There are two basic types of valuation multiples: multiples that relate to a company’s equity value (typically anchored in share price), and multiples that relate to a company’s enterprise value (typically anchored in a financial statement metric).

• Equity multiples refer to the value of shareholders’ ownership and/or claims on the assets and cash flow of a business. An equity multiple therefore expresses the value of this ownership relative to a financial metric that applies to shareholders only. The price-to-earnings (P/E) ratio is an equity metric—that is, it only looks at the equity portion of the company and ignores debt. As such, P/E is highly dependent upon a particular company’s leverage. All else being equal, two identical companies with different capital structures can have markedly different P/E ratios—and indeed different results for any ration that includes a capital item in the denominator (e.g., Price-to-Book, Price-to-Sales, etc.). This can cloud the valuation process.
• Enterprise value multiples refer to the value of the entire enterprise, or the value of all claims on a business—both the equity value and net debt (gross debt less cash on hand), as well as other nonequity claimants. An enterprise value multiple therefore calculates the value relative to  financial metrics that relate to the entire enterprise; prime examples might be, a metric such as EV/EBIT, EV/EBITDA, or EV/Sales. Although EBIT and EBITDA are considered non-GAAP measures, and must be flagged as such in financial statements, they are widely respected as valid indicators of company value.

In practices, when choosing between a ratio such as P/E versus EV/EBITDA, the analyst should consider whether the relative size of interest expense for the target company and, if significant, whether it is an operating expense or a financing expense of the company.      

An operating expense is an expense incurred in carrying out an organization’s day-to-day activities. For example, interest is a cost of doing business for companies such as banks, leasing companies, and other financial institutions. These businesses borrow money at one rate and lend it out at a higher rate. As such, interest expense is directly related to operations. For these companies, P/E is the best valuation measure because the interest expense within the earnings number (the E in P/E) does reflect operations.

A financing expense is an expense triggered by how a particular company is capitalized—that is, how much debt it chooses to carry. One illustration would be an auto parts manufacturer; the amount of debt—and therefore interest expense—a company carries is a balance sheet decision and has little impact on operations. In a case such as this, EV/EBITDA (or EV/EBIT for companies where capital expenses are high) is preferable to P/E.