The standard multiple for valuation
The standard multiple for valuation
The EBITDA multiple is a financial ratio that compares a company’s Enterprise Value to its annual EBITDA. This multiple is used to determine the value of a company and compare it to the value of other, similar businesses.
A company’s EBITDA multiple provides a normalized ratio for differences in capital structure, taxation, fixed assets, and for comparing disparities of operations in various companies. It takes the enterprise value (which represents market capitalization plus net debt) of the company and compares it to the Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).
EBITDA Multiple = Enterprise Value / EBITDA
To Determine the Enterprise Value and EBITDA:
Enterprise Value = (market capitalization + value of debt + minority interest + preferred shares) – (cash and cash equivalents)
EBITDA = Earnings Before Tax + Interest + Depreciation + Amortization
Costco Wholesale Corp has an enterprise value of $69.3B as of Dec. 31, 2016. For the full year of 2016, its EBITDA was reported at $5.036B. The resulting EBITDA multiple is 13.76.
Enterprise value is the total value of a company, including common shares equity or market capitalization, short-term and long-term debts, minority interest, and preferred equity, while excluding cash or cash equivalents. In other words, enterprise value is the sum of all financial claims against the company, whether they are debt or equity, including special liabilities – unfunded pension, employee stock options, environmental provisions, and abandonment provisions.
Enterprise Value is considered a theoretical takeover price in mergers and acquisition transactions (before including a takeover premium). Cash or cash equivalents are not considered because they can reduce the net cost to a potential buyer by paying back debt.
To learn more, read a comparison of Enterprise Value vs Equity Value.
EBITDA or Earnings before interest, tax, depreciation, and amortization is the income derived from operations before non-cash expenses, income, taxes, and capital. It reflects the company’s financial performance in terms of profitability prior to certain uncontrollable expenses. A higher EBITDA margin indicates a company’s operating expenses are smaller than its total revenue, which leads to a profitable operation. EBITDA can also be compared to sales as an EBITDA Margin.
It’s important to pay close attention to what time period the EBITDA you’re using if from. In order for the EBITDA multiple to be comparable between companies, you have to the sure the EBITDA time periods line up. For example, year ended December 31, 2016 (historical results) or forecasted year end December 31, 2017 (forecast results). Forward-looking EBITDA multiples will usually be lower than backward-looking multiples, assuming that most
Forward-looking EBITDA multiples will usually be lower than backward-looking multiples, assuming that most companies have a growing EBITDA profile (the opposite would be true if their EBITDA was forecasted to shrink).
One of the important features of the EBITDA multiple is its inclusion of both debt and equity, resulting in a more fulsome representation of the total business’ performance. It is used extensively as a valuation technique, often to find attractive takeover candidates for a merger or acquisition. Commonly, a business with a low EBITDA multiple can be a good candidate for acquisition. An EV/EBITDA multiple of about 8x can be considered a very broad average for public companies in some industries, while in others it could be higher or lower than that. For private companies, it will almost always be lower, often closer to around 4x.
Investors use a company’s enterprise multiple to determine whether a company is undervalued or overvalued. A low ratio indicates that a company might be undervalued, and a high ratio indicates that the company might be overvalued. Equity research analysts use this multiple when making investment decisions and investment bankers use it when advising on mergers and acquisitions (M&A process).
We hope this guide to EV/EBITDA multiples has been helpful. To continue learning more about other valuation multiples, please see these additional resources: