The enterprise value (EV) to the earnings before interest, taxes, depreciation, and amortization(EBITDA) ratio varies byindustry. However, theEV/EBITDAfor the S&P 500 has typicallyaveraged between 11 and 16 over thelast few years. EBITDA measures a firm's overall financial performance, while EV determines the firm's total value.
As of Dec. 2021, the averageEV/EBITDA for the S&P 500was 17.12. As a general guideline, an EV/EBITDA value below 10 is commonly interpreted as healthy and above average by analysts and investors.To gain a better understanding of how investors can use the EV/EBITDA metric to analyze stocks, we'll take a closer look at each component of the metric and discuss some of the metric's advantages.
Key Takeaways
- The enterprise value to earnings before interest, taxes, depreciation, and amortization ratio (EV/EBITDA) compares the value of a company—debt included—to the company’s cash earnings less non-cash expenses.
- The EV/EBITDA metric is a popular valuation tool that helps investors compare companies in order to make an investment decision.
- EV calculates a company's total value or assessed worth, while EBITDA measures a company's overall financial performance and profitability.
- Typically, when evaluating a company, an EV/EBITDA value below 10 is seen as healthy.
- It's best to use the EV/EBITDA metric when comparing companies within the same industry or sector.
Enterprise Value (EV)
Investors and analysts use the enterprise value (EV) metric to calculate a company's total monetary value or assessed worth. While some investors simply look at a company's market capitalization to determine a company's worth, other investors believe the enterprise value metric gives a more complete picture of a company's true value. That's because the enterprise value also takes into consideration the amount of debt the company carries and its cash reserves.
Calculating Enterprise Value (EV)
To calculate enterprise value, determine the company's market capitalization by multiplying the company's outstanding shares by the current market price of one share. To this number, add the company's total long-term and short-term debt. Lastly, subtract the company's cash and cash equivalents. You now have the company's enterprise value.
This result shows how much money would be needed to buy an entire company. The enterprise value calculates the theoretical takeover price one company would need to pay to acquire another company. While there are other factors that might play into a final acquisition price, enterprise value gives a more comprehensive alternative to determine a company's worth than market capitalization alone.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
Investors use EBITDA as a useful way to measure a company's overall financial performance and profitability. EBITDA is a straightforward metric that investors can calculate using numbers found on a company's balance sheet and income statement. EBITDA helps investors compare a company against industry averages and against other companies.
Calculating EBITDA
To calculate EBITDA for a company, you'll need to first find the earnings, tax, and interest figures on the company's income statement. You can find the depreciation and amortization amounts in the company's cash flow statement. However, a useful shortcut to calculate EBITDA is to begin with the company's operating profit, also known as earnings before interest and taxes (EBIT). From there you can add back depreciation and amortization.
The EV/EBITDA Multiple
The EV/EBITDA ratio is a popular metric used as a valuation tool to compare the value of a company, debt included, to the company’s cash earnings less non-cash expenses. It'sideal for analysts andinvestors looking to compare companies within the same industry.
Theenterprise-value-to-EBITDA ratiois calculated by dividing EV byEBITDA orearnings before interest, taxes, depreciation, and amortization. Typically, EV/EBITDA values below 10 are seen as healthy. However, thecomparison of relative values among companies withinthe same industry is the bestway for investors to determine companies with the healthiest EV/EBITDA within a specific sector.
Benefits of EV/EBITDA Analysis
Just like the P/E ratio (price-to-earnings), the lower theEV/EBITDA, the cheaper the valuation for a company. Althoughthe P/Eratio is typicallyused as the go-to-valuation tool, there are benefits to using the P/E ratioalong with the EV/EBITDA. For example, many investors look for companiesthat have bothlow valuations usingP/E andEV/EBITDA and solid dividend growth.
What Does It Mean a High EV/EBITDA?
A high EV/EBITDA means that there is a potential the company is overvalued. It is important to remember that when using the ratio, you can only really apply it comparatively in a specific sector. Utilities will run at different ratios than consumer discretionary, for example.
What Does Negative EV/EBITDA Mean?
This metric can become confusing when it turns negative and is generally not a widely-used metric. For one, it doesn't give an accurate picture of a company's financial health if they are a startup. Secondly, a company could have sold a portion of their company and is sitting on a load of cash, skewing the ratio.
Why Use EV/EBITDA?
The ratio is most commonly used to compare companies in the same industry. It is a metric used as a valuation tool comparing a company's value to the company's earnings less non-cash expenses.
