A practical guide to choosing the right valuation multiple for each sector and avoiding common valuation traps.
# Valuation Multiples Explained: P/E, EV/EBITDA, and Free Cash Flow Yield
Valuing a stock is both an art and a science. Relying solely on the headline P/E ratio is like buying a house based only on its square footage without inspecting the foundation.
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1. Price-to-Earnings (P/E)
Best for: Stable, mature companies with clean capital structures.
Limitation: Distorted by non-operating gains/losses, tax rates, and capital structure debt differences.
2. Enterprise Value to EBITDA (EV/EBITDA)
Best for: Capital-intensive businesses, industrials, and cross-border comparisons.
Why it matters: Enterprise Value ($$\text{Market Cap} + \text{Total Debt} - \text{Cash}$$) accounts for debt obligations that direct stock buyers often overlook.
3. Free Cash Flow Yield (FCF Yield)
The Ultimate Multiplier: $$\text{FCF Yield} = \frac{\text{Free Cash Flow}}{\text{Market Cap}}$$
Cash is reality; accounting earnings are opinion. A company generating a 7% sustainable FCF yield with a moat provides an outstanding baseline return.
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Sector Multiples Matrix
| Sector | Primary Multiples | Secondary Multiples | |---|---|---| | Big Tech / SaaS | EV/FCF, EV/Sales, Rule of 40 | Forward P/E | | Consumer Staples | P/E, FCF Yield, EV/EBITDA | Dividend Yield | | Banking & Finance | Price-to-Book (P/B), Price-to-Tangible Book | ROE, CET1 | | REITs | Price/FFO, Price/AFFO | NAV Discount | | Industrials / Capex | EV/EBITDA, ROIC | P/E |