EV/EBITDA: valuing a company independently of its debt

The P/E ratio compares a share's price with earnings per share. It has a flaw: two companies with identical activities but different debt levels can show very different P/E ratios. EV/EBITDA addresses this by valuing the whole company, debt included, against its operating performance. This article explains its two components, the calculation and the reading of the ratio, and its limits.

Enterprise value (EV): the price of the whole

Enterprise value (EV) is the price you would have to pay to acquire the entire company, net debt included:

EV = market capitalisation + net financial debt (+ minority interests and other similar items)

Net debt is financial debt minus available cash. A company holding more cash than debt has negative net debt: its EV is then lower than its market capitalisation.

EBITDA: operating performance before depreciation

EBITDA (earnings before interest, taxes, depreciation and amortisation) is the result before interest, taxes, impairments and depreciation; in practice, operating profit plus depreciation, amortisation and impairment charges. It measures what the current business generates, independently of how the company is financed, its taxation and its depreciation policy. You find it, or reconstruct it, from the income statement: see how to read a balance sheet and an income statement.

Calculating EV/EBITDA

EV/EBITDA = enterprise value ÷ EBITDA

Fictitious example. A company has a market capitalisation of €800M, financial debt of €300M and cash of €100M. Its EV is 800 + 300 − 100 = €1,000M. Its annual EBITDA is €125M. Its EV/EBITDA is 1,000 ÷ 125 = 8.

Read simply, this means the company's value is equal to 8 times its annual EBITDA.

Why EV/EBITDA rather than P/E?

It is less sensitive to the financing structure. The P/E ratio looks only at the shareholders' share; EV/EBITDA values the whole company, whatever its financing structure.
It is less sensitive to taxation and depreciation, which vary by country and accounting policy.
It can be used when earnings are low or negative, as long as EBITDA remains positive.

It is read alongside the P/E ratio, not in its place: see the P/E ratio and how to read it and price to book.

How to read a high or low EV/EBITDA

A low EV/EBITDA indicates that the company is valued modestly relative to its operations; a high EV/EBITDA indicates that the market expects growth or strong profitability. Neither is a verdict: a low ratio can reflect a declining sector, a high ratio a fast-growing one.

There is no universal threshold. Comparison is meaningful only between companies in the same sector, and on comparable EBITDA definitions. For sectors, see the 11 stock market sectors.

The limits of EV/EBITDA

It ignores investment. EBITDA does not take into account the spending needed to maintain the production base: a very capital-intensive company can look cheap. Free cash flow complements this point: see free cash flow.
It depends on accounting standards. The treatment of lease contracts (for example IFRS 16, depending on the standards the company applies) changes EBITDA and debt: compare figures established in the same way.
It is not suited to banks and insurers, whose debt is part of the business.
EBITDA is not a standardised accounting result: each company may define it in its own way, with adjustments.

Key takeaways

EV/EBITDA = (market capitalisation + net debt + similar items) ÷ EBITDA.
It values the whole company, independently of its financing structure.
It is compared within the same sector, with comparable definitions.
It ignores investment and is read together with the P/E ratio and free cash flow.

This article is for information and education only and does not constitute personalised investment advice. The figures in the examples are fictitious and illustrative.