EBITDA multiple vs P/E ratio

Searches for an EBITDA multiple and a P/E ratio land on the same idea: a number that turns earnings into a value. The two are built on different earnings and different prices. BDC describes applying a multiple to EBITDA as a common valuation method. The P/E ratio comes from share markets, where a share price is public. When a listed company is compared with a private business for sale, check which of the two is being quoted. This page sets out what each one divides into, and a route by which a P/E-type figure can reach a private business.

What an EBITDA multiple is

BDC says EBITDA is calculated by adding interest, taxes, depreciation and amortization back to net profit, and that a common valuation method is to apply a multiple to it. The CBV Institute defines a multiple as a ratio of the value of a business or security to economic income or a non-financial metric, and lists EBITDA and net income as examples of economic income. The points to carry forward:

• The earnings figure is measured before interest and taxes, so those costs sit outside it.
• BDC notes EBITDA does not account for non-operating expenses such as interest on debt, taxes and other costs.
• BDC lists failing to normalize earnings, and applying an inappropriate multiplier of EBITDA, among valuation mistakes.

What a P/E ratio is

BDC describes the price-earnings ratio, also called the PE multiple, as a financial ratio that investors on financial markets use to estimate the valuation of a company. It is determined by dividing the current price of a common share by the earnings per common share for the latest reporting period. In BDC’s worked examples, earnings per share starts from net profit, less dividends on preferred shares, divided by the number of common shares. BDC also notes that share price is influenced by the sentiment or perception of the financial markets. The numerator is therefore a current market share price, not an estimate made by a buyer or valuator.

Where the two differ

Three differences matter in a purchase or sale. First, the top of the fraction: an EBITDA multiple relates the value of a whole business to its earnings, while a P/E relates the price of one common share to earnings per share. Second, the earnings measure: EBITDA adds interest, taxes, depreciation and amortization back to net profit, while BDC’s P/E examples start from net profit after those items. BDC observes that a company may have no net profit but high EBITDA, so the two earnings figures can point in different directions for the same business. Third, the price source: a P/E uses a quoted market price, and an EBITDA multiple applied to a private business has to come from somewhere else.

How a P/E can reach a private business

CRA Information Circular IC89-3 describes a closely-held corporation as one whose shares are owned by a relatively limited number of shareholders, and says there is no established market for such shares, in that they are sold infrequently. A private business therefore has no market share price to put into a P/E. The CBV Institute describes a Guideline Public Company Method, in which the value of a business is estimated by applying multiples derived from market prices of securities of publicly traded companies in the same or similar lines of business. A multiple of that kind, which could include a price-earnings multiple, is one route by which listed-company pricing enters a private valuation. Whether those companies resemble the business at hand is a question for a valuator, and the EBITDA multiple answer covers the multiple on its own.

Which fits depends on the facts

The factors below are conditions to check, not a recommendation. A qualified professional can say which, if either, applies to a given business.

• If the shares are publicly traded, a quoted price exists and a P/E can be calculated; if the shares are closely held, there is no established market price.
• If earnings have not been normalized for discretionary and non-recurring items, either ratio can be distorted.
• If the business carries significant debt, interest and tax sit between EBITDA and net income, so the two measures can diverge.
• If the comparable multiples come from listed companies rather than private sales, ask how similar those companies are.
• If the figure is for a share of the business rather than the whole, the per-share basis matters.
• If the number is for a lender, a tax filing or a dispute, ask whether a credentialed valuator is needed.