Valuation multiples · RiskAtoms Academy

By the end you will be able to

1Calculate P/E, P/B and EV/EBITDA, and use them to compare companies.
2Explain why EV/EBITDA uses enterprise value rather than market capitalisation.
3Express a company's premium or discount to its peers as a percentage, and use peer multiples to estimate its value.
4Recognise when a multiple misleads: losses, debt, accounting differences and growth.

Why it matters

An estate agent values a flat by asking what similar flats nearby sold for, per square metre. Investors value companies the same way: price per euro of profit, per euro of assets. These ratios are the most quoted numbers in equity research.

Core explanation

Price per unit of something

The dividend discount model (L1.5.03) needs forecasts for ever, and the answer swings with every assumption. Often a quicker question is more useful: how does this company's price compare with similar companies, scaled for size? A ratio of value to size is a valuation multiple. Like price per square metre, it lets you compare a studio with a mansion.

P/E: price per euro of profit. Divide the share price by earnings per share, or equivalently the market capitalisation by the net income. Alto Foods has a P/E of 16.0×: investors pay €16 for each euro of annual profit. Flip it over and you get the earnings yield, 6.25%, which you can compare with a bond yield.

P/B: price per euro of book value. Book value is the shareholders' equity in the accounts. A P/B of 1 means the market values the company at exactly what its accounts say its net assets are worth. P/B suits companies whose assets are mostly financial and close to market value, above all banks and insurers.

EV/EBITDA: the whole business. Think about buying a house that has a mortgage on it. The true cost is what you pay the seller plus the mortgage you take over, less any cash left in the house. Buying a company is the same. Enterprise value adds the debt to the market cap and subtracts the cash. It is paired with EBITDA, a profit measure taken before interest is paid to lenders. Both sides of the ratio belong to all the funders, lenders and shareholders alike, so the ratio is not distorted by how the company is financed.

Match the top and the bottom

An equity value (market cap, share price) goes with a measure that belongs to shareholders (net income, book value). A whole-business value (EV) goes with a measure earned for all funders (EBITDA, sales). Mixing them, such as market cap ÷ EBITDA, gives a number that means nothing.

Why debt matters. Compare two of the peers. Corvo Group has a P/E of 12.0×, Brava Brands 20.0×. Corvo looks 40% cheaper. But Corvo carries €3,000m of debt against Brava's €200m. On EV/EBITDA they are close: 8.4× against 8.0×. Shareholders in a heavily indebted company pay less per euro of profit because that profit is riskier, not because the business is a bargain.

Which multiple fits? Pick one for each case.

Choose the multiple

0 of 4

A bank, whose assets are mostly loans and bonds held close to their market value.
Two telecoms companies with similar networks but very different amounts of debt.
A young company with positive EBITDA but a net loss, after heavy interest and depreciation.
Two consumer goods firms with steady profits and similar, modest debt.

Where multiples mislead. A low multiple is not automatically cheap. Losses make P/E meaningless. One-off gains or charges distort a single year's earnings. Accounting rules differ between countries, so book values and EBITDA are not always like for like. And faster-growing companies deserve higher multiples, as the formal version shows.

The formal version

The definitions, shown in full:

\text{P/E} = \frac{\text{price per share}}{\text{EPS}} = \frac{\text{market cap}}{\text{net income}} \qquad \text{P/B} = \frac{\text{market cap}}{\text{book value of equity}}

Enterprise value, derived on a few lines from what each group of funders is owed:

\begin{aligned} \text{EV} &= \text{value to shareholders} + \text{value to lenders} - \text{cash the buyer gets} \\[2pt] &= \text{market cap} + \text{debt} - \text{cash} \\[2pt] \text{EV/EBITDA} &= \frac{\text{market cap} + \text{debt} - \text{cash}}{\text{EBITDA}} \end{aligned}

Analysts often also add preference shares and minority interests to EV. Comparing with peers uses percentages:

\text{premium (+) or discount }(-) = \frac{\text{company's multiple}}{\text{peer median}} - 1

Where P/E comes from. Take the Gordon model from L1.5.03 and suppose the company pays out a fraction $b$ of its earnings $E_1$ as dividends:

\begin{aligned} P_0 &= \frac{D_1}{r - g} = \frac{b \, E_1}{r - g} \\[2pt] \frac{P_0}{E_1} &= \frac{b}{r - g} \end{aligned}

Higher growth $g$ or lower risk (a lower $r$ ) means a higher fair P/E. With half of earnings paid out, $r$ = 8% and $g$ = 3%, the P/E is $0.5 \div 0.05 = 10$ . A multiple is a compressed forecast.

Try it

Eden Organics, an unlisted organic food maker, is thinking of listing. Compare it with four listed peers. Raise Eden's debt: its P/E does not move, but its EV/EBITDA does. Push its net income below zero and watch P/E become meaningless. Click a heading to sort.

