Before the algebra, the syntax. Every valuation metric has a claim level:
- Equity metrics belong to shareholders alone: market capitalization (price × diluted shares), net income, EPS, book value of equity, FCFE, dividends.
- Enterprise metrics belong to all capital providers: enterprise value, revenue, EBITDA, EBIT, NOPAT, FCFF, invested capital.
The consistency rule: numerator and denominator must sit at the same claim level. Price over earnings is an equity number over an equity number, so it's consistent. EV over EBITDA is an all-capital number over a pre-interest, all-capital one. That's consistent too. Cross the streams and you get a ratio that's gibberish but still computes:
- The EV/EPS sin. EV over net income (or EPS) divides a pie that belongs to lenders and shareholders by a slice that belongs to shareholders alone. Take two identical businesses, one debt-free and one levered. They'll show wildly different EV/E even though their enterprises are the same. The ratio moves when you refinance, without a single rupee of operating change. Any table containing EV/E, EV/PAT, or "EV per share" fails the check.
- The P/Sales sin, the respectable one. Price over revenue is just as inconsistent, an equity numerator over an all-capital denominator, yet it turns up in serious research every day. The trap is that a company can lower its P/S by adding debt. Borrow to buy back shares and market cap falls while revenue doesn't move. So a levered retailer at 0.4× P/S can be dearer than an unlevered one at 0.8×. Use EV/Sales, always. If you inherit a P/S screen, translate it before you trust it.
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How is enterprise value calculated?
Enterprise value is the market value of the operating business. Think of it as what it would cost to buy the whole company and own its operations free of its financing choices:
EV = market cap (diluted)
+ total debt (short + long, at market value where it matters — M3.03)
+ lease liabilities (ASC 842 / IFRS 16 / Ind AS 116)
+ minority (non-controlling) interest
+ preferred stock
− cash and liquid investments (net of any operating minimum, if material)
[± pension deficit, ± market value of non-operating assets such as listed stakes]Every line is there for a reason, and none of it is custom. Minority interest goes in because consolidated EBITDA includes 100% of a subsidiary you own perhaps 70% of. You can either add the outsiders' claim to EV or strip their share out of the denominator, and adding is the standard. Listed non-operating stakes are everywhere in India. Think of holding companies, or an operating company that holds a listed subsidiary's shares. Those stakes must be subtracted from EV if their earnings aren't in your denominator. Cash is subtracted because the buyer gets it back, but then interest income has to come out of any earnings denominator you pair with that EV.
Which matching errors catch analysts out?
Matching is dynamic as well as structural, and three rules catch most real errors:
- Leases. If lease liabilities are inside EV, the denominator must be pre-rent, which is the IFRS 16 / Ind AS 116 EBITDA. If you leave lease debt out, the denominator must charge rent, the old-style EBITDA. Pick one convention and apply it to every row of the table. The lease numbers in comparable company analysis show the trap at work.
- Associates. Equity-method income shows up in profit below EBIT. There's no matching revenue or EBITDA. If the associate's market value is in your EV, its income must be in your denominator, and vice versa. For EV/EBITDA, strip the stake's value out of EV, because EBITDA contains nothing from it.
- Time. Pair trailing EV with trailing EBITDA and forward with forward. A current EV over last year's depressed EBITDA manufactures fake expensiveness, and vice versa. Share counts are diluted, always. Options and RSUs are claims that exist today.
Which multiple pairs with which denominator?
