Income-Based Valuation: P/E, Earnings Yield and EV/EBITDA

If a company has no quoted price, the easiest way to give it one is to borrow the market’s opinion about similar companies. Quoted companies trade at a price that bears a certain relationship to their earnings, dividends and cash profits. A valuer can find that relationship for companies like the one being valued, and apply it to the target’s own earnings, dividends or profit before interest.

This is market-based or income-based valuation. It is quick, it is rooted in prices that investors actually pay. It is the most common way of putting a number on a private company or setting a flotation or takeover price. But it relies on two judgements, the profit figure to use and the multiple to apply, and neither can be settled by calculation.

This topic explains the price/earnings (P/E) ratio method, the earnings yield method, the dividend yield method and the enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) multiple, including how to adjust for the lower marketability of unquoted shares, what a multiple tells you and what it hides, and the advantages and weaknesses of each, with worked examples. The next topic covers valuation by dividends.

The syllabus asks for the estimate of business value using the price/earnings ratio, earnings and dividend yield, and enterprise value multiples. Read asset-based valuation first.

The price/earnings ratio method

The price/earnings ratio (P/E ratio) is the market price of a share divided by its annual earnings per share. For a quoted company it can be observed. For an unquoted one, the value is estimated:

Value of a share = EPS × estimated P/E ratio

The EPS may be last year’s, an average of recent years or a forecast. The P/E ratio is chosen from quoted companies in the same industry and with similar growth and risk. Example: an unquoted company has EPS of ₦20 last year and a forecast of ₦24. Four similar quoted companies have P/E ratios of 9, 11, 13 and 14, an average of 11.75.

Applying the average to the forecast EPS gives 24 × 11.75 = ₦282 a share. Because the shares are unquoted, and cannot be sold easily, a discount of, say, 20% is applied to the quoted ratio: ₦282 × 0.80 = ₦225.60. A more cautious valuer might use last year’s EPS and the lowest comparable ratio: 20 × 9 = ₦180. With 10m shares the first two give ₦2,820m and ₦2,256m. The range ₦180 to ₦282 shows how much depends on the choices.

What a P/E ratio means

A P/E ratio reflects the growth expected, the risk and the dividend policy of a company. If dividends are expected to grow at a constant rate, price = dividend × (1 + g) ÷ (K_e − g), so P/E = payout ratio × (1 + g) ÷ (K_e − g). With a payout of 60%, growth of 5% and a cost of equity of 14%, P/E = 0.6 × 1.05 ÷ 0.09 = 7.0.

Higher growth or lower risk raises the P/E; so a high-growth company deserves a higher multiple than the average, and a riskier one a lower one. The valuer must therefore adjust the average P/E for differences between the target and the comparables.

Advantages: simple, quick and based on market prices; widely used for flotations and takeovers, and a useful benchmark in negotiation.

Weaknesses: subjective choice of EPS and P/E; accounting earnings, not cash flows, can be manipulated and vary with accounting policy; comparable companies are never identical; the ratio of a quoted company contains the market’s expectations at one date and may be distorted by a rising or falling market; and it is meaningless for a loss-making company.

The earnings yield and dividend yield methods

The earnings yield is earnings per share ÷ price, the inverse of the P/E ratio: a P/E of 10 is an earnings yield of 10%. The method is a variation of the P/E method: value = earnings ÷ earnings yield.

A private company with earnings of ₦300m, where quoted companies in the industry offer an earnings yield of 10%, is worth 300 ÷ 0.10 = ₦3,000m. Since a private company is riskier and less liquid, a higher yield should be used, say 12%: 300 ÷ 0.12 = ₦2,500m. The criticisms are the same as for the P/E method: the choice of yield and the earnings figure is arbitrary.

The dividend yield method values a share by its dividend and a suitable yield: value = dividend per share ÷ dividend yield. It is used to value small shareholdings, where the shareholder has little say in the company and is interested only in the income. A dividend of ₦5 a share and a yield on similar quoted shares of 6% gives ₦5 ÷ 0.06 = ₦83.33; a higher yield of 8% for an unquoted company gives ₦5 ÷ 0.08 = ₦62.50.

It is not suitable for valuing control, since a controlling owner can change the dividend.

The enterprise value multiple: EV/EBITDA

Enterprise value (EV) is the value of the business to all its providers of capital: EV = market capitalisation of equity + preference shares + debt + minority interests − cash and cash equivalents. The EV/EBITDA multiple is EV divided by earnings before interest, tax, depreciation and amortisation.

