What is EBITDA/EV Multiple
The EBITDA/EV multiple is a financial valuation ratio that measures a company's return on investment. The EBITDA/EV ratio may be preferred over other measures of return because it is normalized for differences between companies. Using EBITDA normalizes for differences in capital structure, taxation, and fixed asset accounting. The enterprise value (EV) also normalizes for differences in a company's capital structure.
BREAKING DOWN EBITDA/EV Multiple
EBITDA/EV is a comparables analysis method that seeks to value similar companies using the same financial metrics. While computing the EBITDA/EV ratio is more complicated than other return measures, it is sometimes preferred because it provides a normalized ratio for comparing the operations of different companies. If a more conventional ratio (such as net income to equity) were used, comparisons would be skewed by each company's accounting policies. An analyst using EBITDA/EV assumes that a certain ratio is applicable and can be applied to various companies operating within the same line of business or industry. In other words, the theory is that when firms are comparable, this multiples approach can be used to determine the value of one firm based on the value of another. Thus, EBITDA/EV is commonly used to compare companies within an industry.
This is a modification of the ratio of operating and non-operating profits compared to the market value of a company's equity plus its debt. Since EBITDA is often considered a proxy for cash income, the metric is used as a measure of a company's cash return on investment.
Breaking It Down
"EBITDA" is an acronym that stands for earnings before interest, taxes, depreciation and amortization. However, the measure is not based on U.S. generally accepted accounting principles (GAAP). In April 2016, the Securities and Exchange Commission (SEC) stated non-GAAP measures such as EBITDA would be a focal point for the agency to ensure that companies are not presenting results in a misleading manner. If EBITDA is shown, the SEC advises that the company should reconcile the metric to net income. This should assist investors by providing information on how the figure is calculated.
Enterprise value (EV) is a measure of the economic value of a company. It is frequently used to determine the value of the business if it is acquired. It is considered to be a better valuation measure than market capitalization, since the latter factors in only a business' equity without regard to the debt. EV is calculated as the market capitalization plus debt, preferred stock, and minority interest, minus cash. An entity purchasing a company would have to pay the value of the equity and assume the debt, but the cash would reduce the price paid.
The EBITDA/EV uses the cash flows of a business to evaluate the value of a company. When the EBITDA is compared to enterprise revenue, an investor can tell if a business has cash flow issues. A business with healthy cash flow will have a high value. For example, Wal-Mart Inc.'s EBITDA for the fiscal year ended January 31, 2018 was $32.17 billion. Its enterprise value was $290.17 billion during this period. This works out to an EBITDA/EV multiple of 0.1109, or 11.09%.
The reciprocate multiple EV/EBITDA is used to measure the value of a company.