📚 PASS Research Analyst Certification Examination Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 10.6 — Relative valuation

You are sitting in a morning research huddle at a Mumbai-based brokerage, reviewing a mid-cap IT services company. Your lead analyst asks why the stock trades at 25x trailing earnings while the industry average sits at 18x. To answer effectively, you must decompose these ratios beyond their headline figures, moving into the structural components that drive these valuations. This is where the distinction between P/E and EV/EBITDA becomes critical for your investment recommendation.

The Price-to-Earnings (P/E) ratio is the market’s expression of how much investors are willing to pay for every rupee of accounting profit. However, P/E is sensitive to a firm’s capital structure and non-operating income, which can distort your comparison. If two companies have identical operating performance but different debt profiles, their P/E ratios may diverge significantly due to interest expenses and tax shielding. Relying solely on P/E can lead an analyst to mistake a high-debt, high-risk company for an expensive one, or vice-versa, if the underlying leverage is ignored.

To strip away these distortions, professional analysts turn to the Enterprise Value to EBITDA (EV/EBITDA) ratio. By focusing on EBITDA, you are evaluating the cash-generating potential of the company’s core operations before the impact of interest, taxes, depreciation, and amortization. This ratio is particularly powerful in capital-intensive sectors like telecommunications or manufacturing, where depreciation charges are heavy but may not reflect true cash outflow requirements. When you use EV/EBITDA, you effectively normalize for differences in capital structure and accounting policies, providing a cleaner “apples-to-apples” comparison between companies.

Consider an analyst comparing two chemical manufacturers in the Nifty 500 index. One firm is equity-financed with high R&D tax credits, while the other is heavily reliant on long-term debt. Their P/E ratios will likely tell conflicting stories due to the interest burden and tax variations. By switching to EV/EBITDA, the analyst can compare their operational efficiency directly.

If the firm with high debt shows a lower EV/EBITDA but a higher P/E, the analyst realizes the P/E is reflecting financial leverage rather than operational excellence, allowing for a more nuanced and accurate buy-side thesis.

Nuance

⚠️ Nuance
A common professional pitfall is the mechanical application of these ratios without accounting for growth expectations. Candidates often assume that a lower multiple always implies a ‘buy,’ ignoring the possibility that the low multiple is a fair reflection of poor growth prospects or higher systematic risk. An analyst must always adjust relative valuations for the company’s expected growth rate, often by using the PEG ratio or by ensuring that the ‘peer group’ actually shares similar risk-return profiles.

Check Your Understanding

Practice Question 1

An analyst is comparing two firms in the logistics sector. Company A has high debt and high depreciation, while Company B is debt-free. Why might the analyst prioritize EV/EBITDA over P/E in this scenario?

Practice Question 2

Which of the following components is intentionally excluded from the denominator of the EV/EBITDA ratio?

This is a companion read for Section 10.6 — Relative valuation from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.