What is the EV to EBITDA multiple? How do you calculate it and with what formula? Why is it important? If you're looking for answers to these questions, you've come to the right place. In this article, you will learn everything you need to know about it.

What Is The EV to EBTIDA Multiple?

The EV/EBITDA multiple, also known as the enterprise multiple, is the ratio between the enterprise value and the EBITDA of a company. The valuation metric compares the debt-included value (the real value) of a company to its cash earnings. Investors and analysts typically use it to compare businesses within the same industry.

The enterprise multiple functions similarly to the P/E ratio, but it is more useful when comparing business with varying degrees of financial leverage and valuing capital-intensive companies with abnormal levels of depreciation.

The P/E ratio is equal to a company's market capitalization divided by its net income, so it doesn't consider the company's total value and it isn't appropriate to estimate the value of a company with a high level of depreciation and amortization.

How To Calculate The EV/EBITDA Ratio: Formula Explained

As discussed above, the enterprise multiple is the ratio between the enterprise value and the earnings before interest, taxes, depreciation, and amortization of a company. Below is the EV to EBITDA formula:

EV / EBITDA.

The reciprocal is:

EBITDA/EV.

Let's break down the individual components of the formula:

Enterprise Value (EV): Enterprise Value (EV), also referred to as Business Enterprise Value (BEV), reflects the entire business's market value. In laymen's terms, it's the amount an acquirer would have to pay to buy a business. In valuation terms, enterprise value represents the market value of the company's total operating assets. It is equal to:

Market Capitalization.
(+) Total Debt.
(+) Minority Interest and Other Liabilities.
(+) Preferred Equity.
(-) Cash And Cash Equivalents.
(-) Short Term Investments.
(-) Long Term Investments.
(-) Other Adjustments.

EBITDA: Earnings before Interest, Taxes, Depreciation, and Amortization, excluding unusual items. It is a commonly used metric in valuation since it gives analysts a clearer picture of operating profitability when comparing companies with different capital structures. It is equal to:

Earnings Before Taxes.
(+) Net Interest Expense.
(+) Non-Operating Expenses.
(+) Depreciation, Amortization.
(+) Unusual Expenses.

You can find a detailed explanation in this article.

Enterprise value to EBITDA Example Calculation

To illustrate, we can use the formula above to calculate Microsoft's (MSFT) enterprise value to earnings before interest, taxes, depreciation, and amortization. Using the Finbox data explorer, we can find the metrics required to apply the formula:

• Microsoft's Enterprise Value: $1,575.3 Billion.
• Microsoft's EBITDA: $68.1 Billion.

We can now calculate Microsoft's latest twelve months EV/EBITDA:

$1,575.3 / $68.1 = 23.13x.

Microsoft Corporation's EV/EBITDA of 23.1x ranks in the 80.1% percentile for the sector, making it one of the most expensive companies operating in the Information Technology sector in the United States.

Why is the EV/EBITDA ratio important?

You'll be surprised to learn that, according to James O'Shaughnessy's research, stocks with a low enterprise multiple widely outperform the market.

In his studies, he considers the entire U.S. stock market and divides the stocks into ten deciles according to the enterprise multiple. Stocks in the highest decile (those with the highest EV to EBITDA) drastically underperform the market. In contrast, stocks in the lowest decile (those with the lowest EV to EBITDA multiple) widely outperformed it.

In the 45-year backtest period between 1964 and 2009, stocks with the highest EV to EBITDA generated a 5% CAGR compared to the 11.22% CAGR of the overall market. At the same time, stocks with the lowest EV to EBITDA generated a 16.58% CAGR.

If you don't want to underperform the market, you should check in which decile your stocks are.

Microsoft's EV/EBITDA Analysis From The Finbox Data Explorer

Enterprise Value to EBITDA: Benchmarks by Sector

As of December 9, the sectors with the highest EV/EBITDA ratios are real estate, utilities, and consumer discretionary. Healthcare, communication services, and financials are the sectors with the lowest EV/EBITDA multiples.

Key Takeaways

• The EV EBITDA ratio is a valuation multiple between the enterprise value and the EBITDA of a company. It compares the debt-included value (the real value) of a company to its cash earnings, so it is useful when comparing business with varying degrees of financial leverage.
• It excludes depreciation and amortization, so it is also useful to value capital-intensive companies with abnormal depreciation and amortization levels.
• If you want to compare the enterprise multiple with earnings yield (the price to earnings ratio reciprocal), it could be useful to calculate the EBITDA/Enterprise Value ratio (the enterprise multiple reciprocal).
• According to James O'Shaughnessy's research, stocks with a low Enterprise value to EBITDA widely outperform the market. You can view the top 100 stocks with the lowest EV/EBITDA multiples here.