EV/EBITDA or Enterprise multiple is a ratio that helps investors estimate a company’s value. The enterprise multiple considers the company in the same way that a potential acquirer would because it includes debt, which other ratios such as the P/E ratio do not. In other words, if an investor were to buy the entire company, this ratio would inform them how many times EBITDA they would have to pay.
The enterprise value of earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) ratio differs across industries. EBITDA is a key metric of a company’s overall financial performance, while EV measures the company’s total value.
In general, EV/EBITDA ratios of less than 10 are considered safe. However, it is not the same across different industries. An effective way for investors to identify companies with the healthiest EV/EBITDA within a specific sector is to compare relative values among companies in the same industry. It is possible to determine if a sector or industry is currently undervalued or overvalued by comparing its current enterprise multiple to its historical average value.
Enterprise Value (EV)
Enterprise value is a metric to calculate a company’s total value. Some investors check a company’s market capitalization to know a company’s value, while others look at an enterprise value to know its worth. Investors often consider enterprise value rather than market capitalization because it provides a clearer view of a company’s actual value. Some people believe enterprise value gives more accurate data about a company’s actual value because it considers the amount of debt the company has and its cash reserves.
Investors calculate the enterprise value of a company by taking market capitalization, adding the total debt (including long-and short-term debt), and subtracting all cash and cash equivalents. The result shows how much money investors will need to buy the whole company.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
Investors often use EBITDA to measure a company’s financial performance and profitability. EBITDA can be easily found on a company’s balance sheet and income statement. Investors can compare a specific company to other industry averages and companies.
The EV/EBITDA Calculation
To calculate the EV/EBITDA ratio, you can divide EV by EBITDA (earnings before interest, taxes, and depreciation & amortization).
Let’s imagine company 1 and Company 2 are competing in the apparel industry that operates in Canada. Company 1 has an enterprise value of $100M and an EBITDA of $5M, while company 2 has an enterprise value of $200M and an EBITDA of $15M. Holding everything else constant, we can realize that company 2 is undervalued since it has a lower ratio than company 1. Because, typically, the lower the EV/EBITDA, the cheaper the valuation for a company.
|EV = $100M
|EV = $200M
|EBITDA = $5M
|EBITDA = $20M
|EV/EBITDA = $100M/$5M = 20x
|EV/EBITDA = $200M/$20M = 10x
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