P/E vs. EV/EBITDA: when should I use each multiple and what are the pitfalls?

Relative valuation using price multiples is one of the most practical skills tested in CFA Level II. Understanding when to use P/E vs. EV/EBITDA — and their pitfalls — is essential.

P/E Ratio (Price-to-Earnings):

$$P/E = \frac{\text{Price per Share}}{\text{EPS}}$$

Measures what the market pays per dollar of earnings to equity holders.

EV/EBITDA (Enterprise Value to EBITDA):

$$EV/EBITDA = \frac{\text{Market Cap + Debt - Cash}}{\text{EBITDA}}$$

Measures what the market values the entire firm at per dollar of operating cash proxy.

Key Differences:

Feature	P/E	EV/EBITDA
Numerator	Equity value only	Total firm value
Denominator	After interest & tax	Before interest, tax, D&A
Capital structure effect	Affected by leverage	Largely neutral
Depreciation effect	Affected	Excluded
Negative earnings	Meaningless	Can still work
Tax regime differences	Distorted	Less distorted

When to Use Each:

Use P/E when:

• Comparing companies with similar leverage
• Earnings are positive and stable
• Companies in the same tax jurisdiction
• Valuing mature, profitable businesses

Use EV/EBITDA when:

• Comparing companies with different capital structures
• Companies have different depreciation policies or asset ages
• Earnings are negative but EBITDA is positive
• Cross-border comparisons (different tax rates)
• Capital-intensive industries (telecom, utilities, manufacturing)

Worked Example: Comparing Two Retailers

Metric	Ashwood Retail	Birchfield Stores
Share Price	$64	$38
EPS	$4.00	$2.50
Shares Outstanding	50M	80M
Market Cap	$3,200M	$3,040M
Debt	$1,800M	$400M
Cash	$200M	$150M
EV	$4,800M	$3,290M
EBITDA	$480M	$380M

• Ashwood P/E = 64/4.00 = 16.0x
• Birchfield P/E = 38/2.50 = 15.2x
• Ashwood EV/EBITDA = 4,800/480 = 10.0x
• Birchfield EV/EBITDA = 3,290/380 = 8.7x

On P/E, the companies look similar. But EV/EBITDA reveals Ashwood trades at a meaningful premium. The difference? Ashwood has much more debt, which reduces EPS through interest expense, making P/E misleadingly comparable.

Common Pitfalls:

1. Comparing P/E across different leverage levels — distorts comparison
2. Using trailing P/E for cyclical companies — earnings at peak inflate P/E at trough
3. Ignoring adjustments — one-time items, stock compensation, lease differences
4. EV/EBITDA ignoring capex — high capex companies may be overvalued on EV/EBITDA

Exam Tip: If the question mentions companies with different capital structures or D&A policies, EV/EBITDA is the right choice. If both are mature, stable, low-leverage businesses, P/E works fine.

Practice relative valuation analysis with our CFA Level II question bank on AcadiFi.