Hi everyone, Hope you guys aren’t stressing as much as me! I have a small question about EV/EBITDA. As one of the advantages to using EV/EBITDA as opposed to P/E, the book mentions that the former multiple is more appropriate for use in comparing firms with different leverages because EBITDA is pre-interest whereas EPS is post-interest. Here’s my question: Wouldn’t a post-interest be better for comparing companies? For instance, if the company is highly leveraged and has high interest costs, it’s better for an investor to use a multiple which demonstrates that because that will give a better impression of the potential money left over for dividends and other types of returns. Any thoughts? Thanks! Keep up the good work everyone… only 94 more days of hell!
no you want to compare them on the same level so do not include interest and D&A. We are effectively ignoring these expenses to see the earnings before all this, which draws fair criticism too which is what I think you are getting at. It’s just an isolation exercise to look at pure earnings power I think. The highly leveraged companies paying a ton of interest may have awesome earnings but after all those expenses they look like shit at the bottom line, but a lot of small cap companies w/ high earnings power need all that debt financing to grow. Not sure if I’m making sense, let me know, I’m sure the book explains it better than me.
andrew seems like a badass
A standard answer is that the owner can quickly lever or delever a firm, and thus manipulate equity flows; but ebitda can’t be manipulated like that, so it’s more …er… stable/reliable/predictive/something. In m&a situations the acquiror typically tears up the target’s current capital structure and starts from a clean sheet, hence the focus on ebitda. This question is interesting. It only gains traction if two firms, A and B, are ranked differently by the two multiples. We assume the assets are fairly priced. So why would e.g. A’s ev/ebitda be higher but B’s p/e be higher? One explanation could be that A is levered too highly, so investors consider its equity flows to be too risky, and they haircut the p/e for A. In this case, if you delevered A then A’s p/e might rise to where it beats B on both metrics. The two metrics carry different information. If, like above, you can buy the whole firm and recapitalize it, ev/ebitda is perhaps more informative; if you’re considering investing in only the equity (without control) I don’t see why p/e is of any less utility.
good explanation Darien thanks
There is one big area where EBITDA is extremely useful: Global comparisons. EBITDA mostly eliminates the need to adjust for different depreciation methods, different tax regimes (that might impact capital structures), and is both capital struture and capex level-neutral. Handy if you’re a global portfolio manager trying to value AT&T, Vodafone, BT, and KDDI. Ultimately, EV/EBITDA and P/E are two different ratios, not substitutes for one another. Make sure you know what each metric is telling you.
Thanks everyone! You’re right BES, I realized when I was doing the questions that they are more concerned with having understand what each one does, says and its advantages in each situation as opposed to exactly how to calculate. It’s more from a theoretical perspective. I think we need to understand each price multiple inside out and understand its strengths and weaknesses as well as when it’s most appropriate to use as opposed to just memorizing a simple formula. Keep up the good work everyone!
off topic…DARIEN HACKER- Are you from the town of Darien…If so, which state?