I have read that EV/EBITDA is more useful than P/E when comparing firms with different degrees of financial leverage. Why is this the case?
Because EPS is post-interest and EBITDA is pre-interest, so it normalizes for the effects of debt and makes it easier to compare two firms with different leverage.
Think of it in terms of a company.
If the MVAL of equity is 100 and debt is 100 and the company earns a net income of 10, the PE is 10x.
If the company issues 50 of debt to buy back equity, it has mv equity of 50 and debt 150. PE is now 5x.
The more leverage you have, the more return on the equity portion.
Enterprise value is the value of the company itself and ignores the owners decision of capital structure. Using EV/EBITDA you can get a farer representation of valn without leverage clouding your judgement
great explanations, thanks