Memorize the family below. For each multiple it gives the claim level, the matched denominator, and the primary drivers it compresses:
| Multiple | Claim level | Denominator must be | Primary drivers (the companion variables) | Typical habitat |
|---|---|---|---|---|
| P/E | Equity | Net income / diluted EPS | growth, payout (via ROE), r | profitable, stable-leverage firms; consumer, IT services |
| PEG | Equity | EPS growth rate | (a distortion of P/E, see justified P/E) | screens; handle with tongs |
| P/B | Equity | Book equity | ROE vs r, growth | banks, insurers, capital-heavy |
| P/FCFE (P/FCF) | Equity | FCFE ≈ CFO − capex (± net borrowing) | growth, r | mature cash generators |
| EV/EBITDA | Enterprise | EBITDA (lease-consistent) | ROIC, D&A intensity, tax, growth, WACC | capital-intensive; cross-leverage comps; deals |
| EV/EBIT | Enterprise | EBIT | ROIC, tax, growth, WACC | when D&A is a real cost (it is) |
| EV/Sales | Enterprise | Revenue | steady-state EBIT margin, then all of the above | loss-makers, young firms, turnarounds |
| EV/IC | Enterprise | Invested capital | ROIC vs WACC, growth | the value-creation plot (see enterprise multiples) |
| P/CF | Equity | CFO per diluted share, or cash earnings (NI + D&A) | growth, r, accrual intensity, capex intensity | where earnings quality is doubted; capital-heavy equities |
| EV/CFO | Fails the check as written | unlevered CFO = CFO + after-tax interest paid | ROIC, working-capital discipline, WACC | only in the unlevered form |
Sector-specific multiples all belong to the same family: EV/tonne of cement capacity, EV/bed for hospitals, EV/subscriber, EV/ARR, P/AUM for asset managers, P/EV for life insurers. Each is a price over a unit that's expected to become profit. They're intermediate multiples, and the test never changes. A tonne, a bed, or a subscriber is worth what the profit per tonne, bed, or subscriber says it's worth, once you discount it. Phase 5 gives each sector its lens, and this grammar is what keeps those lenses straight.
The last two rows of the table, P/CF and EV/CFO, exist for the same reason. Earnings are an opinion and cash is a fact, so if you distrust a company's accruals, you reach for a cash denominator. Run the claim check on each before you use it. P/CF passes cleanly. Cash from operations is struck after interest paid, so it's an equity-level number, and an equity-level price over it is consistent. Its weakness is what it leaves out. CFO is measured before capital expenditure, so P/CF flatters the very capital-hungry businesses people reach for it to judge. A firm with cash earnings of ₹4.90 a share at ₹42 trades on 8.6× cash flow and 14.0× earnings. That looks like a discount until you subtract the ₹2.40 a share of capex and find P/FCFE at 16.2×. Quote P/CF beside P/FCFE or not at all.
EV/CFO fails the check, and it fails the same way EV/EPS does. The numerator belongs to lenders and shareholders together. CFO belongs to shareholders alone, because the lenders were already paid inside it. Two identical businesses on different leverage will print different EV/CFO for no economic reason. The repair takes one line. Add back after-tax interest paid and you have an unlevered cash flow that matches the numerator. Say a company has an enterprise value of ₹5,000 crore, CFO of ₹500 crore and interest paid of ₹80 crore at a 25% tax rate. Unlevered CFO is 500 + 80 × 0.75 = ₹560 crore, so the matched multiple is 8.93×, against a naive 10.0×. The naive version overstates by 12%, and it overstates most for the most levered peer in your table. That's the one your eye was drawn to.
Do SUE and relative strength measure value?
Screens also hand you three numbers that look like the ones above and aren't. Unexpected earnings is the surprise itself, actual earnings minus the consensus estimate. An FMCG name reporting ₹13.10 against a ₹12.40 consensus has a UE of +₹0.70. Standardised unexpected earnings divides that surprise by the historical standard deviation of the same company's surprises, which turns rupees into a comparable score. With a standard deviation of ₹0.28, SUE = 0.70/0.28 = +2.5. You need the standardisation, because a 70-paise beat is enormous for a utility and noise for a cyclical. Relative strength is cruder still. It's the stock's return over a window against the market's or the sector's, so 34% against an index's 11% is 23 points of excess, or a ratio of 1.21.
None of the three makes a claim about value. They make a claim about revision and drift, meaning the market updates slowly to news, so a large positive surprise or a strong recent return tends to be followed by more of the same over the following months. That's the momentum factor. Its evidence and its failure modes are covered in the portfolio construction module. It appears here only so you can guard against it. A screen that ranks on SUE and one that ranks on forward P/E answer different questions. Mix them in one table without saying so and a momentum bet arrives dressed as a valuation conclusion. Keep them in separate columns, label the columns, and never let a high SUE argue that a multiple is justified.