What it means
Enterprise value is market capitalisation plus total debt minus cash and equivalents. The logic is that a buyer takes on the debt and gets the cash, so the real price of the business is the equity price adjusted for both.
EBITDA is earnings before interest, tax, depreciation and amortisation, which strips out financing and accounting choices to leave something closer to operating cash generation. The ratio matters because a share price on its own tells you nothing about whether a company is cheap.
Two businesses with identical operations can show very different share prices simply because one is funded with debt and the other is not, and EV to EBITDA cancels out that difference. That is why acquirers, lenders and private equity firms lean on it far more heavily than on the price to earnings ratio.
In practice the ratio is used comparatively rather than absolutely. An analyst gathers the multiple for a set of similar listed companies and recent transactions, sees where the subject company sits within that range, and then works out why.
A low multiple can mean the business is undervalued, or it can mean the market expects its earnings to fall. Typical ranges vary enormously by sector, so a single benchmark figure is meaningless.
Capital-intensive, slow-growing industries often trade in the mid single digits, while software and healthcare businesses with high margins and recurring revenue can trade well into the teens. The main weakness is that EBITDA ignores the cash a business must spend to replace its assets.
For an airline or a haulage firm, capital spending is permanent and enormous, so EBITDA overstates what an owner actually keeps, and the multiple has to be read alongside a free cash flow measure.
In practice
Real-world examples.
Example
A private equity firm screening manufacturing targets rejects any business priced above 7.5 times EBITDA, because its debt package and required return will not work at higher entry multiples. The screen removes two thirds of the pipeline before a single meeting is booked.
Example
A corporate development team compares two acquisition candidates with identical operating profit. One has $40,000,000 of debt and the other has none, so the team ranks them on EV to EBITDA rather than on the asking price for the shares.
Example
A lender sets a covenant capping net debt at 3.5 times EBITDA and monitors the borrower's EV to EBITDA separately as an early warning sign. When the multiple falls sharply while earnings hold steady, the credit team asks the borrower what the market has spotted.
Think of it
“EV/EBITDA shows total company value relative to cash earnings-acquisition multiple.
Formula
Calculation
Enterprise value = market capitalisation + total debt - cash and equivalents
EV to EBITDA = enterprise value / EBITDA
A listed packaging group has 60,000,000 shares trading at $10.00, giving a market capitalisation of $600,000,000. It carries $150,000,000 of bank and bond debt and holds $50,000,000 of cash. Enterprise value = $600,000,000 + $150,000,000 - $50,000,000 = $700,000,000.
The income statement shows revenue of $350,000,000 and operating profit of $62,500,000, after charging $25,000,000 of depreciation and amortisation. EBITDA = $62,500,000 + $25,000,000 = $87,500,000.
The ratio is $700,000,000 / $87,500,000 = 8.0 times. If the sector average sits at 9.5 times, the market is applying a discount worth roughly $131,000,000 of enterprise value, and the analyst's job is to establish whether that reflects genuinely weaker prospects or an opportunity.Case study
Seen in the real world.
Marlborough Filtration is an illustrative and entirely fictional maker of industrial filters, used here to show the ratio at work. Its founder wanted to sell and had been told by a friend that businesses in the sector "go for about ten times", so he anchored on a $900,000,000 price.
The adviser rebuilt the picture. EBITDA was $87,500,000 once one-off restructuring costs were added back, so ten times gave an enterprise value of $875,000,000. Subtracting $150,000,000 of debt and adding $50,000,000 of cash produced $775,000,000 for the shares, well short of what the founder had in mind.
Buyers then argued the multiple down to 8.0 times, citing customer concentration and heavy capital spending that EBITDA ignored. The illustrative lesson is that a headline multiple and the cash a seller receives are two different numbers, and the debt bridge between them is where deals are won and lost.
Watch out
Common mistakes.
- Multiplying the EBITDA multiple by EBITDA and calling the answer the share price. That calculation gives enterprise value, and debt must be subtracted and cash added before you reach the value of the equity.
- Comparing multiples across unrelated sectors. A 6 times multiple in heavy industry and a 6 times multiple in software carry completely different messages about growth expectations.
- Using reported EBITDA without checking what sits inside it. One-off gains, capitalised costs and unusual accounting choices can inflate the figure and make the multiple look artificially low.
Questions
People also ask.
Why use EBITDA rather than net profit?
Because net profit is shaped by how the company is financed and by its tax position, whereas EBITDA is closer to the underlying operating performance a buyer would inherit.
Is a low multiple always good news?
No, it frequently signals that investors expect earnings to decline, so the sensible next step is to ask what the market knows rather than to assume a bargain.
Should lease liabilities count as debt?
Under current accounting most leases sit on the balance sheet, so they should be included in enterprise value, and the corresponding EBITDA figure must be measured on the same basis.
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