Why would two companies in the same sector trade at different valuation multiples?

One of our students recently got asked this question in a private equity interview. As a matter of fact, this is probably the most often repeated question across M&A, Equity Research and Private Equity interviews.

The answer:

The most important reason why two companies in the same sector trade at different PE ratios or EV/EBIT multiples is because of the underlying growth in profitability.

Investors are willing to pay a higher multiple for the same dollar of earnings for a company with a higher growth in profits versus another company in the same sector.

Other less important reasons of why multiples differ is because of sustainability in earnings, unsystematic risk profile of the company and potential acquisition premium to list just a few.

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