EV/EBITDA Question.

[HezBallah]

P/E ratios are impacted by a company's choice of capital structure - companies which raise money via debt will have lower P/Es (and therefore look cheaper) than companies that raise an equivalent amount of money by issuing shares, even though the two companies might have equivalent enterprise values (For example, if a company with debt were to raise money by issuing shares of stock, and then used the money to pay off the debt, this company's P/E ratio would shoot up because of the increased number of shares - although nothing about the fundamental value of the business has changed).

1) Why will companies that raise money via debt have a lower p/e? What's the math here? Where does debt fit into the p/e equation?

2. "For example, if a company with debt were to raise money by issuing shares of stock, and then used the money to pay off the debt, this company's P/E ratio would shoot up because of the increased number of shares ". why is this? Where does money raised by issuing shares fit into the p/e equation?

 

[Ripley]

Quote from HezBallah:

1) Why will companies that raise money via debt have a lower p/e? What's the math here? Where does debt fit into the p/e equation?

2. "For example, if a company with debt were to raise money by issuing shares of stock, and then used the money to pay off the debt, this company's P/E ratio would shoot up because of the increased number of shares ". why is this? Where does money raised by issuing shares fit into the p/e equation?

1] The magnitude of this difference is based on various things such as the duration and the interest rate that's being charged on the debt etc. Debt when used judiciously improves the earnings that's being generated, and with good interest rates, it will be much greater than the equity that's underneath than a similar company without much debt, and hence may result in lower P/E for companies with more debt.

2] Because the equity base underneath the stock increases, and hence the price of the stock should correspondingly move up based on the increased equity. The money raised by issuing shares directly influence the shares outstanding and hence the price of the equity that's being traded, aka share price.