http://valuationacademy.com What are the differences between the EV/EBIT, EV/EBITDA, and P/E multiples, and when would you use each one? — Valuation Academy

What are the differences between the EV/EBIT, EV/EBITDA, and P/E multiples, and when would you use each one?

The EV/EBITDA multiple, also known as Enterprise Value/, is used in companies to value its fair market value; through the measurements of the companies finance and investment. It is an economic measure reflecting the worth of a company in an industry.

EV to EBITDA multiple

EV is usually seen as a capital structure-neutral metric, so stock market investors use this multiple. They can compare equivalent companies in order to see the risk of investing in terms of debt. A high EV is seen to be more attractive in the future, whereas a lower EV isn’t. The EV/EBITDA multiple is often combined with, or can be used as an alternative to, the P/E ratio. Although EV/EBITDA is harder to measure that the P/E ratio, the fact that it is unaffected by a company’s capital structure makes it better multiple.

Price to Equity Ratio

P/E is basically a valuation ratio of a company’s current share price, in comparison to its earnings per share. Therefore if the multiple were to be high this suggests to investors that there will be higher earnings growth in the future, compared to companies with a lower P/E.  This multiple is also used in the stock market industry, and is the oldest and frequently used metrics.

EV to EBITDA ratio

Enterprise value to earnings before interest and tax (EV/EBIT) is a measurement to whether a share in a company is cheap or expensive, relative to competing firms or the wider market. The EV/EBIT is a modified multiplier of the P/E ratio that addresses the weaknesses of the P/E ratio. So instead of using just the firm’s share price, it uses enterprise value; which includes debt. The EV is then compared to earnings, before, rather than after tax and interest.

All three are multiples that measure the value of a company’s stance in a market in regards to profit, however,  P/E is the quick way to establish a firm’s relative value and also how many years it will take the firm to make profits equivalent to its market. EV/EBIT is sometimes used instead of the P/E ratio to compare profit growth between firms in industries with a large amount of debt, such as the transportation industry. Finally the fact that EV/EBIT and EV/EBITDA share the advantage of valuing a company regardless of its capital structure make it attractive for various reasons.