Enterprise multiple (EM) is the ratio of enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA), with EV market value of equity plus total debt and preferred stock value minus cash and short-term investments. What happens when EM disagrees with other stock valuation metrics? In their October 2016 paper entitled “Why Do Enterprise Multiples Predict Expected Stock Returns?”, Steve Crawford, Wesley Gray and Jack Vogel investigate how EM interacts with other stock valuation metrics. They first sort stocks into fifths (quintiles) ranked by EM and then re-sort EM quintiles into sub-quintiles based on each of 12 fundamental valuation metrics: (1) financial distress; (2) O-Score (probability of bankruptcy); (3) net stock issuance; (4) composite equity issuance; (5) total accruals; (6) net operating assets; (7) momentum; (8) gross profitability; (9) asset growth; (10) return on assets; (11) investment-to-assets ratio; and, (12) a combination metric derived by first ranking stocks based on each of the 11 individual metrics and then averaging ranks for each stock. There are thus 25 double-sort portfolios for each valuation metric. They then focus on two value-weighted hedge portfolios that concentrate disagreement/agreement between EM and other valuation metrics:

- High-mispricing – long (short) stocks with low (high) EMs and high (low) fundamental valuations, representing extreme disagreement.
- Low-mispricing – long (short) stocks with low (high) EMs and low (high) fundamental valuations, representing extreme agreement.

Portfolio reformations are at mid-year annually for all variables except momentum, for which reformations are monthly. They measure portfolio performance based on monthly return, market alpha, three-factor (market, size, book-to-market) alpha and four-factor (adding momentum) alpha. Using prices and firm fundamentals required to construct specified metrics for a broad sample of U.S. common stocks during July 1972 through December 2015, *they find that:* Keep Reading