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

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