What it means
Enterprise value (EV) is the value of the entire business to all of its investors. It is calculated by adding the market value of the company's shares to its debt and then subtracting the cash it holds.
EBITDA is a measure of operating profit before interest, taxes, depreciation (the spreading of a physical asset's cost over its life) and amortisation (the same idea for intangible assets). Dividing one by the other gives a multiple, such as 8 times or 12 times.
A lower multiple suggests a company is cheaper relative to the earnings it generates, while a higher multiple suggests investors expect strong growth or see lower risk. The number has no meaning on its own and must be compared with similar companies.
Analysts like this ratio for several reasons. It is not affected by the choice between debt and equity funding, nor by differences in tax rates or accounting policies on depreciation.
This makes it useful when comparing companies across countries or when assessing a takeover target. Bankers and private equity investors use it constantly when pricing deals.
A buyer might say it is paying 9 times EBITDA for a business, and the multiple is then compared with recent transactions in the same industry. It also helps lenders gauge how much debt a company can support.
There are important limits. EBITDA ignores capital spending, so a business that needs heavy investment in equipment can look cheaper than it really is.
It also leaves out the cost of working capital and does not show cash flow, so it should be checked alongside other measures. Be careful to use consistent inputs.
Use current debt and cash figures, and decide whether to use the last 12 months of EBITDA or a forecast. Comparing a multiple based on forecast earnings with one based on past earnings can lead to false conclusions.
In practice
Real-world examples.
Example
A private equity firm considers buying a logistics business. It offers 8 times EBITDA, which is in line with recent sales of similar companies in the sector. The partners then test whether the business could support the debt needed to fund the purchase.
Example
An equity analyst compares two telecom operators in different countries. She uses EV/EBITDA because the companies have different amounts of debt and tax rules. The multiple lets her compare them on a like-for-like basis before looking at growth.
Example
A lender assesses a loan request from a manufacturer. The bank checks that the company's debt is a reasonable multiple of EBITDA and that the business would be worth more than the debt in a sale. A multiple of debt to EBITDA above a set limit would trigger extra conditions in the loan.
Formula
Calculation
EV/EBITDA = enterprise value / EBITDA, where enterprise value = market capitalisation + debt - cash
Worked example: a company has a market capitalisation of $400,000,000, debt of $150,000,000 and cash of $50,000,000. Its EBITDA over the last 12 months was $50,000,000.
Step 1: Enterprise value = $400,000,000 + $150,000,000 - $50,000,000 = $500,000,000.
Step 2: EV/EBITDA = $500,000,000 / $50,000,000 = 10.
Step 3: The company is valued at 10 times EBITDA.
If similar companies trade at 8 times EBITDA, this one looks relatively expensive. If peers trade at 12 times, it looks cheap, unless it has weaker growth or higher risk.Case study
Seen in the real world.
Oakridge Packaging is a fictional company with EBITDA of $12 million. The owners asked an adviser what the business might sell for, and the adviser found that similar companies had changed hands at 6 to 8 times EBITDA.
The multiples implied an enterprise value of between $72 million and $96 million. After subtracting $20 million of debt, the owners could expect between $52 million and $76 million for their shares.
In this illustrative story, the owners improved their profit margins before going to market, increasing EBITDA to $14 million. At 7 times EBITDA, the enterprise value rose to $98 million, showing how a small gain in earnings can have a large effect on the price. The owners noted that each extra $1 million of EBITDA was worth about $7 million to a buyer.
Watch out
Common mistakes.
- Using market capitalisation instead of enterprise value, which ignores the debt and cash of the business.
- Comparing the multiple of companies in different industries, where normal levels differ widely.
- Treating EBITDA as cash flow, when it ignores capital spending, interest, tax and changes in working capital.
Questions
People also ask.
What is a good EV/EBITDA multiple?
There is no universal answer, because it depends on the industry, growth and risk, so compare with similar companies.
Why subtract cash?
Cash reduces the effective price a buyer pays, because the buyer gets the cash along with the business.
Can EV/EBITDA be negative?
Yes, if EBITDA is negative, but the multiple then has little meaning and other measures, such as revenue multiples, are used instead.
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