The EV/EBITDA multiple for a company can be found by comparing the enterprise value, or EV, to the earnings before interest, taxes, depreciation and amortization, or EBITDA.
The EV/EBITDA Multiple Ratio
The EV/EBITDA ratio is a metric widely used to help investors determine the value of a business. It compares a company’s value, including debt and liabilities, to the its true cash earnings, less noncash expenses. This metric is often used to compare values of companies that operate in the same industry. Lower values can be an indication a company has been undervalued. Generally, analysts interpret any EV/EBITDA value below 10 as positive; however, it is still important to consider the value in relation to EV/EBITDA values of similar firms.
Calculating the EV/EBITDA
The name of the ratio essentially gives away the formula used for its calculation:
Value=EBITDAEVwhere:EV=Enterprise valueEBITDA=Earnings before interest, taxes,depreciation and amortization
To determine the value, the company’s enterprise value is divided by its earnings before interest, taxes, depreciation and amortization. Enterprise value is calculated as the company's total market capitalization plus debt and preferred shares, minus the company's total cash.
Benefits of the Metric
The EV/EBITDA multiple is often used in conjunction with, or instead of, the price-to-earnings, or P/E, ratio. The former is sometimes considered a better valuation tool for potential investors because it is not affected by changes in a company’s capital structure and makes it possible to obtain fair comparisons of companies that have different capital structures. One other advantage of the multiple is it eliminates the effects of noncash expenses that are not typically a major consideration of investors.