Enterprise Value Multiple
Enterprise value multiple is the comparison of enterprise value and earnings before interest, taxes, depreciation and amortization. This is a very commonly used metric for estimating the business valuations. It compares the value of a company, inclusive of debt and other liabilities, to the actual cash earnings exclusive of the non-cash expenses.
This ratio is also known as “EV/EBITDA ratio” and “EBITDA multiple”. Enterprise multiple can be used to compare the value of one company to the value of another company within the same industry. A lower enterprise multiple can be indicative of undervaluation of a company.
Enterprise value multiple is calculated by dividing the enterprise value (EV) by the earnings before interest, taxes, depreciation, and amortization (EBITDA). This can be written as
Enterprise value multiple = Enterprise Value / EBITDA
Enterprise value multiple is a better measure than the P/E ratio because it is not affected by the changes in the capital structure. Consider a scenario in which a company raises equity finance and uses these funds to repay the loans. This will usually result in lower earnings per share (EPS) and therefore a higher P/E ratio. But the Enterprise value multiple will not be affected by this change in capital structure. This means that Enterprise value multiple cannot be manipulated by the changes in capital structure. Another benefit of Enterprise value multiple is that it makes possible fair comparison of companies with different capital structures.
Another positive point about the Enterprise value multiple is that it removes the effects of non-cash expenses such as depreciation and amortization. These non-cash items are of less significance to the investors because they are ultimately interested in the cash flows.
Norms and Limits
Enterprise value multiple is not usually appropriate for comparison of companies in different industries. Capital requirements of other industries are different. Therefore, Enterprise value multiple may not give reliable conclusions when comparing different industries.
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