Try itCompare five food companies

Percentage calculator →

Eden share price€30.00

Eden net income€90m

Eden debt€500m

Company
Alto Foods	16.0×	2.0×	8.4×
Brava Brands	20.0×	2.0×	8.0×
Corvo Group	12.0×	1.5×	8.4×
Delta Snacks	20.0×	3.0×	9.0×
Eden Organicstarget	16.7×	2.5×	7.6×
Peer median	18.0×	2.0×	8.4×
Eden vs median	−7%	+25%	−9%

Green marks the lowest multiple in each column: the “cheapest” on that measure. A premium (+) means investors pay more per euro of profit or assets than for the typical peer. Eden: market value €1,500m, enterprise value €1,900m. n/m = not meaningful (earnings at or below zero).

A simplification: in reality more debt also means more interest, which would lower net income.

Worked example

Valuing Eden Organics from its peers

Amounts in € millions, last 12 months. Eden has 50 million shares, net income of €90m, book equity of €600m, EBITDA of €250m, debt of €500m and cash of €100m.

Three multiples, three estimates

Step 1 of 6

1
The peers' multiples
Peer P/E P/B EV (€m) EV/EBITDA
Alto Foods 16.0× 2.0× 4,200 8.40×
Brava Brands 20.0× 2.0× 4,800 8.00×
Corvo Group 12.0× 1.5× 4,600 8.36×
Delta Snacks 20.0× 3.0× 2,700 9.00×
Median 18.0× 2.0× 8.38×

Peer	P/E	P/B	EV (€m)	EV/EBITDA
Alto Foods	16.0×	2.0×	4,200	8.40×
Brava Brands	20.0×	2.0×	4,800	8.00×
Corvo Group	12.0×	1.5×	4,600	8.36×
Delta Snacks	20.0×	3.0×	2,700	9.00×
Median	18.0×	2.0×		8.38×

Regulatory lens · looking ahead

No rules apply yet. When a bank, insurer or fund holds shares with no market price, accounting standards allow them to be valued from the multiples of comparable listed companies: IFRS 13 Fair Value Measurement calls this the market approach. Such values sit in Level 3 of the fair value hierarchy, the least certain level, and must be disclosed as such (L4.7).

Sparks

SparkA P/E that looks back ten years

One year of earnings can be flattered by a boom or crushed by a recession. Economists John Campbell and Robert Shiller popularised a cyclically adjusted P/E (CAPE), which divides the price by the average of ten years of inflation-adjusted earnings. For the US market it reached its highest level on record around the dot-com peak of 1999 and 2000.

SparkBanks below book

For years after the 2008 crisis, many large European banks traded at a P/B well below 1. The market was saying it did not believe the assets on their balance sheets were worth what the accounts said, or that the banks could earn their cost of capital on them.

Key takeaways

A multiple divides value by a measure of size, so companies of different sizes can be compared.
P/E = price ÷ EPS; P/B = market cap ÷ book equity; EV/EBITDA = (market cap + debt − cash) ÷ EBITDA.
Match the top and the bottom: equity values with shareholder measures, enterprise value with measures earned for all funders.
EV/EBITDA ignores how a company is financed, so it compares companies with different debt more fairly than P/E.
Premium or discount to peers = multiple ÷ peer median − 1. A low multiple can reflect risk, debt or slow growth rather than a bargain.

Reaction

Check what stuck

Question 1 · objective 1

A company has 300 million shares at €18.00 and net income of €450 million. What is its P/E ratio?

Question 2 · objective 2

The same company has debt of €1,200 million and cash of €300 million. What is its enterprise value, in € millions?

€m

Question 3 · objective 2

Its EBITDA is €900 million. What is its EV/EBITDA multiple?

Question 4 · objective 3

A company trades on a P/E of 15. The median P/E of its peers is 12. By what percentage does it trade above its peers?

%

Question 5 · objective 4

Two retailers have the same EV/EBITDA, but one has far more debt. Its P/E is much lower. What is the best reading?

AThe indebted retailer is a bargainBThe low P/E mostly reflects its debt: the businesses are valued alikeCP/E is wrong and should never be usedDThe indebted retailer must have higher growth

Glossary

Valuation multiple: A company's value divided by a measure of its size, such as profit or assets, used to compare companies.
Market cap: Market capitalisation: share price times the number of shares. The market value of the company's equity.
EPS: Earnings per share: net income for the year divided by the number of shares.
Earnings yield: Earnings per share divided by the share price: the inverse of P/E, as a percentage.
Book value: The shareholders' equity on the balance sheet: assets minus liabilities, at the values in the accounts.
EBITDA: Earnings before interest, taxes, depreciation and amortisation: a rough measure of the profit the operations generate before paying lenders and the tax authority.
Enterprise value: Enterprise value: the value of the whole business to all its funders. Market cap plus debt, minus cash.
Peers: Listed companies similar enough in business, size and risk to be compared with the target.

Deep Dives & Origins

Deep Dives

Koller, Goedhart and Wessels (McKinsey & Company), Valuation: Measuring and Managing the Value of Companies, Wiley, the chapter on using multiples. Intermediate.
A. Damodaran, Investment Valuation, Wiley, the chapters on relative valuation. Intermediate.

Origins

Koller, Goedhart and Wessels, Valuation, Wiley.
Brealey, Myers and Allen, Principles of Corporate Finance, McGraw Hill.
J. Y. Campbell and R. J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook”, Journal of Portfolio Management 24(2), 1998.
IFRS 13 Fair Value Measurement, IASB.

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