How should you value a cyclical company using multiples, and why is a trough or peak LTM multiple misleading?
A core Valuation interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
For cyclicals, the spot LTM multiple is treacherous because earnings and the multiple move inversely over the cycle: at the trough, EBITDA is depressed so EV/EBITDA looks optically high (and P/E can be enormous or negative); at the peak, fat earnings make the multiple look cheap just before it mean-reverts. Valuing on a peak multiple × peak earnings double-counts the boom. The fix is to normalize: apply a mid-cycle (through-the-cycle average) EBITDA or margin, and a mid-cycle multiple, rather than the spot figures. Alternatively, value on metrics less cycle-distorted (e.g., EV per unit of capacity, or a long-run average earnings power). I'd also sanity-check against where we are in the cycle and against replacement cost. The principle is to value normalized earning power, not a single point that the cycle has temporarily inflated or depressed.
WHAT INTERVIEWERS LISTEN FOR
- ✓LTM multiple and earnings move inversely over the cycle
- ✓Trough: optically high multiple; peak: optically cheap
- ✓Normalize to mid-cycle EBITDA/margin and a mid-cycle multiple
- ✓Cross-check vs cycle position and replacement cost
COMMON MISTAKES
- ✗Applying peak multiple to peak earnings
- ✗Using spot trough multiple at face value
- ✗No normalization for the cycle
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