How EBITDA-multiples compare over time in valuation

How EBITDA-multiples compare over time in valuation

I recently analyzed how EBITDA-multiples compare over time in valuation, analyzing 5-years of EBITDA and business valuation data. Doing so, my focus was on industrial and technology companies.

I also searched for correlations with economic growth, inflation and central banks monetary spending. I wanted to see data if macro factors had played a major role in recent years explosion in value expectations.

My goal?

To understand how EBITDA-multiples compare over time in valuation, why and what a entrepreneurs need to observe timing their valuations.

Specifically, I analyzed how industrial and technology companies EBITDA-multiples compare over time in valuation in the US and the EU. I have used data from 6 different sources:

This is how EBITDA-multiples compare over time in valuation:

  • EBITDA-multiples will continue to stay high if you believe central banks will continue their expansive monetary spending for years ahead.
  • If central banks will be more cautious with their monetary policy, or if growing inflation actually leads to higher interest rates, then you will see decreasing EBITDA-multiples.
  • A maturing technology industry, and venture capital industry, means near-term revenues and profitability will grow in importance. Technology EBITDA-multiples will be higher than the equivalent industrial EBITDA-multiples.

This kind of analysis is rarely shared with non-corporate finance customers and usually comes with a hefty subscription fee.

Read more about soft factors in business valuation.

Now it’s time to share what I discovered:

Summary of my key findings

This is how business valuation and EBITDA-multiples compare over time:

  1. Somewhat surprising, the enterprise values of both technology and Industrial companies has grown 82% each in the last 5-years. The value of industrial businesses however grew 73% in the last two years, compared with 57% for the technology sector.
  2. There is no correlation between GDP growth and the value growth of businesses in the last 5-years. Such correlation can be seen at longer periods but for the last 5-years another factor has boosted business values.
  3. Inflation, measured as Producer Price Index, has been stable in the last 5 years. The correlation between inflation and business valuation has been weak to non-existing. Again, business valuation has been boosted by another factor.
  4. The single most important factor behind increasing company valuations has been growing money supply from 12 years supper-economy boosted with massive central bank spending. Interestingly, following an almost perfect correlation, something happened in 2020 when business valuations stopped growing despite continued monetary spending.
  5. When you look how EBITDA-multiples compare over time for technology companies, not much has happened. Increased technology company valuations have been measured and judged with AAR-multiples, Annual Recurring Revenues, a kind of EV/Sales-multiple. EBITDA have been slim to non-existing in the technology sector and EBITDA-multiple valuation have not been widely used. Speed in sales growth has been prioritized, fueled by massive money supply hungry for many and large growth investments. So far!
  6. Industrial company valuations use EBITDA-multiples as a proxy but has not changed either over time. Growing sales traction, that could have led to higher multiples, has been countered with margin pressure from competition and customers increased purchase and sourcing interests.

I provide details on these findings below.

Why I wanted to know how EBITDA-multiples compare over time

EBITDA is the operating profit, excluding depreciations, and can be seen as an indication for a business ability to generate cash flow:

  • EBITDA is a great performance indicator if you sell well, have enough gross margin and manage your spending.
  • EBITDA-growth traction shows if you create resources for further growth. If you create the all mighty important cash flow which is the liquidity and blood of a business.
  • EBITDA-margin indicates how effective you operate your business.

The EBITDA-multiples is the company value compared with your EBITDA.

“I’d wanted to know how EBITDA-multiples compare over time in valuation to see if investors have seen fundamental changes in how businesses has been operated.”

Professional investors asses the Enterprise Value of a companies, listed or private, by discounting future estimated cash flows. That Enterprise Value can be compared with the company’s current EBITDA which gives the EBITDA-multiple.

The higher the EBITDA-multiple, the higher the value of a company, but also investors expectation on future cash flow growth.

Founders usually like to know the EBITDA-multiple relevant to their specific business to get an indication of the Enterprise Value.

For example: A company whose discounted valuation has come to 1,000, with a current EBITDA of 50, then the EBITDA-multiple is 20x. If you know the average EBITDA-multiple for your specific sub-industry sectors then you can get an understanding of the value your business. If your EBITDA is 7, then your value is probably around 140, if you use the relevant EBITDA-multiple.”

Timing is important in fund raising, changes in co-ownership or employee programs, exits and IPO’s. Understanding how investor sentiment and EBITDA-multiples compare over time is important if you like to time your own business valuation.

EBITDA-multiples in technology and industrials, over time

Technology businesses and industrial company’s EBITDA-multiples has increased similarly during the last 5-years. Actual EBITDA-multiples has increased 82% in both sectors when I look how EBITDA-multiples compare over time.

However, there are large differences:

  1. Industrial company’s EBITDA-multiples have increased in the last 2 – 3 years. Much faster than technology companies: 73% versus 57%.
  2. In absolute EBITDA-multiples however, earnings from technology companies are still much more highly valued than earnings from industrial companies. In 2020, technology companies are being valued at a 27,6x their EBITDA while industrial companies are value at 20,6x EBITDA.

EBITDA valuation multiples20162017201820192020
US, Energy (S&P 500)35,112,37,48,9
US, Industrials (S&P 500)11,413,111,913,520,6
US, Information technology (S&P 500)12,013,611,516,922,7
US, Saas & Cloud (170 companies)18,021,423,629,132,5
EU small cap, listed average8,09,58,08,69,9

Investors has shifted some of their preferences in 2020 – 2021 towards industrial companies. Increased competition for investments leads to lower return requirements, higher valuations and therefor increased EBITDA-multiples forr industrial companies.