Because EV includes debt and EBITDA is before interest, the multiple is independent of how the company is financed and can be compared between companies with different gearing. Ignoring depreciation also removes differences in accounting policy and the age of assets. The method:

1. Find a comparable company and calculate its EV and its multiple.
2. Multiply the target’s EBITDA by the multiple to give the target’s enterprise value.
3. Deduct the target’s net debt (debt less cash) to give the value of equity.
4. Allow for the lower marketability of an unquoted company’s shares, if appropriate.

Example: the comparable company, Kola, has 15m shares at ₦8.00 (equity ₦120m), debt at market value ₦40m and cash ₦10m. EV = 120 + 40 − 10 = ₦150m. Its EBITDA is ₦30m, so the multiple is 150 ÷ 30 = 5.0 times. The target has EBITDA of ₦48m and net debt of ₦20m (debt ₦25m, cash ₦5m). Its EV = 5.0 × 48 = ₦240m; equity = 240 − 20 = ₦220m; and with a 25% discount for unquoted shares, 220 × 0.75 = ₦165m.

The multiple can be calculated on historic or forecast EBITDA; a multiple on forecast figures is usually lower and should be applied to the target’s forecast.

What the multiple tells you

An EV/EBITDA multiple of 5 means the buyer pays five times the annual EBITDA, so it would take about five years of EBITDA, before tax, interest and capital spending, to repay the price. A multiple much higher than comparable deals suggests overpaying; but a high multiple may reflect growth, a strong market position, or a high quality of earnings. A low one may reflect poor prospects.

Multiples depend on capital intensity, the nature of the business, competitive position and the sustainability of cash flows.

Advantages: unaffected by capital structure; takes net debt into account; strips out differences in depreciation, tax and capital spending; widely used by investors. Disadvantages: simplistic (many value drivers in one number); ignores capital expenditure and tax, which can matter (a business with heavy capital spending needs far more than its EBITDA to stand still); static; and hard to compare when there are many differences.

The ideas in more depth

Why unquoted shares are discounted

A quoted share can be sold at once at a known price; an unquoted share cannot. An investor needs a higher return, and so pays less, for an asset that is hard to sell, and a minority holder in a private company has little control over dividends or the timing of a sale.

Studies of private sales show discounts of the order of 20% to 30%; a valuer states the discount used and the reason, and a controlling stake, which can be sold with the whole company, needs less discount than a minority holding.

Why EV is used with EBITDA and equity with earnings

Earnings belong to shareholders after interest, so they match the value of the equity (P/E and earnings yield). EBITDA is before interest, so it matches the value of the whole enterprise, equity plus debt. Pairing an EV with earnings, or equity value with EBITDA, is a mismatch and gives nonsense. That is why EV must be reduced by net debt to find the value of the equity.

Sources and references

• No accounting standard prescribes valuation multiples; they are market conventions. EBITDA is not defined by accounting standards, so state its definition. For the fair value hierarchy of inputs see International Financial Reporting Standard (IFRS) 13 Fair Value Measurement.

These points are stated as at 5 November 2026.

Worked examples

1. Before discount.
   24 × 11.75 = ₦282.
2. After discount.
   282 × 0.80 = ₦225.60.

1. Value.
   300 ÷ 0.12 = ₦2,500m.

1. EV.
   5.0 × 48 = ₦240m.
2. Equity.
   240 − 20 = ₦220m.

How to answer in the exam

• Select the profit figure (historic, average or forecast) and say why.
• Select and justify the multiple from comparables and state any discount.
• Match the multiple to the right measure: equity value for earnings and dividends, EV for EBITDA.
• Comment on limits and give a range.

Common mistakes in the exam

• Using the P/E ratio of a quoted company without adjusting for an unquoted target.
• Forgetting to deduct net debt from the enterprise value.
• Using total market value of debt, not net of cash, for the target.
• Applying a historic multiple to forecast earnings, or the reverse.
• Using a lower yield for a private company instead of a higher one.
• Applying the dividend yield method to value a controlling stake.

Quick revision

• Value = EPS × P/E; earnings yield = 1 ÷ P/E; dividend yield for small holdings.
• EV = equity + preference + debt + minorities − cash.
• EV/EBITDA × EBITDA = EV; less net debt = equity.
• Discount for unquoted shares; all methods rest on judgement.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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