (such as profit from associates or invested companies booked using the equity method), non-operating income (lawsuits gains, insurance claims, etc)... which are included in EPS (at least the reported EPS)
Its a measure of payback period. Think about it intuitivley the numerator(capital structure+minority interest-cash) claims to assets and the denominator(EbITDA a unlevered measure of CF from operations that gets rid of management estimations and bias) vs PE which is Mkt price/EPS. Eps is heavily influenced through management with estimations. A couple examples would type of depreication on long lived assets (DDB, SOYD, Straightline) and inventory cost flow method(Fifo, Lifo, WA) These all effect your underlying net income which is part of your EPS equation (Net Income - Prf / WACSO) which is basic EPS. So in the end PE is Management bias and only concetrates on the common equity portion so basically how much your willing to pay per dollar of earnings. Where as EV/EBITDA takes the whole capital structure into consideration and is less managmeent bias. Hope this helped and feel free to PM me if you have any Q's............................LUI im not to sure if i understand your reported EPS statement. If diluted is better than basic than only basic is reported and if diluted is worse than basic than both are reported.
a lower number and it's easier to sell lower numbers.
conceptually, why is EV/EBITDA a lower number?
EV measures the value of the underlying business, whereas market cap. is a measure of ownership in the company. This is an important distinction because on the one hand you are measuring how well the underlying business of the company is doing, and on the other you are measuring how well the company as an entity is doing. The distinction is subtle but very important. The whole basis for capital structure neutrality is that you are trying to measure the company's operations and business verses measuring the specific management of company. Also, the management of the company can very well skew the performance of the business because managment has discretion over such things as revenue recognition, depreciation, inventory cost flow, and other tax implications.
The simple answer is:
EV multiples measure the company in an unlevered state whereas P/E and other similar multiples measure the company in a levered state.
Notice the difference between EV/EBITDA and P/E. EV is always compared to a metric that does not include interest payments (leverage) whereas P/E and many other multiples use net income which has interest payments taken out of it.
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