EBITDA multiple (sometimes known as enterprise multiple) is a metric for determining a company’s worth. It is mostly utilized by potential acquirers and examines its debt rather than other indications (such as the price-to-earnings ratio).

What is the EBITDA Multiple?

Firstly let’s define EBTIDA multiple. The EBITDA multiple is a financial ratio that compares a company’s enterprise value to its yearly EBITDA (which might be historical or forecast/estimate). Also, we can use this multiple to calculate a company’s value and compare it to the value of other comparable companies.

The EBITDA multiple of a firm provides a normalized ratio for analyzing variances in capital structure, taxation, fixed assets, also operations across different companies. The ratio compares a company’s enterprise value (market capitalization plus net debt) to its Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) for a specific time period.

Understanding EBITDA/EV Multiple

EBITDA/EV is a comparable analysis tool that uses the same financial parameters to value similar organizations. While the EBITDA/EV ratio is more difficult to calculate than other return metrics, it is occasionally chosen since it gives a normalized ratio for comparing firms’ operations.

When utilizing EBITDA/EV, an analyst assumes that a certain ratio is suitable and can be used to a variety of firms in the same line of business or industry. In other words, this multiples technique may be used to assess the worth of one business based on the value of another when firms are comparable, according to the idea. As a result, EBITDA/EV is frequently used to compare firms within a sector.

Furthermore, this is a tweak to the operational and non-operating profit ratios in relation to the market value of a company’s stock plus debt. EBITDA is utilized as a measure of a company’s cash return on investment since it is typically regarded as a proxy for cash income.

EBITDA multiple formula

The EV/EBITDA multiple responds to the question, “How much are investors ready to pay for each dollar of EBITDA created by a firm right now?” EBITDA is also a capital structure neutral cash flow indicator, whereas enterprise value indicates the debt-inclusive value of a company’s activities (i.e., unlevered). As a result, the EV/EBITDA multiple is commonly used to compare enterprises with different levels of financial leverage. The EV/EBITDA multiple is calculated by dividing a company’s enterprise value by earnings before interest, taxes, depreciation, and amortization (EBITDA).

EBITDA Multiple = Enterprise value / EBITDA

Because EV/EBITDA is an enterprise value multiple, you must make sure that the numerator and denominator represent the same investor groups — in this example, all investor groups (e.g., common and preferred equity shareholders, debt lenders).

EBITDA multiple – Example Calculation

Firstly let’s assume that as of March 1, 2018, ABC Wholesale Corp has a market capitalization of $69.3 billion, with a cash balance of $0.3 billion and debt of $1.4 billion as of December 31, 2017. Its EBITDA for the entire year of 2017 was $5.04 billion, and the current analyst average forecast for 2018 EBITDA is $5.5 billion. What are the historical and forward-looking multiples that result?

The stages to answering the question are as follows:

  1. Calculate the Enterprise Value: $69.3 + $1.4 – $ 0.3 = $70.4B (Market Cap plus Debt minus Cash).
  2. Divide the EV by 2017A EBITDA = $70.4 / $5.04 = 14.0x
  3. Divide the EV by 2017A EBITDA = $70.4 / $5.50 = 12.8x

EBITDA Multiples by industry

The value of EBITDA Multiples varies from one company to the next and from one sector to the next. We should expect larger values in high-growth branches, such as high-tech sectors, than in slow-growth ones (for example, in the textile industry or railways). EBITDA multiples change depending on the industry and the size of the company. The EBITDA multiple will be influenced by the size of the subject firm, its profitability, its growth prospects, and the industry in which it works. Also, you can see in the table below shows the variances in average multiples by industry; multiples for individual firms within those industries will vary depending on their size.

IndustryEBITDA Average Multiple
Healthcare information and technology38.58
Airlines6.42
Drugs, biotechnology56.20
Hotels and casinos17.27
Retail, general14.70
Retail, food8.89
Utilities, excluding water12.74
Homebuilding10.52
Medical equipment and supplies32.70
Oil and gas, exploration and production4.60
Telecom, equipment (phones & handheld devices)14.50
Professional information services (big data)33.16
Software, system & application41.53
Wireless telecommunications services7.40

Additionally, EBITDA multiples will be lower in industries with more risk and smaller profit margins. Airlines run on low and cyclical profit margins. They are extremely vulnerable to fluctuations in fuel prices and the economic cycle. Oil and gas exploration and production, both high risk and economically cyclical, are two examples from the table. While EBITDA multiples by industry can provide insight into the growth, profitability, and consistency of earnings in various company sectors and are beneficial for determining a quick and easy valuation for a certain topic firm, they are only an estimate and not a full assessment.

When are EBITDA multiples by industry use, and when are they not?

When there is a level of comparability, EBITDA multiples might be beneficial. EBITDA may offer a decent approximation of enterprise value when dealing with an income-producing property when comparable assets are generally consistent. It is useful for analyzing stocks or making portfolio selections.

Using EBITDA to assess value for tangible and intangible assets gets increasingly complex. Nevertheless, it could be achievable in some instances. A power purchase agreement, for example, may be present in the power market for a new project. Also, in these rare cases, a comparison may be possible—the purchase agreement provides an estimate of revenues. If you can figure out the market value of comparable power plants and the difference between the subject company’s expenses and those of other companies in the same market, you can use EBITDA. Of course, to make comparisons, you’d still need to make modifications, although EBITDA may be useful in this case.

In other cases, the issue is still one of comparability. Two cable businesses, for example, provide identical services and goods, but their market demographics and customer markets are vastly different, making comparison difficult to impossible. In August 2020, Lumen Technologies Inc. announced the sale of its telecommunications assets in 20 U.S. states as an example. This came after Lumen announced in July 2020 that it would sell part of its South American holdings. As a result, the U.S. assets had an EBITDA of 5.5, whereas the South American assets had an EBITDA of 9.

Advantages & Disadvantages Of Using EBITDA Multiples For Valuation

EBITDA multiples are commonly employed for valuation since they are simple to calculate from financial records. For example, to compute operating income before depreciation and amortization and enterprise value, multiply the amount of the company’s stock market value, outstanding debt, and cash on the balance sheet by EBITDA to get multiple. It’s a lot faster and easier than doing a cost or income analysis to figure out how much something is worth.

Therefore, the disadvantage is that EBITDA does not provide a direct value for a firm It is only an approximation that allows value assessment by comparing measures for similar companies. As a result, it has the same constraints as using the market technique to determine value. The main disadvantage of using EBITDA multiples is that they are only a rough estimate because the subject firm is likely to differ in one or more important ways.

Another significant disadvantage is that accounting laws do not define EBITDA. Because it isn’t legally defined, corporate managers and others are prone to misrepresenting it. While it is a convenient and rapid approach to estimate a number, it is not without danger of inaccuracy.

FAQ

What does a high EBITDA multiple mean?

A high EV/EBITDA multiple indicates that the firm is likely overpriced, while a low EV/EBITDA multiple indicates undervalued the company. In general, the lower the EV-to-EBITDA ratio, the more appealing the firm as an investment.

What EBITDA multiple should I use?

Typically, a multiple of four to six times EBITDA is employed. On the other hand, prospective purchasers and investors will advocate for a lower valuation, perhaps by utilizing an average of the company’s EBITDA over the last five years as a starting point.

Is a lower EBITDA multiple better?

An EV/EBITDA ratio of less than 10 is considered good when examining a firm. When comparing firms in the same industry or sector, utilizing the EV/EBITDA statistic is ideal.