The EV-to-EBITDA multiple explained.

The EV-to-EBITDA Multiple is a “valuation metric” used to measure the fair market value of a company. I value the EV/EBITDA ratio above the Price-to-Earnings ratio as the Enterprise Value and the EBITDA component tend to be a lot more in-depth than the price and the earnings alone. Using the total EV against the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) allows us to value similar companies side by side from the perspective of an acquirer.

The EV/EBITDA ratio measures the entire value of a business against the amount of EBITDA it earns on an annual basis. It gives investors an idea of how many times the EBITDA they have to pay, were they to acquire the entire business. EV/EBITDA is an important ratio because it considers non-cash expenses and gives a better picture of a company’s financial position with its potential to generate cash flow.

The main criticism is the use of EBITDA in the ratio which does come with drawbacks. EBITDA allows wider discretion on what can or can’t be added within the calculation. Management can alter the EBITDA over different reporting seasons. Many legendary investors have criticised the use of it, especially those who think EBITDA is a representation of cash earnings and a proxy for operating cash flow. Whilst it can measure profitability it is not a good measure for cash flow. The exclusion of working capital from EBITDA can be vital in valuing a capital-intensive business.

The EV/EBITDA multiple can be used to compare companies with different levels of debt as its use of the Enterprise Value makes it independent of capital structure (Shareholders Equity and Debt). The question investors need to ask is “How much are we willing to pay for every dollar of EBITDA that is generated?”

The EV-to-EBITDA multiple is a great way to scan for opportunities. Low multiples are often considered Undervalued with higher multiples considered Overvalued. It is all dependent on industries and I have found it more useful in capital-intensive sectors. Higher multiples like the P/E ratio are often found in higher growth sectors.

What is the EV-to-EBITDA formula?

• EV-to-EBITDA = Enterprise Value ÷ EBITDA
• Enterprise Value = Market Cap + Total Debt + Preferred Equity + Minority Shares – Cash – Cash Equivalents.
• EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation.

How to use the EBITDA Multiple?

In our example below we will use the same two companies from our Enterprise Value discussion and then we will add in the EBITDA calculations to work out our EV/EBITDA multiple. The multiple should be used against an industry benchmark and with business at the same stage of the business cycle, for example, don’t measure a hyper-growth company against a maturing growth one. Let’s assume an industry benchmark of EV/EBITDA of 10x.

	Company A	Company B
Market Cap (Equity)	$5.5 billion	$5.5 billion
(+) Total Debt	–	$1.2 billion
(+) Preferred Equity	$98 million	$133 million
(+) Minority Interest	–	$5 million
(-) Cash	$1.2 billion	$75 million
Enterprise Value	$4.39 billion	$6.76 billion
Income Statement
Net Income	$387 million	$517 million
(+) Taxes	$46 million	$38 million
(+) Interest	$29 million	$17 million
(+) D&A	$31 million	$42 million
EBITDA	$493 million	$614 million
EV/EBITDA	8.9x	11x

Using a “bottom-up” approach to EBITDA we have our calculations below:

Company A $4.39b ÷ $493m = 8.9x

Company B $6.76b ÷ $614m = 11x

This is telling investors that Company A would cost 8.9x EBITDA if you were to buy the entire business. The lower EV/EBITDA multiple implies that Company A generates higher earnings relative to its enterprise value compared to Company B. Investors may take the view that Company A is more profitable and efficient.

If the industry benchmark is 10x we can see that Company A is undervalued compared to Company B. Before making assumptions that Company A is the better buy, we need to understand why it is undervalued and at the same time why Company B is being valued higher. A higher multiple may represent greater growth prospects or perhaps is lower risk as the market is prepared to pay more. Investors may have greater confidence in the company’s future and market position.

We have to also consider for a given level of cap-ex, a company which reports higher depreciation will have higher multiples.

When looking at an individual company and valuing it we can also use the multiple to look at how the business has been tracking. Simply looking at the past Enterprise Value and EBITDA we can gauge whether it is increasing or decreasing.

For example let’s take Company A and look back over the past 3 years:

	2021 FY	2022 FY	2023 FY
Enterprise Value	$2.9 billion	$3.5 billion	$4.39 billion
EBITDA	$487 million	$507 million	$493 million
EV/EBITDA	5.95x	6.9x	8.9x

So in this simplified case and putting previous years side by side we see that there is a significant change in the EBITDA multiple. As it increases, we need to research is it becoming overvalued or perhaps investor sentiment is growing. What is causing the denominators to change in the ratio?

In Summary…

The ratio like everything else is all dependent on what you are looking for and your investment style. Low Multiples often means undervaluation (be careful of a value trap the lower it is). Higher multiples can either mean overvaluation or strong growth prospects, in which case further analysis may reveal which one it is. Using the EV/EBITDA multiple alongside other ratios is a must.

I use this ratio more than the others including the P/E. I believe it helps to rephrase the valuation question especially considering enterprise value. For example, if I notice a company with a high EV/EBITDA of say 25x, I don’t immediately discount it or get all jittery that I’ve found a hyper growth prospect. Invert the question “In the private markets could a company like this command 25x EBITDA? What makes it so special to be valued so high?”

My own experiences in private markets have helped me to look at these valuations with a little more understanding having sold companies before. I also look at a business with perhaps a low multiple and think this would sell for a lot more on the private markets and is therefore undervalued based on 1) The underlying business is strong with rising earnings or sales, no debt, big TAM (total addressable market) ahead and 2) This will surely be noticed by private equity or another M&A firm.

I find these mispricing’s mostly in the micro-cap to small-cap part of the market where there is a lot more inefficiency in price to value.