Valuation multiples: P/E, P/B, EV/EBITDA and their traps
Calculate the three most used valuation multiples correctly and recognise the situations in which a low multiple is misleading.
What you will learn
- How to calculate the price-to-earnings, price-to-book and EV/EBITDA multiples step by step
- Why enterprise value includes debt and cash, and when that changes the picture
- How to choose a fair comparison: own history, peers and sector
- The five most common traps that make a share look cheap when it is not
Explanation
A valuation multiple compares the price of a share or a whole company with one figure from its financial statements. The statements themselves (income statement, balance sheet, cash flow statement) were covered in lessons 3–5 of this course. It does not tell you what a company is worth, only what the market currently pays for one euro of earnings, equity or operating profit.
Price-to-earnings ratio (P/E)
P/E = share price ÷ earnings per share (EPS). EPS is net income divided by the number of shares outstanding. A P/E of 16 means investors pay €16 for €1 of annual profit. The inverse, EPS ÷ price, is the earnings yield: a P/E of 16 equals an earnings yield of 6.25%.
Trailing P/E uses the earnings of the last 12 months. Forward P/E uses analysts' estimates for the next 12 months. Forward figures are forecasts and can be wrong; always know which version you are reading.
Price-to-book ratio (P/B)
P/B = share price ÷ book value per share, where book value is shareholders' equity from the balance sheet. P/B is most useful for banks and insurers, whose assets are mostly financial and carried close to market values. For software or brand companies, book value misses the most important assets, so a high P/B says little.
EV/EBITDA
Enterprise value (EV) is the price of the whole business, not just the shares: EV = market capitalisation + financial debt − cash (in detailed work you also add minority interests and preferred capital). EBITDA means earnings before interest, taxes, depreciation and amortisation. Because EV includes debt and EBITDA is measured before interest, EV/EBITDA compares companies with different financing more fairly than P/E.
EBITDA ignores depreciation, so it flatters businesses that must spend heavily on machines, networks or stores. There, EV/EBIT is often more honest.
How to compare
- Against its own history: is the multiple high or low compared with the company's last 5–10 years, and has the business changed?
- Against close peers with similar growth and risk.
- Never across sectors: a utility at P/E 14 and a software firm at P/E 30 can both be fairly valued, because growth, risk and capital needs differ.
Worked example
Hypothetical example: two companies in the same industry, A and B. Both have 100 million shares and both earn EBITDA of €625 million. Figures are invented; fees and taxes are excluded.
| Item | Company A | Company B |
|---|---|---|
| Share price | €40 | €25 |
| Market cap (price × 100 m shares) | €4,000 m | €2,500 m |
| Net income | €250 m | €200 m |
| EPS (net income ÷ 100 m) | €2.50 | €2.00 |
| P/E (price ÷ EPS) | 40 ÷ 2.50 = 16.0 | 25 ÷ 2.00 = 12.5 |
| Equity / book value per share | €2,000 m / €20 | €1,000 m / €10 |
| P/B | 40 ÷ 20 = 2.0 | 25 ÷ 10 = 2.5 |
| Debt − cash | €1,500 m − €500 m | €3,000 m − €500 m |
| EV | 4,000 + 1,500 − 500 = €5,000 m | 2,500 + 3,000 − 500 = €5,000 m |
| EV/EBITDA | 5,000 ÷ 625 = 8.0 | 5,000 ÷ 625 = 8.0 |
On P/E, B looks 22% cheaper, yet on EV/EBITDA both are valued the same. The difference is B's €2,500 million of net debt, which makes its equity riskier. The lower P/E is compensation for risk, not a bargain.
Common mistake
Other traps to check every time:
- One-off items: a gain from selling a building raises net income for one year only.
- Negative or tiny earnings: P/E becomes meaningless.
- Value trap: a low multiple that stays low because the business is shrinking.
Practice activity
Hypothetical example: Company C trades at €30 per share and has 50 million shares. Reported net income is €150 million, which includes a one-off gain of €50 million from selling a property. Financial debt is €400 million, cash €100 million, EBITDA (already excluding the one-off gain) €220 million.
On paper, calculate: (1) the reported P/E, (2) the P/E after removing the one-off gain, (3) EV and EV/EBITDA. Which P/E is more useful?
Show solution
(1) Market cap = €30 × 50 m = €1,500 m. Reported EPS = €150 m ÷ 50 m = €3.00. P/E = 30 ÷ 3.00 = 10.0.
(2) Adjusted net income = €150 m − €50 m = €100 m (tax effects on the gain ignored for simplicity). Adjusted EPS = €2.00. P/E = 30 ÷ 2.00 = 15.0.
(3) EV = 1,500 + 400 − 100 = €1,800 m. EV/EBITDA = 1,800 ÷ 220 ≈ 8.2.
Use the adjusted P/E of 15.0: the property sale will not repeat, so it says nothing about future earning power. The "cheap" P/E of 10 was an illusion.
Limitations: in reality the one-off gain was taxed, so the true adjustment is smaller than €50 m; check the notes to the accounts for the after-tax amount.
Key takeaways
- P/E = price ÷ EPS; P/B = price ÷ book value per share; EV = market cap + debt − cash.
- EV/EBITDA neutralises differences in debt; P/E does not.
- Compare multiples only with the company's own history and close peers.
- Clean out one-off items and think in full cycles before calling a share cheap.
Next step
Multiples show what the market pays today; in the next lesson you will estimate what future cash flows are worth with a discounted cash flow model.
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