The EV/EBITDA ratio is a popular valuation metric that is used for estimating business valuation. It compares the price (or market cap) of the company adjusting for cash, debt and other liabilities compared to the earnings. It is a more advanced version of the PE ratio as it takes into account the company cash and debt situation.
The formula for calculating enterprise multiple is:
Enterprise multiple = EV / EBITDA
Where EV or enterprise value is calculated as taking the market equity value (market cap) plus its debt (total debt) less any cash.
Enterprise value (EV) = Market cap + total debt - cash
The Enterprise value measures the value of a company’s business instead of only measuring the market value of the company. In a way is calculating how much it would cost to buy the business free of its debts and liabilities.
The EBITDA stands for earnings before interests, taxes, depreciation and amortisation. It often used in valuation as a proxy for cash flow.
Since EV/EBITDA is a valuation metric, lower enterprise multiple can be indicative of the company being undervalued. Usually, EV/EBITDA values below 10 are seen as desirable (undervalued). However it’s better when the enterprise multiple is used to compare the value of one company to the value of another company within the same industry and sector as multiple averages generally differ depending on the sector and industry.
|RF Regions Financial Corp||2.73||$10.32B||Banks - Regional|
|AMP Ameriprise Financial Inc||2.96||$17.48B||Asset Management|
|MET Metlife Inc||2.97||$32.76B||Insurance - Life|
|BEN Franklin Resources Inc||2.98||$9.7B||Asset Management|
|RJF Raymond James Financial Inc||3.12||$9.48B||Capital Markets|
The EV/EBITDA ratio tells investors how many times EBITDA they have to pay if they where to acquire the whole business. It’s a good way to compare relative values of different businesses especially when evaluating stable and mature businesses. Since the ratio is not affected by capital structure changes (unlike PE ratio) it makes it possible to do a more fair comparison of companies with different capital structures.
One of the main downsides is that this ratio does not take into account growth rates and growth potential of the business and since it uses EBITDA does not adjust for capital expenditures which depending on the industry can be an important expense.