EV/EBITDA ratio

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Definition

The EV/EBITDA ratio is a 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 “enterprise multiple” and “EBITDA multiple”. The enterprise multiple can be used compare the value of one company to the value of another company within the same industry. A lower enterprise multiple can be indicative of an undervaluation of a company.

Calculation (formula)

The EV/EBITDA ratio is calculated by dividing the enterprise value (EV) by earnings before interest, taxes, depreciation, and amortization (EBITDA). This can be written as

EV/EBITDA Ratio = EV / EBITDA

The EV/EBITDA ratio is a better measure than the P/E ratio because it is not affected by 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 a lower earnings per share (EPS) and therefore a higher P/E ratio. But the EV/EBITDA ratio will not be affected by this change in capital structure. This means that the EV/EBITDA ratio cannot be manipulated by the changes in capital structure. Another benefit of the EV/EBITDA ratio is that it makes possible fair comparison of companies with different capital structures.

Another positive aspect to the EV/EBITDA ratio is that it removes the effect 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

The EV/EBITDA ratio is not usually appropriate for the comparison of companies in different industries. Capital requirements of other industries are different. Therefore, the EV/EBITDA ratio may not give reliable conclusions when comparing different industries.

Quote Guest, 2 December, 2014
Which financial numbers should I use when comparing a company EV/EBITDA with its peer group? the current/last published financial reports, or should I make a forecast for the later years and base the EV/EBITDA on the forecasted financial reports?
Quote Guest, 8 October, 2015
It depends on whether you are interested in current valuations or projected ones. Obviously projected valuations are subject to errors as they are pro forma financials whereas the current valuations (if reported accurately) provide a clear current value of the enterprise.
Quote Guest, 11 January, 2017
What is the approximate range of EV/EBITDA ratio for a well manged company?
Quote Guest, 11 June, 2017
An EV/EBIDTA ratio of 6-8 is indicative of fair valuation.  However, the EV/EBIDTA ratio can be misguiding. Take the case of a negative net worth company, for eg. Jet Airways.  The ratio will not indicate the real state of affairs of the company's financial health. So one needs to be careful in taking investment decisions based purely on this ratio.
Quote Guest, 16 June, 2021
Is a negative EV/EBIDTA good or bad? Should one buy a stock with a negative EV/EBIDTA?