372  Using Multiples
forward industry multiples for a large sample of companies trading on U.S. 
exchanges.3 When multiples for individual companies were compared with 
their industry multiples, their historical earnings-to-price (E/P) ratios had 1.6 
times the standard deviation of one-year-forward E/P ratios (6.0 percent ver-
sus 3.7 percent). Other research, which used multiples to predict the prices of 
142 initial public offerings, also found that multiples based on forecast earn-
ings outperformed those based on historical earnings.4 As the analysis moved 
from multiples based on historical earnings to multiples based on one- and 
two-year forecasts, the average pricing error fell from 55.0 percent to 43.7 per-
cent to 28.5 percent, respectively, and the percentage of firms valued within 
15 percent of their actual trading multiple increased from 15.4 percent to 18.9 
percent to 36.4 percent.
To build a forward-looking multiple, choose a forecast year for EBITA 
that best represents the long-term prospects of the business. In periods of 
stable growth and profitability, next year’s estimate will suffice. For com-
panies generating extraordinary earnings (either too high or too low) or 
for companies whose performance is expected to change, use projections 
further out.
Use Net Enterprise Value Divided by Adjusted 
EBITA or NOPAT
Most financial websites and newspapers quote a price-to-earnings ratio by 
dividing a company’s share price by the prior 12 months’ GAAP-reported 
earnings per share. Yet these days, sophisticated investors and bankers use 
what we call forward-looking multiples of net enterprise value to EBITA (or 
NOPAT). They find that these multiples provide a more apples-to-apples com-
parison of company values.
The reasons for using forward earnings are the same as the ones discussed 
in the previous section. Using net enterprise value to EBITA (or NOPAT) 
rather than a P/E eliminates the distorting effect of different capital struc-
tures, nonoperating assets, and nonoperating income statement items, such 
as the nonoperating portion of pension expense. Any item that isn’t a helpful 
indicator of a company’s future cash-generating ability should be excluded 
from your calculation of the multiple. For example, one-time gains or losses 
and nonoperating expenses, such as the amortization of intangibles, have no 
direct relevance to future cash flows; including them in the multiple would 
distort comparisons with other companies.
3 J. Liu, D. Nissim, and J. Thomas, “Equity Valuation Using Multiples,” Journal of Accounting Research 
40 (2002): 135–172.
4 M. Kim and J. R. Ritter, “Valuing IPOs,” Journal of Financial Economics 53, no. 3 (1999): 409–437.

Use Net Enterprise Value Divided by Adjusted EBITA or NOPAT   373
Sometimes analysts use an alternative multiple: enterprise value to earn-
ings before interest, taxes, depreciation, and amortization (EBITDA). Later 
in this section, we’ll explain the logic of using EBITA or NOPAT instead of 
EBITDA.
Why Not Price to Earnings?
This book has focused throughout on the drivers of operating performance—
ROIC, growth, and free cash flow—because the traditional metrics, such as 
return on assets (ROA) and return on equity (ROE), mix the effects of op-
erations and capital structure. The same logic holds for multiples. Since the 
price-to-earnings ratio mixes capital structure and nonoperating items with 
expectations of operating performance, a comparison of P/Es is a less reliable 
guide to companies’ relative value than a comparison of enterprise value (EV) 
to EBITA or NOPAT.
To show how capital structure distorts the P/E, Exhibit 18.4 presents finan-
cial data for four companies, named A through D. Companies A and B trade at 
10 times enterprise value to EBITA, and Companies C and D trade at 25 times 
enterprise value to EBITA. In each pair, the companies have different P/Es. 
Companies A and B differ only in how their business is financed, not in their 
operating performance. The same is true for Companies C and D.
Since Companies A and B trade at typical enterprise value multiples, 
the P/E drops for the company with higher leverage. This is because the 
EV-to-EBITA ratio ($1,000 million/$100 million = 10 times) is lower than the 
ratio of debt value to interest expense ($400 million/$20 million = 20 times). 
Exhibit 18.4  P/E Multiple Distorted by Capital Structure
$ million
Company A
Company B
Company C
Company D
Income statement
EBITA
100 
100 
100 
100 
Interest expense
– 
(20)
– 
(25)
Earnings before taxes
100 
80 
100 
75 
Taxes
(40)
(32)
(40)
(30)
Net income
60 
48 
60 
45 
Market values
Debt
– 
400 
– 
500 
Equity
1,000 
600 
2,500 
2,000 
Enterprise value (EV)
1,000 
1,000 
2,500 
2,500 
Multiples, times
EV/EBITA
10.0 
10.0 
25.0 
25.0 
Price/earnings
16.7 
12.5 
41.7 
44.4