How do you use cash flow multiples to compare enterprise value vs equity value of different companies?

1 Why use cash flow multiples?

Cash flow multiples are useful because they reflect the actual cash-generating ability of a company, rather than its accounting earnings or book value. Cash flow multiples can also adjust for different capital structures, growth rates, and risk profiles of different companies. For example, a company with high debt and low growth may have a low EV/Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) multiple, while a company with low debt and high growth may have a high EV/Free Cash Flow (FCF) multiple.

3 How to compare EV and EQ using cash flow multiples?

To compare EV and EQ using cash flow multiples, you need to use consistent cash flow measures and adjust for the effects of debt and cash. For example, if you use EBITDA as the cash flow measure, you can compare EV/EBITDA multiples of different companies to see how much EV they generate per unit of EBITDA. However, if you want to compare EQ/EBITDA multiples, you need to subtract net debt (debt minus cash) from EV to get EQ. This is because net debt reduces the value of equity and affects the cash flow available to shareholders. Similarly, if you use FCF as the cash flow measure, you can compare EV/FCF multiples of different companies to see how much EV they generate per unit of FCF. However, if you want to compare EQ/FCF multiples, you need to add net cash (cash minus debt) to EQ to get EV. This is because net cash increases the value of equity and affects the cash flow available to shareholders.

4 How to interpret cash flow multiples?

Cash flow multiples can help you evaluate the relative value, growth potential, and profitability of different companies. Generally, higher cash flow multiples indicate higher value, higher growth, and higher profitability. However, you also need to consider other factors, such as the industry average, the historical trends, the future projections, and the risks and opportunities of each company. For example, a company with a high EV/EBITDA multiple may be overvalued or may have a competitive advantage, a strong market position, or a high growth potential. A company with a low EQ/FCF multiple may be undervalued or may have a high debt burden, a low return on equity, or a low growth potential.

5 How to use cash flow multiples in practice?

Cash flow multiples can be a useful tool for making better investment decisions, valuation estimates, and business analyses. For instance, you can use them to screen for potential investment targets based on their value and growth prospects, or to estimate the fair value of a company by looking at its peer group or industry average. Additionally, cash flow multiples can help you analyze the drivers and trends of a company's cash flow performance and value creation, as well as evaluate the impact of strategic decisions on a company's cash flow and value.