EBIT Multiples and growth are an ongoing question for many owners looking to sell or buyers looking to buy a company. What EBIT multiple is applicable to my company, what is my company worth, my company is growing or is about to grow; how is the price affected? If the company has been growing, up to what point in the growth cycle is a growth premium in EBIT multiple still achievable?
Growth Premiums
Many businesses are valued on an earnings multiple which is a simple and easy way to determine and evaluate a price. The earnings multiple is an indicator of growth with a high multiple indicating strong growth and therefore a “growth premium” is included in the price. This multiple does vary across industries with industries such as IT which are scalable has higher multiples compared to a mature manufacturing business which does not have great growth prospects. The size of the business and reliability of profits also impact on valuation.
Smaller businesses have lower multiples due to higher risk. If there is no evidence of growth a “mature” company multiple will be applied. For a similar size company which has a distinct competitive advantage and the ability to grow a “growth premium” high EBIT multiple and price will prevail.
Stages of Growth
The stages of growth shown in the graph are of a typical business which experiences a rapid growth phase. The periods of moderate growth will generally provide a more neutral earnings multiple. When the prospect of significant growth has been identified, even prior to the growth actually commencing, a “growth premium” multiple will be applied.
Towards the end of the rapid growth phase, the outlook for growth will be moderated and the earnings multiple will be more neutral indicating the more pedestrian growth ahead. Although at the end of the rapid growth phase, the EBIT multiple returns to a more moderate level, the value of the company is now based on a significantly higher EBIT and hence the higher value of the company.
It is important to understand where your company is in relation to EBIT multiples and growth, where you are on the growth curve and what type of multiples are applicable. The EBIT multiples in the graph are indicative however note that multiples are typically based on EBITDA focussing on cash flow earnings.
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