Here we have some scenario analysis for a company with a base case return on invested capital of 11%, cost of capital of 10%, and expected growth of 3%. The company's EV to EBIT multiple on these inputs is 10.4 times. If we increase the return on invested capital to 15%, the company is generating more earnings and therefore more cash from its existing asset base. So this increases the company's enterprise value and the multiple also increases to 11.4 times.

If we instead increase the expected growth rate to 6%, the company's earnings and cash flows are going to grow more quickly. So the company's enterprise value again, increases, and the multiple increases to 11.4 times.

If we instead decrease the cost of capital to 8%, well the earnings and cash flows of the company are unchanged, but the present value of those cash flows increases. So again, the enterprise value of the company increases and the multiple increases this time to 20 times. So if we see a company trading on higher multiples than peers, then it's a reflection that this company is expected to generate a higher return on invested capital, and peers is expected to grow more quickly than peers or has a lower cost of capital in peers, but often it's a combination of all three of these items.

The final scenario is also worthy of mention here, the company's return on invested capital is 10%, which is exactly the same as the cost of capital. The multiple is just 10 times, even though the company is expected to grow at 6%, that's the same as the high growth scenario to the left, but why is the valuation and the multiple so low. Well, what is actually happening here is the growth rate is completely irrelevant in this scenario because the return on capital is equal to the cost of capital. The multiple is therefore just the inverse of the cost of capital. But why does growth not matter in this scenario? How about I set a business where I borrow at a rate of 5% and invest all those borrowings into my company where I generate a return on that capital of 5%? Am I generating any value for my shareholders? Well, no, because all of my profits are going to be used to cover the cost of my borrowings. What about if I ask the bank to roll up the interest and add it to the bank loan each year so I can reinvest the profits I generate each year in the business to grow more quickly? Even if I do this, the additional profits that I generate from growth will still only be enough to cover the additional interest on my additional borrowings. It doesn't matter how much I grow, my return on capital still only covers the cost of my capital. So I'm not generating any additional value for shareholders.