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Old 10-05-2010, 09:16 PM
DaveyD DaveyD is offline
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Join Date: Oct 2010
Location: AZ/Maricopa + USA
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Default Stock valuation P/E Vs. Enterprise value to EBITDA. Understanding the Relationship.

In the following example we find the price for RCKY to be higher when we use P/E than when we use enterprise value to ebitda. Can some one please explain to me why this is the case?


Problem:
Suppose Rocky Shoes and Boots (RCKY) has earnings per share of $2.30 and EBITDA of $30.7 million. RCKY also has 5.4 million shares outstanding and debt of $125 million (net of cash.) You believe Deckers Outdoors Corporation is comparable to RCKY in terms of its underlying business, but Deckers has no debt. If Deckers has a P/E of 13.3 and an enterprise value to EBITDA multiple of 7.4, estimate the value of RCKY’s shares using both multiples. Which estimate is likely to be more accurate?


Solution:
Using Decker’s P/E, we would estimate a share price for RCKY of P0 = $2.30 x 13.3 = $30.59. Using the enterprise value to EBITDA multiple, we would estimate RCKY’s enterprise value to be V0 = $30.7 million x 7.4 = $227.2 million. We then subtract debt and divide by the number of shares to estimate RCKY’s share price: P0 = (227.2 – 125)/5.4 = $18.93. Because of the large difference in leverage between the firms we would expect the second estimate which is based on enterprise value to be more reliable.

If you could shed any light on the question raised above I would greatly appreciate it. Thank you for your time and consideration.
-Cheers.
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