EV/EBITDA: enterprise value to EBITDA

Enterprise value (EV) is roughly the price of the entire company, debt included: the market value of its shares plus its debt, less the cash it holds. EBITDA is earnings before interest, taxes, depreciation and amortization, a rough measure of the cash the operations generate before financing and investment.

Divide one by the other and you get how many years of today's EBITDA the market is paying for the business. A multiple of 8 means the business is priced at eight times one year of its operating earnings.

Fuller versions of enterprise value also add preferred stock and minority interests, the claims on the business that sit beside ordinary shareholders. EBITDA can also be built from net income by adding back interest, taxes, depreciation and amortization; both routes should land close to each other.

A company has shares worth $8 billion on the market, $3 billion of debt and $1 billion of cash. Its enterprise value is 8 + 3 − 1 = $10 billion.

Last year it reported $900 million of operating income and $350 million of depreciation and amortization, so EBITDA is $1.25 billion. EV/EBITDA is 10 ÷ 1.25 = 8.0.

Suppose a peer has the same EBITDA and the same share value, but no debt and $1 billion of cash. Its enterprise value is $7 billion and its EV/EBITDA is 5.6. Their P/E ratios could be close, yet the first company carries $3 billion more in claims ahead of its shareholders, and EV/EBITDA shows it.

• A lower multiple means the market pays less for each dollar of operating earnings. That can reflect slower expected growth, higher risk or simply less attention, so a low number is a question, not an answer.
• There is no single good number. Multiples differ a lot between sectors: software companies with high growth and little capital tied up are usually priced at much higher multiples than utilities, energy producers or car makers.
• The useful comparison is with similar companies and with the company's own history, measured the same way.
• A negative or near-zero EBITDA makes the ratio meaningless. A company that loses money at the operating level has no multiple to compare.

P/E divides the share price by earnings after interest and taxes, so it depends on how the company is financed. Two identical businesses, one funded with debt and one with shares, can show very different P/E ratios.

EV/EBITDA looks through the financing. It counts debt in the price and measures earnings before interest, so companies with different balance sheets can be set side by side. It also leaves out depreciation, which makes companies with different accounting for their assets easier to compare. Analysts often read the two ratios together.

• EBITDA is not cash flow. It ignores the money spent on new equipment and buildings, and for capital-heavy businesses that spending is a real and recurring cost.
• It also ignores interest and taxes, which shareholders do pay for. A company with heavy debt can look reasonable on EV/EBITDA and still leave little for its owners.
• Leases blur the comparison. Under IFRS, used by many companies outside the US, lease costs move out of operating expenses into depreciation and interest, which raises EBITDA; under US rules most lease costs stay in operating expenses. Two similar companies can differ for this reason alone.
• One-off items such as restructuring charges or asset sales can move a single year's EBITDA. A multiple built on an unusual year says little about a normal one.
• Banks and insurers do not fit. For them debt is raw material, not financing, so enterprise value has no clear meaning.

• Enterprise value is the market value of common shares plus total debt, less cash and equivalents, plus preferred stock and minority interests at their balance sheet value. If any of these parts is unknown, EV/EBITDA is shown as unavailable rather than estimated.
• EBITDA is operating income plus depreciation and amortization from the latest completed fiscal year in the company's annual report filed with the SEC.
• If either enterprise value or EBITDA is zero or negative, the ratio is not shown.
• On the company page EV/EBITDA is one of the valuation multiples compared with sector peers, next to P/E, P/B and free cash flow yield; a lower value ranks as a lower price for the same operating earnings.
• It is not used for banks, brokers and insurers, whose pages use measures built for their business instead.