EV to EBITDADefined along with Examples

Written By:
Lisa Borga

The EV to EBITDA is an important valuation metric that is useful for measuring a company’s value as compared to similar stocks in its sector.

EV stands for enterprise value which is the sum of preferred shares, debt minus cash, minority shares, and market capitalization; whereas EBITDA is earnings before interest, taxes, depreciation, and amortization, and EV to EBITDA is a ratio between these two values.

This ratio can help an investor in assessing the valuation of a company by helping them to compare the valuation of the company to a similar company in the same industry or a similar industry.

Generally, if a company has an EV to EBITDA multiple that is less than ten, it is considered good.

What Is Enterprise Value?

Enterprise value is used to compute the total monetary value of a company.

Enterprise value is generally considered more useful for investors than market capitalization since it provides a better overall view of the value of a company.

This is because EV considers a company’s cash reserves as well as its debt in addition to the market capitalization value.

Calculating EV

In order to compute enterprise value, a company’s preferred interest values, debt, and minority interest are added to the market capitalization value.

Then the total of the company’s cash and cash equivalents are subtracted from this value. Here is the formula for enterprise value.

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

The enterprise value indicates the amount of money an investor would need to purchase a company.

The investors purchasing the company would have to assume the company’s debt. Including debt in the calculation of enterprise value is part of why it is considered to be a good metric when considering the value of a company.

This is because debt is considered a very important consideration when a takeover of a company is being considered.

What Is EBITDA?

EBITDA is a way of representing a company’s profitability and financial performance.

This is a basic metric that can be computed by investors by using values that can be found on the balance sheet and income statement of a company.

This metric allows investors to compare a company to other companies in the same industry by using the industry averages of these other companies.

EBITDA Formula

EBITDA is a company’s earnings before interest, taxes, depreciation, and amortization.

This is a way of representing a company’s financial performance and can help investors determine the potential of a company as far as its ability to generate profits is concerned.

Here is the formula for EBITDA.

EBITDA = Operating Profit + Depreciation + Amortization

The operating profit in this formula is the sum of the net profit, taxes, and interest.

Amortization expense and depreciation expense are also important in this calculation. A short description of these terms follows to help you understand them.

Depreciation

Depreciation is an accounting technique in which the cost of an asset is spread out over the expected useful lifespan of the asset.

Depreciation allows a company to reduce its taxes because it reduces the earnings on which it pays taxes.

Amortization

Amortization is a way of distributing the cost of an intangible asset over time.

Amortization expenses the cost of the intangible asset over its useful lifespan.

Advantages of the EV to EBITDA Ratio

A lower EV to EBITDA value is considered better, as is the case with the price-to-earnings ratio.

When this value is lower, it means a cheaper valuation for the company.

The price-to-earnings ratio is used more commonly as a valuation tool for companies.

However, there are advantages to using both the EV to EBITDA and the price-to-earnings ratio.

Some investors even prefer to invest in companies that have a low EV to EBITDA ratio and a low price-to-earnings ratio along with good dividend growth.

A high EV to EBITDA ratio indicates that a company may be overvalued.

Although, it is essential to remember that the ratio is only considered to be dependable when used to compare companies that are in the same sector.

Key Takeaways

• The EV to EBITDA ratio compares a company’s value, including debt, to its cash earnings minus non-cash expenses.
• The EV to EBITDA is a commonly used valuation tool which allows investors to compare different companies to determine which they believe would be a good investment.
• EV is a measure of the total value of a company. Whereas EBITDA is a measure of the financial performance of a company.
• An EV to EBITDA value of less than ten is considered good.
• The EV to EBITDA multiple works best when comparing companies in the same sector or industry.