By |Published On: October 23rd, 2014|Categories: Research Insights, Value Investing Research|

New Evidence on the Relation Between the Enterprise Multiple and Average Stock Returns

  • Loughran and Wellman
  • A version of the paper can be found here. (Also described in a much more entertaining fashion in Toby’s new book: Deep Value)
  • Want a summary of academic papers with alpha? Check out our Academic Research Recap Category.


Practitioners increasingly use the enterprise multiple as a valuation measure. The enterprise multiple is (equity value debt preferred stock – cash)/ (EBITDA). We document that the enterprise multiple is a strong determinant of stock returns. Following Fama and French (1993) and Chen, Novy-Marx, and Zhang (2010), we create an enterprise multiple factor that generates a return premium of 5.28% per year. We interpret the enterprise multiple as a proxy for the discount rate. Firms with low enterprise multiple values appear to have higher discount rates and higher subsequent stock returns than firms with high enterprise multiple values.

Core Idea:

Tests the effectiveness of enterprise multiples.

  • Enterprise value = market value of equity + debt + preferred stock – cash and short-term investments
  • Enterprise Multiple (EM) = EV/EBITDA

Alpha Highlight:

  1. Using Enterprise Multiples as a screening tool works, as those with low EM outperform those with high EM.
2014-10-03 17_39_51-0Value Reseach Recap.pptx - Microsoft PowerPoint (Product Activation Failed)

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Their explanation for why it works: “What drives the enterprise multiple effect in stock returns? We interpret the enterprise multiple as a proxy for the unlevered investment return (i.e., the weighted average cost of capital), which is in turn positively related to the firm’s cost of equity. Firms with high enterprise multiple values (signaling high valuation ratios) appear to have lower discount rates and lower subsequent realized stock returns than firms with low EM values.”

Our research yields similar results.

About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.