EV to EBITEnterprise Value Defined along with formula and how to calculate to earnings before interest & taxes

Written By:
Lisa Borga

What is the EV to EBIT Ratio?

The EV to EBIT or EV multiple is known as a valuation metric.

It can be computed by dividing enterprise value by earnings before interest and taxes.

This can be used to value a company and compare it to similar companies.

It compares the price of a company after adjusting for cash, debt, and other liabilities to its earnings.

Explaining Enterprise Value

Enterprise value, also referred to as firm value, is a measure of the total value of a company.

This value shows the value of the company to all of its stakeholders.

This includes shareholders, debt holders, preference holders, and minority shareholders.

Here is a formula to use for calculating the firm value or enterprise value of a company.

EV = Market Cap + Debt + Minority Interest + Preference Shares – Cash & Cash Equivalents

Firm value is basically the amount of money an investor would need to spend to buy a public company.

This value assumes that the person buying the company will also take on and pay the company’s debt.

Understanding EBIT

EBIT is an acronym that stands for income before interest and taxes.

This is a company’s income before subtracting income taxes or interest.

EBIT is not a Generally Accepted Accounting Principle.

Still, it is a way of showing a company’s operational earnings as well as its profit earning abilities.

EBIT is often used by people within a company to look at the company’s operational performance as well as its profits.

EBIT is also used by investors who want to better understand a company’s profits.

Two formulas can be used for calculating EBIT. Here are the formulas.

The following formula is considered the direct method for obtaining EBIT.

EBIT = Earnings – Cost of Goods Sold – Operating Expenses

The other formula is considered the indirect method for finding EBIT.

Earnings Before Interest and Tax = Net income + Interest expenses + Tax expense

The Formula for EV to EBIT

Here is the formula for EV to EBIT.

EV to EBIT formula = Enterprise Value / EBIT = EV / EBIT = (Market Capitalization + Debt + Minority Interest + Preference Shares – Cash & Cash Equivalents)/EBIT

This formula measures whether or not a company’s shares are expensive or not when compared to competing firms or the market as a whole.

The ratio is a better version of the traditional P/E multiple in that it does not have the limitations this multiple had because it has a balance sheet.

The EV to EBIT formula uses the enterprise value, which includes debt, instead of solely using the share price of the company.

The P/E ratio is an easy valuation technique to use and can be used to measure the ability of a company to generate profits as compared to the market, and it is also a very common valuation technique.

The EV to EBIT ratio is sometimes used along with the P/E multiple to compare the profit expansion of different firms in industries that have a lot of debt, such as highly capital-intensive companies.

This ratio can be used to determine whether a company is over or undervalued by looking at whether the multiple is small or large.

A smaller value is typically considered better. Investors can look at this multiple to assess the ability of a company to generate profits and to compare a company to other companies when choosing a stock to invest in.

EV to EBIT Ratio Vs. EV to EBITDA

EV to EBIT is less often used than EV to EBITDA, which provides an indication of a company’s value in relation to its earning capability, but it remains a valuable tool for analyzing the value of an investment as well as in comparisons between multiple similar equity offerings.

The most significant difference between these two ratios is that EV to EBIT includes both depreciation and amortization, which for companies in which fixed assets play a significant role can provide a more accurate analysis of value.

When used to analyze low capital intensive industries, these two metrics will provide very similar results and can be used near interchangeably.

Value of the EV to EBIT Ratio

The EV to EBIT ratio is a valuable metric for investors and analysts in analyzing the value of a given stock.

If an investor were to calculate the EV to EBIT ratio for a given equity investment and receives a high result, this would indicate that the stock is overvalued, and they may wish to investigate further before making an investment.

However, an opposite result would indicate that the stock may be undervalued and that share prices are below the actual value of a company’s worth.

As this shows, the EV to EBIT ratio can be a valuable tool for providing an analysis of the actual value of a company.

However, as with any metric used to analyze investment opportunities, it should not be used as a sole indication of a potential investment’s value.

Instead, it should be used in addition to other valuation multiples in order to gain a well-rounded picture of any company’s actual health and value as an investment, as well as if the market is providing a valid interpretation of a given investment’s value.

Final Thoughts

EV to EBIT, though less often used than EV to EBITDA, remains a valuable tool among investors and analysts due to its ability to provide a unique valuation perspective.

When used in addition to other tools, it can help indicate if the market is providing an accurate view of an investment’s value.