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Why is P/E ratio of a new private company lesser as compared to public company ?

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Nik@16

Contributor
Aug 22, 2018
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India
Why is P/E ratio of a private company during it's sale lesser as compared to public company ? Generally , Do we also have to sell our previous reserves that came from previous profits while selling our company ? Please Help.
 
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Nik@16

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Aug 22, 2018
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India
Liquidity of the investment for investors and availability of freely moving capital.
Generally asking , Do we also have to sell reserve that we made from previous year's profits while selling our company ?
 

Kak

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Generally asking , Do we also have to sell reserve that we made from previous year's profits while selling our company ?

Not if you distribute it first.
 
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Vigilante

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A quick look at P/E ratios for Apple Inc (AAPL) and Amazon.com Inc (AMZN) illustrates the dangers in using only the P/E ratio to evaluate a company. In late June, 2014, Apple was traded at $92.18 with a P/E ratio (TTM) of 15.34. On the same day, Amazon’s stock price was $334.38 with a P/E ratio of 511.06. One of the reasons Amazon’s P/E is so high is that it has been sacrificing profits in order to expand aggressively on a wide-scale, thus, keeping earnings suppressed and the P/E ratio very high. If you were to compare these two stocks based on P/E alone, it would be impossible to make a reasonable evaluation. A low P/E ratio doesn’t automatically mean a stock is undervalued, just like a high P/E ratio doesn’t necessarily mean it is overvalued.

Read more: How can the price-to-earnings (P/E) ratio mislead investors? | Investopedia How can the price-to-earnings (P/E) ratio mislead investors?
Follow us: Investopedia on Facebook
 

TheOwl8

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Dec 5, 2013
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Generally asking , Do we also have to sell reserve that we made from previous year's profits while selling our company ?

It depends. This should be discussed between the buyer and seller and have an impact on the sales price. In my experience, small businesses will often want to withdraw their equity before the sale, especially if it is a pass-through entity and they've already paid tax on it.

The sales agreement will usually stipulate X dollars of working capital remain in the business, so that during the transition of the sale there aren't cash flow problems.
 

Nik@16

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Aug 22, 2018
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India
It depends. This should be discussed between the buyer and seller and have an impact on the sales price. In my experience, small businesses will often want to
It depends. This should be discussed between the buyer and seller and have an impact on the sales price. In my experience, small businesses will often want to withdraw their equity before the sale, especially if it is a pass-through entity and they've already paid tax on it.

The sales agreement will usually stipulate X dollars of working capital remain in the business, so that during the transition of the sale there aren't cash flow problems.

withdraw their equity before the sale, especially if it is a pass-through entity and they've already paid tax on it.

The sales agreement will usually stipulate X dollars of working capital remain in the business, so that during the transition of the sale there aren't cash flow problems.
So it means we can take away reserves and previous year profits in most cases ?
Thank you so much.
 
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Nik@16

Contributor
Aug 22, 2018
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India
A quick look at P/E ratios for Apple Inc (AAPL) and Amazon.com Inc (AMZN) illustrates the dangers in using only the P/E ratio to evaluate a company. In late June, 2014, Apple was traded at $92.18 with a P/E ratio (TTM) of 15.34. On the same day, Amazon’s stock price was $334.38 with a P/E ratio of 511.06. One of the reasons Amazon’s P/E is so high is that it has been sacrificing profits in order to expand aggressively on a wide-scale, thus, keeping earnings suppressed and the P/E ratio very high. If you were to compare these two stocks based on P/E alone, it would be impossible to make a reasonable evaluation. A low P/E ratio doesn’t automatically mean a stock is undervalued, just like a high P/E ratio doesn’t necessarily mean it is overvalued.

Read more: How can the price-to-earnings (P/E) ratio mislead investors? | Investopedia How can the price-to-earnings (P/E) ratio mislead investors?
Follow us: Investopedia on Facebook
I wanted to know that is general reserve of previous year's profit included if we sell our private company to someone for P/E ratio of 3.
 

Vigilante

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I wanted to know that is general reserve of previous year's profit included if we sell our private company to someone for P/E ratio of 3.

no
 
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JM35

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So it means we can take away reserves and previous year profits in most cases ?
Thank you so much.
Nik - it really depends on your business model and the cash needs of the business. If you are selling a smaller online business, it is common for sellers to remove all cash and earnings from the business. When you get to larger businesses (mostly million+) or businesses that operate brick and mortar, or have a degree of physical operations, you have to leave behind an agreed upon amount of "Net Working Capital" which is essentially the amount of cash a business needs on hand to be able to fund it's operations. Happy to go into further detail if necessary.

As for the "P/E" ratio of a business, you can't compare the P/E ratio of a public company to that of a private company per se. When a private company is trading at 6x, that is 6x the company's EBITDA (earnings before interest, taxes, depreciation and amortization). EBITDA is an enterprise-value metric, meaning it takes into account the value of 100% of the business, because EBITDA is earnings available to both equity and debt holders of a business. P/E or price to earnings ratio only gives you a value of the equity of the business, not 100% of the business (if the business has debt). This is because earnings or net income come after all debt and interest payments have been made.

Again, this is going to vary depending on the size and type of business you sell. Most online businesses are going to sell based on their net income, while larger multi-million dollar business usually trade off of EBITDA (ie. this is what private equity firms trade off of).

Are you trying to put a valuation on your own business?
 

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