The enterprise value (EV) to the earnings before interest, taxes, depreciation, and amortization聽(EBITDA) ratio varies by聽industry. However, the聽EV/EBITDA聽for the S&P 500 has typically聽averaged from 11 to 14 over the聽last few years.锘 EBITDA measures a firm's overall financial performance, while EV determines the firm's total value.

As of Jan. 2020, the average聽EV/EBITDA for the S&P 500聽was 14.20. As a general guideline, an EV/EBITDA value below 10 is commonly interpreted as healthy and above average by analysts and investors.聽To gain a better understanding of how investors can use the EV/EBITDA metric to analyze stocks, we'll take a closer look at each component of the metric and discuss some of the metric's advantages.

Key Takeaways

  • The enterprise value to earnings before interest, taxes, depreciation, and amortization ratio (EV/EBITDA) compares the value of a company鈥攄ebt included鈥攖o the company鈥檚 cash earnings less non-cash expenses.
  • The EV/EBITDA metric is a popular valuation tool that helps investors compare companies in order to make an investment decision.
  • EV calculates a company's total value or assessed worth, while EBITDA measures a company's overall financial performance and profitability.
  • Typically, when evaluating a company, an EV/EBITDA value below 10 is seen as healthy.
  • It's best to use the EV/EBITDA metric when comparing companies within the same industry or sector.

Enterprise Value (EV)

Investors and analysts use the enterprise value (EV) metric to calculate a company's total monetary value or assessed worth. While some investors simply look at a company's market capitalization to determine a company's worth, other investors believe the enterprise value metric gives a more complete picture of a company's true value. That's because the enterprise value also takes into consideration the amount of debt the company carries and its cash reserves.

Calculating Enterprise Value (EV)

To calculate enterprise value, determine the company's market capitalization by multiplying the company's outstanding shares by the current market price of one share. To this number, add the company's total long-term and short-term debt. Lastly, subtract the company's cash and cash equivalents. You now have the company's enterprise value.

This result shows how much money would be needed to buy an entire company. The enterprise value calculates the theoretical takeover price one company would need to pay to acquire another company. While there are other factors that might play into a final acquisition price, enterprise value gives a more comprehensive alternative to determine a company's worth than market capitalization alone.

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

Investors use EBITDA as a useful way to measure a company's overall financial performance and profitability. EBITDA is a straightforward metric that investors can calculate using numbers found on a company's balance sheet and income statement. EBITDA helps investors compare a company against industry averages and against other companies.

Calculating EBITDA

To calculate EBITDA for a company, you'll need to first find the earnings, tax, and interest figures on the company's income statement. You can find the depreciation and amortization amounts in the company's cash flow statement. However, a useful shortcut to calculate EBITDA is to begin with the company's operating profit, also known as earnings before interest and taxes (EBIT). From there you can add back depreciation and amortization.

The EV/EBITDA Multiple

The EV/EBITDA ratio is a popular metric used as a valuation tool to compare the value of a company, debt included, to the company鈥檚 cash earnings less non-cash expenses. It's聽ideal for analysts and聽investors looking to compare companies within the same industry.

The聽enterprise-value-to-EBITDA ratio聽is calculated by dividing EV by聽EBITDA orearnings before interest, taxes, depreciation, and amortization. Typically, EV/EBITDA values below 10 are seen as healthy. However, the聽comparison of relative values among companies within聽the same industry is the best聽way for investors to determine companies with the healthiest EV/EBITDA within a specific sector.

Benefits of EV/EBITDA Analysis

Just like the P/E ratio (price-to-earnings), the lower the聽EV/EBITDA, the cheaper the valuation for a company. Although聽the P/E聽ratio is typically聽used as the go-to-valuation tool, there are benefits to using the P/E ratio聽along with the EV/EBITDA. For example, many investors look for companies聽that have both聽low valuations using聽P/E and聽EV/EBITDA and solid dividend growth.