The two most common multiples we look at are the price/ earnings (PE) and enterprise value-to-EBITDA (earnings before interest, taxes, depreciation and amortisation) multiples (EV/EBITDA), with each possessing merits depending on the type of company.
The PE multiple is most commonly used and is particularly useful for comparing stable, profit-making companies. It is calculated by dividing the share price by earnings per share (EPS) to produce a multiple that allows us to compare companies of differing size, sector and region.
In contrast, the EV/EBITDA multiple is useful where similar companies employ different accounting methods for the depreciation of capital expenditure (i.e., fixed assets a company has purchased) and amortisation of investments and goodwill. Depreciation and amortisation (D&A)can either be capitalised and then depreciated across a number of years or expensed entirely in a particular year. The two methods have different impacts on earnings which would make it harder to compare two companies. The benefit of using the EV/EBITDA multiple is that EBITDA is positioned above D&A on the income statement, nullifying the impact of the differing accounting methods and making the two valuations more comparable.
Another example where the EV/EBITDA multiple is more useful is for loss-making companies that are investing heavily in growth. Typically these companies will be generating EBITDA but have very low or negative earnings, making them appear expensive on a PE basis.
The EV/EBITDA multiple is by no means a perfect solution however, as EBITDA is a non-statutory item. Companies have different methods of calculating EBITDA, meaning adjustments often need to be made to compare apples with apples.
