What is the 'EBIT/EV Multiple'

The EBIT/EV multiple is a financial ratio used to measure a company's "earnings yield." EBIT stands for earnings before income and taxes, while EV is enterprise value. The concept of this multiple as a proxy for earnings yield was introduced by Joel Greenblatt, a noteworthy value investor and professor at Columbia Business School.

BREAKING DOWN 'EBIT/EV Multiple'

Enterprise value is market capitalization + debt + minority interest + preferred stock - cash. For the vast majority of companies, since minority interest and preferred stock in the capital structure is uncommon, EV is market cap + debt - cash. If EBIT/EV is supposed to be an earnings yield, the higher the multiple, the better for an investor. Thus, there is an implicit bias towards companies with lower levels of debt and higher amounts of cash. A company with a leveraged balance sheet, all else equal, is riskier than a company with less leverage. The company with modest amounts of debt and/or greater cash holdings will have a smaller EV, which would produce a higher earnings yield.

The EBIT/EV ratio can provide a better comparison than more conventional profitability ratios like return on equity (ROE) or return on invested capital (ROIC). While the EBIT/EV ratio is not commonly used, it does have a couple of key advantages in comparing companies. First, using EBIT as a measure of profitability, as opposed to net income, eliminates the potentially distorting effects of differences in tax rates. Second, using EBIT/EV normalizes for effects of different capital structures. Greenblatt states that EBIT "allows us to put companies with different levels of debt and different tax rates on an equal footing when comparing earnings yields." EV, to Greenblatt, is more appropriate as the denominator because it takes into account the value of debt as well as the market capitalization. A downside to the EBIT/EV ratio is that it does not normalize for depreciation and amortization costs. Thus, there are still potential distorting effects when companies use differing methods of accounting for fixed assets.

Example of EBIT/EV Multiple

Say Company X has EBIT of $3.5 billion, market capitalization of $40 billion, $7 billion in debt, and $1.5 billion in cash. Company Z has EBIT of $1.3 billion, market cap of $18 billion, $12 billion in debt, and $0.6 billion in cash. EBIT/EV for Company X would be approximately 7.7% while the earnings yield for Company Z would be approximately 4.4%. Company X's earnings yield is superior not only because it has greater EBIT, but also because it has lower leverage.

RELATED TERMS
  1. Capitalization Ratios

    Capitalization ratios are indicators that measure the proportion ...
  2. Debt Ratio

    The debt ratio is a financial ratio that measures the extent ...
  3. Times Interest Earned - TIE

    Times interest earned (TIE) is a metric used to measure a company's ...
  4. Enterprise Multiple

    Enterprise multiple is a measure (the company's enterprise value ...
  5. Funded Debt

    A funded debt is a company's debt that will mature in more than ...
  6. Earnings Yield

    The earnings yield refers to the earnings per share for the most ...
Related Articles
  1. Investing

    Using Enterprise Value To Compare Companies

    Learn how enterprise value can help investors compare companies with different capital structures.
  2. Investing

    Target Corp: WACC Analysis (TGT)

    Learn about the importance of capital structure when making investment decisions, and how Target's capital structure compares against the rest of the industry.
  3. Investing

    Analyzing IBM's Debt Ratios in 2016 (IBM)

    Look over the debt ratios for the IBM Corporation, such as its debt-to-equity ratio, its interest coverage ratio and its cash flow to debt ratio.
  4. Investing

    Analyzing AT&T's Debt Ratios in 2016 (T)

    Learn about AT&T Inc. and its key debt ratios, such as the debt-to-equity ratio, interest coverage ratio and cash flow-to-debt ratio.
  5. Investing

    Key Financial Ratios for Retail Companies

    Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
  6. Investing

    McDonald's Stock: Capital Structure Analysis (MCD)

    Learn about the importance of capital structure, and what equity and debt capitalization measures can tell us about the performance of McDonald's Corporation.
  7. Investing

    5 Common Trading Multiples Used In Oil And Gas Valuation

    Before you decide to invest in oil and gas, you should understand these multiples.
  8. Investing

    GM Stock: Capital Structure Analysis

    Learn why GM's enterprise value increased, and get an update on the company's capital structure, including equity and debt capitalization.
  9. Investing

    Yahoo Stock: Capital Structure Analysis (YHOO)

    Learn about Yahoo's capital structure, including whether or not a decline in year-over-year earnings is leading the company to use more debt.
RELATED FAQS
  1. NOI (net operating income) versus EBIT (earnings before interest and taxes): What's ...

    Find out about net operating income (NOI), earnings before interest and taxes (EBIT), why they are not equivalent, and which ... Read Answer >>
  2. What are the most common leverage ratios for evaluating a company?

    Learn more about some of the most common leverage ratios used by traders to determine whether a company is using debt in ... Read Answer >>
  3. What are some strategies companies commonly use to reduce their debt to capital ratio?

    Explore the different strategies that companies can employ and steps that can be taken to reduce a company's debt to capital ... Read Answer >>
  4. What are financial risk ratios and how are they used to measure risk?

    Explore some of the primary financial risk ratios that investors and analysts commonly use to evaluate a company's overall ... Read Answer >>
  5. What is the difference between the gearing ratio and the debt-to-equity ratio?

    Dive deeper into gearing ratios: what are they, how are they used and why the debt to equity ratio is one of the most popular ... Read Answer >>
  6. How does degree of financial leverage (DFL) affect earnings per share (EPS)?

    Learn about degree of financial leverage, how to calculate a company's DFL and how the DFL affects earnings per share. Read Answer >>
Trading Center