The price-to-earnings (P/E) ratio is most popular and widely used financial metrics. It has a number of flaws for which the initiative value to EBITDA (EV/EBITDA) ratio compensates. The EV/EBITDA ratio is a financial metric that measures the return that a company makes on its capital investments. The calculation of this ratio can be complex. This ratio is preferred more than the other metrics. It figures out differences in taxation, capital structure and asset counting.
The P/E ratio is a valuation metric that links earnings per share (EPS) of a company to its current market price. This metric is used as an indicator of a company’s future growth potential. The P/E ratio does not help in explaining the whole cause. So, it is most useful when comparing only companies within the same industry or comparing companies against the general market.
There are many problems that rise for investors due to the use of the P/E ratio. The earnings portion of the metric is based on an accounting value that is prime for manipulation, causing the metrics overall consistency to be questionable. Use of the EV/EBITDA ratio helps to stimulate some of the P/E’s downfalls through the inclusion of interest costs, tax, reduction and repayment (EBITDA).
The EV/EBITDA ratio is less published than the P/E ratio. By making cross-sector comparisons difficult. The use of enterprise value (EV), while beneficial, also cause problems. This value does not always depict all of a company’s balance outstanding, and negative EV values create problems in calculation.
The P/E ratio has been established as a key market valuation metric, and the pure volume of current and historical data gives the metric weight in regard to stock analysis. In favour of the EV/EBITDA ratio, some experts oppose that using it, instead of P/E as the primary stock valuation measure, produces better investment returns.
Both metrics have advantages and disadvantages, and investors are likely to gain a clearer picture of a company by considering both measures as part of the process of equity evaluation.