Principle
Enterprise Value (EV) based valuation multiples (e.g., EV/EBITDA, EV/EBIT, EV/Revenue) are generally preferred over Equity Value multiples (e.g., P/E) for comparing different companies because they provide a cleaner comparison of core operational value, independent of capital structure differences.
Rationale
- Capital Structure Neutrality:
- Enterprise Value (EV) reflects the value of operations available to all capital providers (Debt holders, equity holders, etc.) and is thus unaffected by the company’s leverage ratio.
- Equity Value is directly influenced by the amount of debt a company uses.
- Numerator-Denominator Consistency:
- EV Multiples: Pair EV (value to all providers) with operating metrics calculated before payments to specific capital providers (e.g., EBITDA, EBIT, Revenue – which represent flows available to all providers). This creates an “apples-to-apples” comparison of operational value relative to operational performance.
- Equity Multiples: Pair Equity Value (value to equity holders) with metrics after payments to other providers (e.g., Net Income, EPS – which represent profit available only to equity holders). While consistent, this comparison is clouded by differing leverage levels affecting both numerator and denominator.
Conclusion
EV multiples allow for a more standardized comparison of companies based on their operational efficiency and value, removing the distorting effect of different financing strategies.
See also: Enterprise Value (EV), Equity Value, Valuation Multiples, Capital Structure, EBITDA, Comparables Analysis (Comps)