Why is EV/EBITDA considered capital-structure neutral, while P/E is not?
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The answer
EV/EBITDA is capital-structure neutral because it compares enterprise value, the value of the whole business to all capital providers, to EBITDA, a pre-interest measure of operating performance. Since EBITDA is earned before any payments to debt holders, two operationally identical companies will show the same EV/EBITDA regardless of how much debt each one carries.
P/E, on the other hand, divides equity value, which belongs only to shareholders, by net income, which is the bottom-line profit after interest has already been subtracted. That means a more leveraged company has higher interest expense and lower net income, so its P/E ratio will be different from an unlevered peer even if the core business is exactly the same.
The sensitivity is by design: P/E reflects the earnings left for shareholders after financing costs, while EV/EBITDA purposely strips that leverage effect out so you can compare pure operating performance without the balance sheet distorting the picture.
Enterprise value bridge
| Equity value | 800 |
| + Total debt | 380 |
| − Cash & equivalents | (150) |
| + Minority interest | 20 |
| + Preferred stock | 15 |
| Enterprise value | 1,065 |
Also asked as
- Write the formula for EV/EBITDA, EV/EBIT, P/E, and EV/Revenue, and state which value measure (EV or Equity Value) each performance measure must pair with and why.
- A company has EV of $3,500M, Revenue of $1,750M, EBITDA of $437.5M, EBIT of $306.25M, Equity Value of $2,900M, and Net Income of $145M. Compute all four multiples.
- When would you prefer EV/EBIT over EV/EBITDA? Give the specific distortion EV/EBIT corrects for.
- Why is EV/Revenue used mainly as a fallback rather than a primary valuation tool, and what information does it fail to capture? Then name two kinds of company where even EV/Revenue does not apply, say what specifically breaks in each case, and state what you would use instead.
- Two companies have identical EBITDA and EV, but Company A has $15M of D&A and Company B has $70M of D&A. Compute EV/EBIT for both given EV of $1,200M and EBITDA of $150M for each, and explain what the divergence tells you.
- Explain the difference between an LTM multiple and an NTM multiple, and describe a scenario where comparing one company's LTM multiple to another's NTM multiple would mislead you.
- Company X is unlevered with EBIT of $250M, a 25% tax rate, and no interest expense. Company Y has the same EBIT and tax rate but $60M of annual interest expense. Both trade at a P/E of 12.0x. Compute each company's net income, equity value, and (assuming both hold $300M of cash and Company Y carries $750M of debt supporting that interest expense) each company's EV and EV/EBIT. Explain why the identical P/E is misleading.
- A company has negative LTM EBITDA of −$20M but Revenue of $400M and 70% gross margins, growing 40% annually. Walk through how you would approach valuing it with multiples, including what you would and would not trust EV/Revenue to tell you.
- TargetCo trades at EV of $5,000M with LTM EBITDA of $500M and NTM (consensus) EBITDA of $575M. A colleague compares TargetCo's EV/NTM EBITDA to a peer's EV/LTM EBITDA of 11.0x and concludes TargetCo is cheaper. Compute TargetCo's EV/NTM EBITDA, identify the analytical error, and explain what additional data you'd need to make a fair comparison.
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- Why is minority interest added to enterprise value? Anchor your answer in consolidation accounting and the consistency of EV/EBITDA.
- Why do you normalize a peer's EBITDA for one-time items before computing its multiple? Give two specific examples of items you'd adjust for.
- Cash Subtracted From Enterprise Value, Explained
- Define control premium and write the formula. Against which share price should it be measured, and why?
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The rest of this topic
Multiples: which pairs with which