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Why can’t you use EV/Earnings or Price/EBITDA as valuation metrics?

Enterprise Value (EV) equals the value of the operations of the company attributable to all providers of capital.  That is to say, because EV incorporates all of both debt and equity, it is NOT dependant on the choice of capital structure (i.e. the percentage of debt and equity).  If we use EV in the numerator of our valuation metric, to be consistent (apples to apples) we must use an operating or capital structure neutral (unlevered) metric in the denominator, such as Sales, EBIT or EBITDA.  These such metrics are also not dependant on capital structure because they do not include interest expense.  Operating metrics such as earnings do include interest and so are considered leveraged or capital structure dependant metrics.  Therefore EV/Earnings is an apples to oranges comparison and is considered inconsistent.  Similarly Price/EBITDA is inconsistent because Price (or equity value) is dependant on capital structure (levered) while EBITDA is unlevered.  Again, apples to oranges.  Price/Earnings is fine (apples to apples) because they are both levered.

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