EV to EBITDA Valuation

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EV to EBITDA Valuation –

EV to EBITDA Valuation is a valuation metric used to compare a company’s value. The EV/EBITDA ratio can be calculated by dividing Enterprise Value by Earnings Before Interest, Tax, Depreciation, and Amortization. Enterprise value gives a more clear picture of the company’s debt and cash than market capitalization. EBITDA is useful to measure a company’s financial performance and profitability. Normally a ratio below 10 is a sign of a healthy company. The EV/EBITDA ratio varies from industry to industry. To calculate this ratio, we need to calculate the EV and EBITDA of a company.

EV Calculation –

Enterprise Value can be calculated by adding the company’s market capitalization with the Debt of a company and subtracting cash. The difference between market cap and enterprise value is market cap calculates only the equity side but enterprise value calculates all equity, debt, and cash. Enterprise value can be used for acquisitions and mergers or takeovers. EV provides a better accurate estimate for acquisitions or takeovers. EV is also used for ratio calculations as it provides better estimates.

Enterprise Value = Market Cap + Debt – Cash

EBITDA Calculation –

EBITDA means Earnings Before Interest, Tax, Depreciation, and Amortization. In another way, we can say EBITDA means adding operating profit/earnings with depreciation and amortization. Operating profit is calculated by adding net profit, interest, and tax.

EBITDA = Earnings + Interest + Tax + Depreciation + Amortization

EV / EBITDA Ratio – Enterprise Value Multiples

We have discussed EV and EBITDA and their formulas now we will discuss how to use these terms for valuation. As we know enterprise value is the price you pay to acquire the company at the current juncture and EBITDA is Earnings Before Interest, Tax, Depreciation, and Amortization. So EV/EBITDA tells us about the payback period of your investment in the company. EV/EBITDA of 10 shows that it takes approximately 10 years for you to recover the cost of acquiring the company through EBITDA.

EV/EBITDA ratio is used to determine whether a company is undervalued or overvalued. The ratio lower compared to peers or sector ratio indicates that a company might be undervalued. A ratio higher compared to peers or sector ratio indicates that a company might be overvalued. The ratio should be higher for high-growth companies and lower for slow-growth companies.

EV / EBITDA Formula –

EV / EBITDA ratio can be calculated by dividing Enterprise Value by EBITDA.

EV / EBITDA = Enterprise Value / EBITDA

EV – Enterprise Value

EBITDA – Earnings Before Interest, Tax, Depreciation and Amortization.

EV / EBITDA Example –

Let’s take example of company A,

Enterprise Value = Market cap + Debt – Cash

Enterprise Value = 300 + 90 – 80

Enterprise Value of company A = 310

EBITDA is given which is 25,

EBITDA of company A = 25

Now we can calculate EV/EBITDA,

EV / EBITDA = Enterprise VALUE / EBITDA

EV / EBITDA = 310 / 25

EV / EBITDA of company A = 12.4

Now, Let’s take example of company B,

Enterprise Value = Market cap + Debt – Cash

Enterprise Value = 600 + 170 – 190

Enterprise Value of company B = 580

EBITDA is given which is 70,

EBITDA of company B = 70

Now we can calculate EV/EBITDA,

EV / EBITDA = Enterprise VALUE / EBITDA

EV / EBITDA = 580 / 70

EV / EBITDA of company B = 8.3

EV / EBITDA Meaning –

From the above example, we have calculated the EV/EBITDA ratio of company A is 12.4 and company B to be 8.3. Let’s consider the sector EV/EBITDA ratio is 10, So now we can conclude that company A is overvalued and company B is undervalued. The simple meaning of this ratio is how much multiple the enterprise value is of the EBITDA. EV/EBITDA works better in the case of service companies and the P/E ratio works well for manufacturing companies and companies where the business model is matured.

Key Takeaways from EV / EBITDA Ratio –

1. EV to EBITDA Valuation is used to compare a company’s value.
2. A lower ratio indicates the undervalued sign and a higher ratio indicates the overvalued sign depending on the sector.
3. EV/EBITDA ratio simply means how much multiple the Enterprise Value of the EBITDA.
4. The ratio tells us the payback period of the investment.
5. A ratio below 10 is a sign of a healthy company.

Check the Articles below for more

1. Investopedia