What it means
Enterprise value is what it would cost to buy the entire business: the market value of the equity plus net debt. EBIT is operating profit, measured before interest and tax, so it belongs to everyone who funds the company rather than to shareholders alone.
Dividing one by the other pairs a return with the full pool of capital that produced it. Analysts flip the more common EV/EBIT ratio because a yield is easier to compare against alternatives.
A 12% operating earnings yield can be set directly against a bond yield, a required return or another company, and unlike a price to earnings ratio it does not become unstable when the profit figure is small. The measure is popular in quantitative screening for exactly that reason.
Ranking a universe of companies from the highest EBIT/EV yield to the lowest puts the cheapest businesses at the top without the distortion caused by different debt levels, since both parts of the ratio sit above the financing line. Compared with the equity-only price to earnings ratio, EBIT/EV is harder to mislead.
Two companies with identical operations but very different borrowing will show very different price to earnings ratios and similar EBIT/EV yields, because enterprise value already contains the debt. That makes it the better tool when comparing across an industry with mixed balance sheets.
The main cautions concern the quality of EBIT and the completeness of enterprise value. Operating profit inflated by one-off gains, or depressed by charges that recur every year, produces a misleading yield, and pension deficits, lease liabilities and minority interests all belong in the denominator.
Getting enterprise value right takes considerably more work than reading a share price off a screen.
In practice
Real-world examples.
Example
A value-oriented fund screens 400 industrial companies by EBIT/EV yield and shortlists the top 40. Because the screen ignores capital structure, it surfaces two heavily borrowed businesses that look expensive on price to earnings but cheap on the operating profit an acquirer would actually buy.
Example
A private equity team compares a target carrying $180,000,000 of debt against a debt-free competitor. The price to earnings ratios are not comparable at all, but both convert cleanly to EBIT/EV yields of 9% and 11%, which tells the team the debt-free business is the better entry price on operations alone.
Example
A listed group's board weighs buying back shares against acquiring a rival. Its own EBIT/EV yield is 10% while the rival would be bought at a yield of 6%, so the finance director argues that the buyback delivers more operating profit per dollar committed unless synergies close the gap.
Formula
Calculation
Enterprise value = market capitalisation + total debt - cash. EBIT/EV multiple = EBIT / enterprise value.
An industrial company has a market capitalisation of $600,000,000, total debt of $150,000,000 and cash of $50,000,000. Net debt is $150,000,000 - $50,000,000 = $100,000,000, so enterprise value is $600,000,000 + $100,000,000 = $700,000,000. With EBIT of $84,000,000, the EBIT/EV multiple is $84,000,000 / $700,000,000 = 0.12, or a 12% operating earnings yield. Expressed the other way round, EV/EBIT is $700,000,000 / $84,000,000 = 8.3 times. A larger peer with an enterprise value of $1,200,000,000 and EBIT of $96,000,000 yields $96,000,000 / $1,200,000,000 = 8%, equivalent to 12.5 times, so the first company is meaningfully cheaper on operating earnings.Case study
Seen in the real world.
This illustrative example features Redgate Industrial Coatings, a fictional listed manufacturer. On a price to earnings basis Redgate looked expensive at 22 times, and several analysts dropped it from their lists on that basis alone.
An acquirer looked instead at EBIT/EV. Redgate had a market capitalisation of $420,000,000, debt of $30,000,000 and cash of $90,000,000, so net cash of $60,000,000 reduced enterprise value to $360,000,000. Against EBIT of $54,000,000 that was a yield of 15%, or 6.7 times EV/EBIT, because the large cash pile and a high tax charge had depressed the earnings per share that the price to earnings ratio depended on.
In this fictional illustration the acquirer bid and completed, funding part of the price with the target's own cash. The case shows why enterprise value multiples are the standard language of acquisition analysis while price to earnings remains the language of the stock market.
Watch out
Common mistakes.
- Calculating enterprise value from market capitalisation and gross debt while forgetting to deduct cash, which overstates the denominator and understates the yield.
- Comparing an EBIT/EV yield with a price to earnings ratio directly, when one is a percentage yield and the other a multiple of times.
- Using a single distorted year of EBIT, since one-off gains or recurring "exceptional" charges push the yield well away from the sustainable figure.
Questions
People also ask.
Why use EBIT/EV rather than EV/EBIT?
They contain identical information, but the yield form is easier to rank in a screen and easier to compare against bond yields or a required rate of return.
Should EBIT be adjusted before the calculation?
Generally yes, by removing genuinely one-off items, so that the yield reflects operating profit the business can repeat rather than a single unusual year.
Does the multiple work for banks and insurers?
Not well, because debt is raw material rather than funding for those businesses, so enterprise value has little meaning and equity-based measures are used instead.
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