Treasury Practice

EV/EBITDA

Published: May 2008

EV/EBITDA, also known as the enterprise multiple, is a ratio that is used to determine the value of a business compared to its earnings before interest, tax, depreciation and amortisation. Unlike other valuation ratios, such as the price-earnings ratio (P/E ratio), its valuation includes the cost of paying off debt.

The formula is as follows:

\(\frac{Enterprise\: value\:EV}{Earnings \:before\: interest,\: tax,\: depreciation\:and \:amortisation\:EBITDA}\)

Therefore, if a company’s EV was €150m and its EBITDA was €15m, its EV/EBITDA would be expressed as 10x. This is because its EV is 10 times its EBITDA.

Enterprise value (EV)

Enterprise value is the value of the entire company to both shareholders and debtors. It is calculated using the following formula:

\({\mathrm{EV}}=\mathrm{Market\: capitalisation\:+\:Net\: debt}\)

The inclusion of net debt gives a more accurate valuation.

Since EV/EBITDA is usually used for the valuation of shares, it is generally assumed that the company’s debt is worth its market value (in the case of bonds) or its book value (for other forms of debt), which is the value shown in the company’s accounts.

When is it used?

EV/EBITDA is widely used and is particularly useful as a formula for comparing the value of different companies. It has advantages over similar ratios because its result is not affected by capital structure and the denominator is not affected by taxes. This makes it particularly useful for international comparisons. It is normally used instead of, or alongside, the P/E ratio.

EV/EBITDA is used by investors, who are primarily interested in cash flows and who are less interested in the non-cash factors that EV/EBITDA excludes: amortisation and depreciation. It can be calculated using forecast profits as an alternative to past figures.

Risks

EV/EBITDA may not always present an accurate picture of a company’s value. In the 1990s, many young technology companies were able to boast of misleading EBITDA profits while suffering large pre-tax losses as a result of their rapidly depreciating technology assets, since depreciation is not taken into account in EBITDA.

It is important to ensure that the EV and the EBITDA are calculated for the same part of the business (ie either the whole group or one of its component companies); otherwise this will cause incorrect results. If correct figures cannot be found for the relevant part of the business then the formula will need to be adjusted to take this into account.

EV/EBITDA is less effective when used to compare the value of companies in different industries. This is because different industrial sectors often require companies to have different levels of capital expenditure.

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