What it means
Every multiple has the same shape: a measure of value on top, a measure of performance underneath. The price-to-earnings multiple divides share price by earnings per share, enterprise value to EBITDA divides the whole business value by profit before interest, tax, depreciation and amortisation, and a revenue multiple divides value by sales.
Which one you use depends on what the underlying figure actually captures. Multiples matter because they turn a valuation argument into a comparison.
If similar businesses in the sector have sold for 8 to 10 times EBITDA, a seller asking 15 times needs a reason, and a buyer offering 5 times needs one too. In private company sales, the negotiation is very often about the multiple rather than about the profit figure.
There is an important distinction between equity multiples and enterprise multiples. A price-to-earnings ratio values only the shares, so it is affected by how much debt the company carries.
Enterprise value to EBITDA values the whole business before financing, so it compares companies with different debt levels on a fairer basis. The number underneath is where most disputes happen.
Buyers and sellers argue about whether EBITDA should be adjusted for one-off legal costs, an owner's above-market salary, or a discontinued product line, and each adjustment is multiplied several times over in the final price. Adding $200,000 of adjusted profit at a multiple of 8 adds $1,600,000 to the price.
A higher multiple is not automatically better or worse. It reflects expected growth, the quality and predictability of earnings, customer concentration, sector risk and how much a buyer wants the asset.
A stable subscription business will command a higher multiple than a project-based business with the same profit, and reasonably so.
In practice
Real-world examples.
Example
A family-owned printing business with $1,200,000 of adjusted EBITDA is offered 4.5 times by a trade buyer, valuing the enterprise at $5,400,000. The owners argue for 6 times on the strength of three long-term contracts, a difference of $1,800,000.
Example
An investor compares two retailers with identical price-to-earnings ratios of 14 times and finds one carries $300,000,000 of debt while the other has none. On an enterprise value to EBITDA basis the indebted retailer is materially more expensive.
Example
A software company with modest profits but 40% annual growth trades at 9 times revenue. Analysts justify the multiple by projecting profits several years out, which is also why the share price falls hard the quarter growth slows.
Formula
Calculation
Multiple = value / financial metric
Enterprise value = market capitalisation + total debt - cash
Enterprise value to EBITDA = enterprise value / EBITDA
Take an illustrative listed company with a market capitalisation of $240,000,000, debt of $60,000,000 and cash of $20,000,000.
Enterprise value = $240,000,000 + $60,000,000 - $20,000,000 = $280,000,000.
If EBITDA for the year is $35,000,000, the multiple is $280,000,000 / $35,000,000 = 8.0 times.
For the equity multiple, if the share price is $24.00 and earnings per share are $2.00, the price-to-earnings multiple is $24.00 / $2.00 = 12.0 times.
Now run it in reverse. If comparable transactions in the sector are completing at 10 times EBITDA, the implied enterprise value is $35,000,000 x 10 = $350,000,000, and the implied equity value is $350,000,000 - $60,000,000 + $20,000,000 = $310,000,000. That is $70,000,000 more than the current market capitalisation, which is the kind of gap that starts a bid conversation.Case study
Seen in the real world.
Pellworth Packaging is a fictional business used purely to illustrate how multiples behave in a negotiation. Its owners want to sell and present adjusted EBITDA of $4,000,000, expecting the 8 times multiple they have seen quoted for the sector, which would value the enterprise at $32,000,000.
The buyer's diligence team makes two arguments. It strips out $500,000 of adjustments it considers unsupportable, taking EBITDA to $3,500,000, and it argues for 7 times rather than 8 because 45% of revenue comes from a single customer. That produces an enterprise value of $3,500,000 x 7 = $24,500,000, some $7,500,000 below the asking figure.
The deal eventually completes at 7.5 times $3,700,000, which is $27,750,000, with part of the gap bridged by an earn-out tied to retaining the large customer. The illustrative lesson is that the multiple and the number it is applied to are negotiated together, and small movements in either translate into very large movements in price.
Watch out
Common mistakes.
- Comparing an equity multiple with an enterprise multiple. They value different things, and mixing them makes a heavily indebted business look cheap.
- Applying a sector multiple without adjusting for size and risk. Small private companies almost always trade below the multiples of large listed peers.
- Focusing only on the multiple and not the profit figure underneath. An inflated adjusted profit at a modest multiple can be more expensive than the reverse.
Questions
People also ask.
What is a good multiple?
There is no universal answer; it depends on sector, growth, earnings quality and how much debt the buyer needs to fund the deal.
Why do buyers prefer enterprise value to EBITDA?
Because it strips out financing choices and lets them compare the operating business itself before deciding how to fund it.
Can a loss-making company have a multiple?
Not an earnings multiple, but it can be valued on a revenue multiple or on projected future profits instead.
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