EV/EBITDA

Enterprise value is market capitalisation plus net debt: the cost of acquiring the company outright, since a buyer assumes the borrowings and receives the cash. EBITDA is earnings before interest, tax, depreciation and amortisation. The ratio states the price paid for each dollar of operating profit before financing and accounting choices.

Both halves sit before financing, which is the reason to reach for it. A P/E sets equity value against profit measured after interest, so the same operating business financed two ways produces two different P/E ratios.

The table takes one business, $100m of operating profit and $20m of depreciation, and finances it twice: once with no debt and once with $400m of borrowing at 5%. Tax is 25% in both cases and the operations are identical.

The levered company looks cheaper on a P/E, at 12.1x against 15.0x, purely because interest has reduced its net income and its equity is a smaller share of the same business. On EV/EBITDA both come out at 9.4x, which is the correct answer: it is the same company doing the same thing.

That is the whole case for the multiple. It is standard in acquisitions for the same reason, since an acquirer really does assume the debt.

Adding back depreciation treats the consumption of assets as though it were not a cost. For a software company with few physical assets the effect is small. For an airline, a telecom operator or a manufacturer, the aircraft, network and machinery do wear out, and the money to replace them is not optional.

It also excludes interest, which a leveraged company must pay, and tax, which is real. A company can report healthy EBITDA and still not generate enough cash to service its debt, which is why the multiple is read alongside a leverage measure rather than on its own.

The well-known objection, that EBITDA means earnings before the costs you would rather not think about, is unfair as a general rule and fair often enough to be worth carrying.

Most established, profitable companies have historically traded in a broad band of roughly 8x to 15x. Software and other asset-light businesses sit well above it, and cyclical, capital-heavy industries well below. The band is wide enough that a number only means something beside comparable companies in the same industry.

Net debt to EBITDA, which the screener carries alongside, answers what the multiple cannot: how much of the enterprise value is borrowed, and whether operating profit covers it. Around 3x is a common threshold for lenders, and above 5x the company is usually described as highly leveraged.

A low EV/EBITDA on a company at five times net debt is a different proposition from the same multiple with no borrowings, and the two are frequently confused when screening on the multiple alone.

Comparing companies in the same industry with different capital structures, which is the case it was designed for.

Valuing a business that is loss-making after depreciation but cash-generative before it, where a P/E returns a negative number and says nothing.

Framing what an acquirer would pay, since acquisition prices are quoted on enterprise value.

Comparing across borders, where interest costs and tax rates differ enough to make net income comparisons awkward.

The unadjusted figure is defined by the income statement. Adjusted EBITDA is defined by management, and it adds back whatever the company considers unrepresentative: restructuring, acquisition costs, litigation, and frequently stock-based compensation.

A restructuring charge that recurs every year for a decade is not unrepresentative. Where adjusted and unadjusted EBITDA differ materially and persistently, the gap is the figure to examine, and a multiple quoted on the adjusted number is not comparable with one quoted on the reported number.

Comparing the multiple across industries, where capital intensity and growth differ structurally.

Reading a low multiple as cheap without checking net debt to EBITDA beside it.

Using EBITDA as a proxy for cash flow at a capital-heavy company, where the replacement spending it ignores is the largest cost the business has.

Mixing an adjusted EBITDA against a reported one when comparing two companies.

Applying it to banks and insurers, where interest is operating income rather than a financing cost and the whole construction breaks down.