Valuation · Stocks Explained
Start with the claim being priced
The price to earnings ratio divides share price by earnings per share, or equity market value by profit available to common shareholders. State whether earnings are historical, forecast or adjusted. A multiple based on a loss is usually not a useful ranking.
Enterprise value commonly starts with equity market value, adds debt and other senior claims, and subtracts cash treated as surplus. Details vary, especially for leases, minority interests and financial companies. Show the bridge rather than copying an unexplained number.
Match numerator and denominator
Equity value belongs with earnings or cash available to equity holders after financing costs. Enterprise value belongs with operating measures before distributions to lenders and shareholders. Combining enterprise value with net income mixes different claims.
Consider a company with a $600 million market capitalisation, $200 million of debt and $50 million of surplus cash. Simplified enterprise value is $750 million. With net income of $30 million, its PE is 20. With EBITDA of $75 million, its EV to EBITDA ratio is 10.
Understand what a shortcut omits
EBITDA excludes interest, taxes, depreciation and amortisation. It does not subtract the cash needed to maintain equipment or fund working capital. Two companies with the same EBITDA can produce very different cash for investors.
A price to sales comparison omits margins and capital requirements. A low PE can reflect a temporary earnings peak, weak prospects or unusual income. A high multiple can reflect expected growth, but that growth may not arrive.
Build a comparable set
Choose businesses with similar products, geography, accounting and financial risk. Align fiscal periods and currencies, and reconcile adjustments. Compare margins, growth, reinvestment and returns on capital alongside the multiple.
Use the comparison to ask what assumptions explain the gap. Avoid assigning a peer average mechanically. A valuation is stronger when you can connect the multiple to plausible future cash flows.
Try it yourself
Equity value is $400 million, debt is $120 million and surplus cash is $20 million. EBITDA is $50 million. What is the simplified EV to EBITDA ratio?
Show the worked answer
Enterprise value is $500 million. Dividing by $50 million gives 10. This ratio still requires scrutiny of capital expenditure, working capital, leases and whether cash is truly surplus.
Further reading
Educational material. Examples are hypothetical and do not recommend a security or a personal allocation.
