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.

Understanding Finance

Helping clients understand what we do is key to building relationships. To explain some of the industry jargon that creeps into our world, we’ve pulled together a section of our site to help.

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