The EBITDA multiple is a financial ratio that compares a company’s Enterprise Value to its annual EBITDA (which can be either a historical figure or a forecast/estimate). 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, and fixed assets and compares disparities of operations in various companies. The ratio takes a company’s enterprise value (which represents market capitalization plus net debt) and compares it to the Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) for a given period.
Let’s walk through an example together of how to calculate a company’s EBITDA multiple. ABC Wholesale Corp has a Market Cap of $69.3B as of March 1, 2018, a cash balance of $0.3B, and debt of $1.4B as of December 31, 2017. For the full year of 2017, its EBITDA was reported at $5.04B and the current analyst consensus estimate for 2018 EBITDA is $5.5B. What are the resulting historical and forward-looking multiples?
Here are the steps to answer the question:
Calculate the Enterprise Value (Market Cap plus Debt minus Cash) = $69.3 + $1.4 – $ 0.3 = $70.4B
Divide the EV by 2017A EBITDA = $70.4 / $5.04 = 14.0x
Divide the EV by 2017A EBITDA = $70.4 / $5.50 = 12.8x
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What is Enterprise Value?
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.
EBITDA or Earnings before Interest, Tax, Depreciation, and Amortization is the income derived from operations before non-cash expenses, income taxes, or interest expense. It reflects the company’s financial performance in terms of profitability prior to certain uncontrollable or non-operational 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.
EBITDA can be calculated as follows.
Plus: Depreciation & Amortization
Plus: Any adjustments that may be justified by an analyst (see a guide on “Adjusted EBITDA“)
Note: The depreciation and amortization expense should be taken from the cash flow statement.
Historical vs Forecast EBITDA
It’s important to pay close attention to what time period the EBITDA you’re using is from. In order for the EBITDA multiple to be comparable between companies, you have to be sure the EBITDA time periods line up. For example, the 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 companies have a growing EBITDA profile (the opposite would be true if their EBITDA was forecasted to shrink).
How Important is the EBITDA Multiple?
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 as a proxy to indicate if a company is overvalued or undervalued. When the value of the ratio is low, it signals that the company is undervalued, and when it is high, it signals that the company is overvalued. Equity research analysts use this multiple to help investment decisions and investment bankers use it when advising on mergers and acquisitions (M&A process).
More Valuation Resources
We hope this guide to EV/EBITDA multiples has been helpful. To continue learning more about other valuation multiples, please see these additional resources: