Why are EBITDA Multiples Different for Similar Companies?
Interview question I got--Why would two similar companies, same industry, same growth prospects have different ebitda multiples? What about different P/E multiples?
P/E or EV/EBITDA Multiples for Similar Companies
When looking at two companies in the same peer group, with similar profiles and the same growth prospects - it is natural to assume that they would trade at the same multiple of earnings. However, this is not always the case.
The following are some factors that could cause the multiple to be different:
- One company is an acquisition target
- Company is in M&A process
- Companies have different EBITDA margins
- One company has controlling market share
- One company has been hit by bad news or scandal recently
Also, when considering the EBITDA profile of the business this does not account for the capex and working capital profile of the business which can affect the value of the business in the market's eye.
Not familiar with EV/EBITDA? Check out an overview below:
Read More About Trading Multiples on WSO
- Why does a Low EV/EBITDA Multiple Make a Good Acquisition Target?
- P/E vs. EV/EBITDA - Advantages/Disadvantages?
- Why use EV/EBIT multiple when compared companies in the asset intensive industry?
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If one is an acquisition target it would lift the multiples to behave more like transaction comps which are generally higher (due to control premium)
1) One company is part of an acquisition and the other is not. 2) Both are part of an acquisition, but the process is more competitive for one of the two companies. 3) EBITDA margin would also play a part. Assuming same EV, the adjustments between top line and EBITDA would cause you to have different multiples.
good question. a few weeks ago, I was looking at 2 companies within the industrials sector and both of them had exactly the same sales growth, margins, market share, etc. One was trading at 6x EV/EBITDA and the other one was trading at 11x EV/EBITDA. after some footnote reading I realised why: the 2nd company had some exceptional increase in COGS (long story short, it had exposure to a certain commodity whose price went up and the company didnt hedge properly, 1st company didnt use that specific commodity in their COGS). Therefore investors realising this COGS increase/ EBITDA Decrease is just a one-off event that happened in 2010 didnt penalise the company, realizing that next year, EBITDA would go back up to its historical level. So the reason EV/EBITDA was 11x was not because of some growth/margin/market share story but simply because EBITDA dropped massively during 2010. Debt stayed the same, market value of equity stayed the same (as a consequence of investors realizing the the exceptional nature of the EBITDA decrease), only thing that changed was the drop in EBITDA which caused the multiple to go up substantially. A good way to detect this is to look at HISTORICAL ev/ebitda multiples and see how they evolved over time. if 2, 3 companies have historically traded at same multiples and you see a SUDDEN spike amongst them, that might be caused by some exceptional, one off event. On the other hand, if the historical multiples show a PERSISTENT difference between them, then one is simply better than the other (higher sales growth/margins/market share/lower capex, ...etc). Lacking these exceptional events, I find it impossible for 2 companies (within the same industry) with exactly the same growth/margins/share/capex to trade at significantly different multiples (by significantly different I mean >2x). An up to 2x difference is acceptable in my opinion even if they have very similar characteristics like the ones mentioned above, because there might be some structural factors that justify that (in reality no 2 companies are EXACTLY the same) : size of 1 vs the other (small cap vs large cap), free float on the market of 1 company vs the other), which in turn affects how liquid the stock is, etc etc.
Don't you normalise / add back extraordinary items to earnings etc purely for this reason?
All of this can be circumvented by looking at forward multiples instead of historical.
Don't outthink yourself. Because the basis for valuation may not be EBITDA. For example, perhaps it is a technology or other growth story where the momentary EBITDA margin differences are not material to the long term cash flows. Or the capex/wc profile make free cash flow multiples the basis for valuation.
One example: by engineering the dividend payout to a high yield, you can take valuation away from the basic EBITDA multiple and focus investors on dividend yield. For illustration, see telecom landline HYDS to see how a conventional LEC may trade at a 2x+ discount to the high dividend yield stock.
same EBITDA, different EV/EBITDA multiples? (Originally Posted: 01/19/2010)
quick and probably simple question, guys.
if two companies have the exact same EBITDA then why would they trade at different EV/EBITDA multiples?
thanks
There are two variables here. If one variable is exactly the same, then the other must be different, which is EV. The answer is: two companies have two different enterprise values. Therefore, their EV/EBITDA multiples are different.
For example:
Company A: EV: 100 EBITDA: 10 EV/EBITDA: 10x
Company B: EV: 200 EBITDA: 10 EV/EBITDA: 20x
Hope this helps.
Actually, a very complicated question. The answer could be company specific, industry specific, etc. An industrial with a very predictable $300M of EBITDA would never trade at the same multiple as a high-growth tech company who just reached $300M of EBITDA this year, but is expected to achieve $400M of EBITDA next year.
And outside of actual company performance, there are market dynamics. The market may assign a premium to certain names because of management team, liklihood of being a take-out target, etc.
Just think about what a company's stock price represents in theory. It's the NPV of all future cash flows. So, a stock trading at a higher multiple is either expected to grow earnings (and thus cash flow) at a higher rate than comparable companies with lower multiples.
There should be a comprehensive summary in your Corp. Fin. text book. Or, take a look at the Vault Guide.
EV= Market Cap+Debt (can vary on how its computed)+minority interest+Preferred Stock-Cash & Cash Equivalents
Anything that may vary within the computation of EV will throw the multiple.
I'm sure the OP knows better than "The EV must be different"
.
Different EV/Revenue Multiples, Same Projected Growth Rates (Originally Posted: 01/17/2016)
Hi all,
Recent interview question I got was:
I'm looking at companies in X industry. We tend to look at EV/Revenue multiples rather than EV/EBITDA or EBIT since operating profits are usually negative. Consider company A and B--assume both companies have the same projected growth rates. Why might company A have an EV/Revenue of 10x and company B have an EV/Revenue of 5x?
I got this at the end of my superday and my brain was already fried. I said things like company A might have a better market position, stronger management team. Also threw out things like varying EV's and revenues leading to different multiples. He didn't seem happy with my answer, and was looking for answers more related to financial metrics.
Anyone have any advice on what would be a stronger answer to this type of question?
Thank you in advance.
I suspect you guys are really overthinking this question--keep in mind that this was an interview question, probably for SA based on timing.
My guess would be one company has significantly higher capex than the other, which is not reflected in EBITDA
Different margins. While EBITDA and EBIT might be negative, one might be more negative than the other, and they are likely to be projected to eventually turn positive if the companies are worth anything.
I was thinking margins could be it as well. I just wasn't positive since we were talking about revenue multiples, and revenue isn't affected by margins.
You're thinking about it backwards. Every multiple whether it's off of sales, EBITDA, earnings is just a proxy for valuing a company based on its conversion to FCF and the visibility / predictability of that FCF.
one company is more levered than other and has a higher wacc.
Buyer specific synergies
EBITDA Multiples (Originally Posted: 09/11/2017)
Hi,
Given three companies,
A: EV/EBITDA = 4x B: EV/EBITDA = 5x C: EV/EBITDA = 6x
Over time, all three converge to 5x, which one would you invest in and why?
Thanks!
C. You would want the higher multiple to decrease because that would most likely imply rising EBITDA. This in turn could imply higher bottom line growth and thus a better investment.
Disagree, because option C could also imply flat EBITDA with falling EV.
Generally, you like to see multiple expansion on an investment - thus option A. From a private equity perspective, multiple expansion with flat EBITDA is more desirable than a flat multiple with growing EBITDA (again, this is a broad answer to a broad question).
What is the most appropriate EBIDTA multiple to take? (Originally Posted: 03/26/2017)
Hi everyone,
as I'm trying to build and fix my first DCF model, I'm struggling to understand what is the most "appropriate" EBITDA multiple to take. The reason I ask this is because I've come across two different methods of getting the multiple:
Paul Pignataro gets his multiple by taking the enterprise value of year N, and dividing it by EBITDA in year N. This multiple is used to multiply the projected EBITDA in the DCF's final year to get the terminal value. - as shown in his video
(My concern about this is that year N might be a tremendous growth year, but that multiple does not represent the long term stable growth)
The other way is shown in the formula below:
I'm currently applying this formula to the 5th projected year. This means that the numbers in here is based on projections and less reliable than if it was based on historical numbers. (If Nth year means the most recent record year, please let me know).
Are my concerns valid? And what is the recommended method of doing so in practice?
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