Technology businesses on the other hand see decreased valuations compared with the peak in late 2020 and early 2021. The main reason is a concern for growing inflation. Higher inflation usually means high interest rates. Higher interest rates lead to lower discounted cashflow values, in particularly for back-ended cash flows often projected by technology companies.

No correlation between EBITDA-multiple growth and GDP growth

My analysis shows no correlation between increasing EBITDA-multiples and GDP growth in the last 5-year period.

Company earnings-expectations tend to grow with higher economic activity but for the last 5-years another factor has boosted growth in business valuations: Money supply available to investors.

Will this change? Will GDP growth lead to higher earnings growth in the future? Yes, most likely. That is how businesses has worked for centuries.

Will higher earnings growth also lead to higher EBITDA-multiples if we look how EBITDA-multiples compare over time 5 years from now? No, I’m almost certain that EBITDA-multiples remain similar to today, for most businesses.

A higher EBITDA does not necessarily mean higher EBITDA-multiples from valuations. It just means a higher absolute value, if you earn a higher EBITDA.

“You need to fundamentally change the efficiency of your business model to earn a higher EBITDA-multiple.”

No or limited correlation with inflation, so far.

Inflation, measured as Producer Price Index, has stayed flat for the last 5-years. When I analyze how EBIDA-multiple valuations compare over time I find no correlation with inflation. Yet.

Look at the graph. EBITDA-multiples dipped in 2017 but started to increase in 2018 when monetary policies went on the offensive.

Money supply has changed how EBITDA-multiples compare over time

Now comes the most important insight from my data analysis: Money supply has boosted valuations and with that how EBITDA-multiples compare over time.

The most important factor affecting business value in 2016 – 2021:

A 12-year global super-economy has produced massive amounts of risk willing money. Recent years or central bank spending has further boosted the amount of risk willing money available for new businesses. A fast-growing venture capital industry, fueled with massive money supply, has pushed up valuations in their competition for investments.

Recent years of money supply growth and central bank spending correlate well with how EBITDA-multiple valuations develops over time. Increased money supply has boosted company valuations.

But something happened in 2020.

Central bank spending picked up even further in 2020, and USA plan to increase spending even further 2021.

Why has EBITDA-multiple valuation stagnated in 2021 despite further central bank spending?

  1. Inflation concerns: So far inflation has been flat for the last 5-years but raw material price increases, component shortages and salary inflation fuel a concern for higher interest rates (leading to lower discounted values of companies).
  2. Industrial companies are viewed positively post Covid-19 but potentially increased EBITDA-multiples from sales traction growth are countered by expected margin pressure. I expect raw material and component cost increases along with salary and travel expense inflation to take a toll on margins.
  3. Valuating technology businesses will likely see increased EBITDA-multiples, but actual valuations will decrease. Tech businesses has been valued with ARR-multiples, Annual Recurring Revenues, a kind of EV/Sales multiple, producing no or limited profit. With expectations changing EBITDA-multiples will increase in importance.

How will EBITDA-multiples compare over time?

We will see small changes only when we look how EBITDA-multiples compare over time.

Do not expect digitalization-lead increases in how EBITDA-multiples compare over time.

I’m certain, as certain as one can be, that digital business model improvements will be countered by margin pressure. Margin pressure will come from increasingly transparent and competitive purchasing and sourcing processes.

Focus not only on sales, processes, automation and digitalization but also on purchasing and sourcing. At least if you aspire to higher valuation metrics.

To sum it up

In 2018 – 2021 companies saw tremendous valuation growth, fueled by:

  1. Inspiration from previous generation tech startups finally reaching unicorn sizes, en masse.
  2. A boost in risk willing money supply from a, so far, 12-years global super-economy.
  3. An additional boost in money supply from aggressive monetary policies.
  4. A consequent explosion in venture capital, aggressively looking for fast-growth investments.
  5. 2020 – 2021 Covid-19 making digital business model transformations a necessity.

Will company’s EBITDA-multiple valuations continue to grow?

My thinking is that speculative valuations of non-profitable future-targeting high-tech service companies will take a hit in valuation:

  1. Super-economy money-supply tend to shift priority towards sub-technology sectors such as renewable energy, electric vehicles and financial services.
  2. General monetary policy spending will most likely also decrease in favor of tangible and targeted spending on infrastructure and welfare.
  3. Increasingly investors will request tech companies to produce some kind of profitability as a proof of concept. Sales growth will slow down somewhat in quest for margins and more demanding money supply.

I am certain, yes certain, that current high AAR- and EV/Sales-multiples will come down from the 50x levels seen 2020/2021.

“EBITDA-multiple valuations will grow in importance and technology company EBITDA-multiples will be higher than those of industrials. Superior scalability potential, marginal cost advantages and much higher gross margins commands higher EBITDA-multiple valuations.”

Technology company’s valuation metrics is already coming down from their peak in 2020/2021. How far is yet to be seen.

Industrial company’s has seen a recent 73% boost in EBITDA-multiples when I compare over time. Will this multiple growth be sustainable? Yes, probably since more money has already been supplied to the systems.

Will EBITDA-multiples increase even further when we compare how EBITDA-multiples compare over time 5-years from now? Let me know what you think.

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