Enterprise value, EV/EBITDA and EV/EBIT

Enterprise value, usually shortened to EV, is an estimate of what it would cost to buy the whole operating business, debt and all, net of the cash it holds. Multiples built on it, mainly EV/EBITDA and EV/EBIT, let you compare companies that finance themselves very differently. They are staples of professional valuation and of acquisition analysis.

Why enterprise value exists

Market capitalization only measures the value of the shareholders' stake. Two companies with identical operations can have very different market caps if one is financed with a lot of debt and the other with none. A P/E ratio inherits this problem, because interest on debt is deducted before earnings.

Enterprise value looks at the business as a whole, including everything owed to lenders and other claimants:

Enterprise value = market capitalization
                 + total debt
                 + preferred stock
                 + noncontrolling interests
                 - cash and cash equivalents

Because EV includes debt, it should be matched with an earnings measure that is calculated before interest, since that profit is available to lenders and shareholders alike. That is why the usual denominators are EBITDA and EBIT, covered in EBIT vs EBITDA.

EV/EBITDA = enterprise value / EBITDA
EV/EBIT   = enterprise value / EBIT

Example (illustrative numbers)

EV/EBITDA = 10,000 / 1,000 = 10.0
EV/EBIT   = 10,000 /   800 = 12.5

EV/EBIT is always at least as high as EV/EBITDA when depreciation and amortization are positive, because EBIT is the smaller number. Compare EV/EBITDA only with other EV/EBITDA figures, and EV/EBIT only with other EV/EBIT figures.

EV/EBITDA vs EV/EBIT

• EV/EBITDA ignores depreciation and amortization entirely. That makes it handy when comparing companies with different asset ages or depreciation policies. But it also treats the cost of replacing equipment and facilities as if it were free.
• EV/EBIT charges for depreciation, which acts as a rough proxy for the ongoing cost of maintaining the asset base. For capital-intensive businesses, many practitioners consider it the more honest measure. See depreciation and amortization.

A company can have a modest EV/EBITDA and still look expensive on EV/EBIT if it needs to keep spending heavily on equipment.

How to read it

Rules of thumb:

• Compare within an industry. Typical multiples vary with growth, capital intensity and margins, so a cross-industry comparison is rarely informative.
• Higher growth and returns justify higher multiples. Slower, riskier or more capital-hungry businesses tend to trade at lower ones.
• Use the same definition on both sides. Compare EBITDA with EBITDA, and check whether each source adds back stock-based pay or other items.
• Pair with leverage. If net debt is large relative to earnings, the EV multiple says nothing about whether that debt is manageable. See net debt to EBITDA.

Definitions and variations

No single formula is universal. Points where sources differ:

• Lease liabilities. Under US accounting, some lease costs are already deducted within operating profit. Adding all lease liabilities to debt while using an EBITDA that is already after lease costs mixes two treatments of the same obligation. Be consistent.
• Cash. Some analysts subtract all cash; others subtract only cash they consider excess, not needed to run the business.
• EBITDA itself. "Adjusted EBITDA" can exclude restructuring, stock-based compensation and other items, and definitions differ by company.
• Other claims. Pension deficits and similar obligations are sometimes added to debt.
• Share count. Market cap should use diluted shares so that options and convertibles are reflected.

Common mistakes and limits

• Using EV for banks and insurers. For lenders, debt is a raw material of the business, not a financing choice, so EV-based multiples are not meaningful. Equity-based measures such as price-to-book are the norm.
• Negative or tiny EBIT or EBITDA. The multiple becomes meaningless or huge.
• Ignoring capex. EBITDA-based multiples can flatter companies that must reinvest heavily.
• Cyclical swings. At peak earnings, the multiple looks low; at a trough, high.
• Stale balance sheets. Debt and cash change, so use the latest filing.

Where to see it on StocksXray

StocksXray's peer-multiples model, one of the three models blended into fair value, uses the sector median EV/EBIT alongside P/E and P/FCF. For how the sector comparison works, see relative valuation with peer multiples and the methodology page.

Key takeaways

• Enterprise value is market cap plus debt, preferred stock and noncontrolling interests, minus cash.
• EV multiples compare businesses regardless of how they are financed, because EBIT and EBITDA are measured before interest.
• EV/EBIT charges for depreciation; EV/EBITDA does not, which can flatter asset-heavy companies.
• Keep definitions consistent, and avoid EV multiples for banks and insurers.